The best engineering in the oil patch today is financial engineering. That’s evident in how Chesapeake Energy (NYSE:CHK) is using financial engineering to minimize the short-term cost of its mammoth debt.
Chesapeake has been fighting the debt for years, but it was still over $9.1 billion, against $16.5 billion of assets, as of Sept. 30.
Its latest cunning plan includes issuing $1.5 billion in new bonds, at 11.5%, swapping them for lower-coupon debt at a discount to its cash value. This raises the carrying cost of debt but reduces the principal by 30-35%. Bondholders are taking the deal because their existing 8% bonds are trading at under 50 cents on the dollar.
Getting debt holders to take a haircut buys Chesapeake Energy Corp time. Time is the most precious commodity in the oil patch as 2020 approaches.
How Much Time?
Chesapeake shares are up 11% since Dec. 4. But that puts them at about 79 cents each, a market cap of $1.5 billion for a company that had more than $10 billion in revenue last year.
It’s a terrible comedown for the company that practically birthed the fracking revolution, by cracking rocks in the U.S. Northeast to extract national gas. At its peak in 2008, Chesapeake sold for over $50 a share. During the boom years early in the decade, Chesapeake even paid regular dividends, up to 35 cents per share.
But those days are long gone, not just for Chesapeake but for the rest of the frackers. Now it’s “brother can you spare a dime.”
Some 33 companies have filed for bankruptcy just this year, just through September, as oil prices have fallen from a peak of $110 a barrel in 2014 to a recent trading range at $50-60. Staying out of bankruptcy in this environment counts as a big achievement.
Triple Technology Impact
This isn’t just affecting the Texas oil patch.
The “success” of the recent OPEC+ Summit looks a lot like Chesapeake’s restructuring. It’s bringing in options traders for short-term trades but few people really know where oil prices are heading.
That’s because technology is affecting oil in three ways, none of them good. Renewable energy is now approaching the cost of natural gas, while efficiency cuts demand. Fracking is producing more product from formerly played-out fields. The trade war, which reduces Chinese demand for oil, isn’t helping.
Oil companies are also getting better at finding new pools of oil. In addition to Exxon Mobil’s (NYSE:XOM) Guyana strikes, due to start coming to market next year, there are reports of big new fields off Norway and Mexico. Nigeria, Iraq and the U.S. aren’t playing by OPEC’s rules, while Iran is defying sanctions.
Each time the Energy Information Agency looks at the balance of supply and demand, it’s seeing lower prices. While a slow bleed in prices is being forecast, there is enormous uncertainty. Traders are placing futures bets at over $80 a barrel and below $40. Natural gas prices could spike this winter to $5 per mcf, but they could also fall next year to below $2.
The Bottom Line on CHK Stock
Fracking means the U.S. could dominate the oil market into the next decade. But the value of that dominance looks overestimated. That’s just another cloud over CHK stock.
The dollar isn’t just strong because of U.S. technology. It’s strong because oil continues to be traded in dollars. Weaker oil prices mean there is less demand for dollars.
If anything is going to sink the U.S. economy in the next year, it’s that. Chesapeake’s financial engineering may just be a harbinger for what’s to come for everyone, and not just in the oil patch.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this story.
