Chesapeake Energy (NYSE:CHK) announced last week that it was dialing back its active rig count, from 18 to what should be an average of 14 for 2019. The scaled-back capacity is largely in response to falling gas and oil prices, which have badly hurt CHK stock.
With no certainty as to when prices might rebound, most energy companies are rightfully becoming pickier about which assets to continue operating.
On the surface, the decision by CHK to cut its rig count is a step in the wrong direction; fewer rigs means less production, only exacerbating the revenue headwind caused by weaker commodities prices.
However, there’s a reason why CHK stock jumped on the news. Ultimately, Chesapeake Energy stock is moving closer to a recovery from a big pullback that it suffered late last year. CHK stock is in that position because years of its streamlining work are starting to bear fruit in a big way.
Reconfiguring
The 2014 implosion of oil prices — and to a lesser degree, natural gas prices — indiscriminately hammered the energy sector. From giants like Exxon Mobil (NYSE:XOM) to the smallest, nimblest names like Helmerich & Payne (NYSE:HP), all were sent scurrying by a meltdown none of them saw coming. There was nowhere and no way to hide. CHK was no exception.
At least in one regard, however, the beating oil prices and energy stocks took set the stage for a long-overdue, positive outcome. That is, nearly all of the companies in the sector took steps to become more operationally efficient and to use their capital more effectively.
Not all of these companies regrouped as well as others, however. Broadly speaking, CHK improved itself more than most of its competitors.
Much of its restructuring centered around the sale of natural gas properties in Ohio’s Utica basin. The $2 billion in proceeds from that transaction were used to pay down what was then well over $9 billion in debt.
In early 2018, CHK sold properties in Oklahoma for a more modest $500 million. In early 2016, it shed $700 million worth of assets.
The company’s shrinking pile of debt has undoubtedly given CHK the breathing room it needs to address new opportunities.
Quality Over Quantity
But CHK CEO Doug Lawler isn’t merely shrinking his way to better viability. Instead, Lawler is looking to aggregate a network of properties that he knows the company can operate cost-effectively. Sometimes that means selling, but sometimes it means buying.
That efficiency is measurably taking shape. The company’s preliminary fourth-quarter results and 2019 outlook, which were posted last week, included this statement: “We expect our capital efficiency to improve in 2019 as total net capital per rig line is projected to decrease by 15 to 20 percent compared to 2018.”
The location of the company’s assets has a great deal to do with that progress.
CHK is increasingly focused on its Eagle Ford assets, which delivers the highest profit margins among the company’s properties. The pricing of crude around the nearby Gulf Coast is above the industry average, and the company doesn’t intend to lower its rig count in that area.
Indeed, the upcoming acquisition of WildHorse Resources (NYSE:WRD) will add to its fruitful Eagle Ford exposure. CHK plans to devote four rigs to the assets it’s getting from WildHorse.
The Outlook of CHK Stock
At the end of the preliminary Q4 report, Lawler stated,”The improvement in our capital efficiency, along with our focus on our high-margin oil investments, should result in higher operating cash flow and stronger margins in 2019 compared to 2018.”
To that end, approximately 16 million barrels of its 2019 oil production is hedged at $58.61, versus the current market price of less than $52 per barrel.
Granted, most energy outfits are becoming more cost-effective through streamlining, reorganizing and hedging, and CHK is still not where it ultimately aims to be, from an operational standpoint.
Asset sales never quite generate as much money as forecast, and acquisitions like WildHorse Resources are never quite as cheap as hoped. But nevertheless, Chesapeake Energy stock is coming out of its fourth-quarter funk, as investors increasingly understand the overhaul that Lawler is putting in place is a slow, painstaking process that’s worth the wait.
That said, CHK stock is still well-positioned to deliver quick, outsized gains if oil and gas prices end up ripping higher from here. That’s a distinct possibility, too, with OPEC rumored to be mulling a production cut to buoy recently-depressed prices.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.
