In February and early March, when I wrote bullish columns on Chesapeake Energy (NYSE:CHK), I did not believe that the novel coronavirus would spread all over the country and result in the U.S. closing much of its economy. Of course, the mass closures caused demand for oil to plunge, resulting in the plummeting of CHK stock.
In the wake of the plunge in oil prices, I’m much more bearish on CHK stock. In fact, I think that the company is much more likely than not to take steps that cause its shares to be worthless.
After all, the company’s lead shareholder, Franklin Resources, is reportedly “taking steps to prepare for a potential debt restructuring or bankruptcy.” I’m sure that Franklin is well-aware of the company’s difficulties and is taking those steps for good reason.
Further, as multiple other columnists on InvestorPlace have pointed out, Chesapeake owes a great deal of money and planned to rely on asset sales to finance most of its debt this year. Given extremely low oil prices, those asset sales may not be viable.
But I do believe that Chesapeake still has a 20%-30% chance to survive without pushing CHK stock to zero. Here are the four reasons why I think that the company, by the proverbial skin of its teeth, could avoid a bankruptcy or restructuring that would wipe out its shareholders.
Hedging for CHK Stock
As of February, Chesapeake hedged 72% of its oil production at a fixed price of $59.59 per barrel. It also hedged 30% of its natural gas production at $2.76 per BTU. As a result, one Seeking Alpha columnist estimated that the company can come close to breaking even at $50 per barrel oil prices and $2.22 per BTU natural gas prices.
Of course, oil and natural gas prices are way below those levels now. But fossil fuel prices can surge tremendously in a very short time. And given the positive developments on the coronavirus front, I think that oil and natural gas prices can come close to those levels by the time Chesapeake’s next major debt payments are due in July and August.
Many states are preparing to open their economies at the beginning of May. Similarly, many European countries also look poised to lift their closures in the first week or two of May. We’ll start seeing everything from beaches to golf courses and restaurants open in both the U.S. and Europe.
And with more places open, Americans and Europeans will be more likely to drive.
Many more Americans will soon take antibody tests which will allow people to see if they’ve already had the virus and are thus immune to it.
All of these factors — along with Gilead Sciences’s (NYSE:GILD) drug that has been promising in tests so far to treat coronavirus patients — will result in Americans and Europeans traveling much more in May and June. As that phenomenon takes hold, oil prices should jump.
And if oil prices surge, Chesapeake could have a chance to sell enough assets at a high enough price to make its bond payments and stay in business without pulling CHK stock to zero.
Chinese Energy Purchases
In previous columns, I noted that, in its trade deal with the U.S., China committed to buying American oil and natural gas. I also reported that Trump administration officials had said that China would carry out those purchases despite the coronavirus epidemic.
When many weeks passed without news of the purchases materializing, I had all but given hope of them happening. But in my research for this article, I discovered that they are indeed starting to occur.
For example, on April 9, S&P Global Platts reported that “a couple of vessels … loaded (with liquid natural gas) from the U.S.” were heading towards China.” The news service stated that “these vessels would be the first to be delivered to China from the U.S. since March 2019.” Meanwhile, China appears to be buying meaningful amounts of U.S. oil for its reserves.
Positive Supply Developments
On April 13, the EIA forecast that oil production “in the seven most prolific shale basins in the United States” would drop by over 180,000 barrels per day in May. That would be the second largest such monthly drop since 2007.
Meanwhile, a recent agreement among OPEC and other nations is supposed to result in production cuts of 9.7 million barrels per day. Further, there have been indications that additional cuts could be implemented.
Finally, reductions of oil production in the U.S. shale fields automatically results in less natural gas production. That’s because natural gas is a byproduct of oil production in the shale field. Natural gas prices have bounced 13% off their March low of $1.60. As shale production continues to drop, that trend could continue. Chesapeake still gets about 50% of its revenue from natural gas.
The Bottom Line on CHK Stock
If oil-producing countries don’t uphold their promises on production cuts and China doesn’t massively step up its petroleum purchases, oil prices may not rebound too much in May and June. In that case, there’s a good chance that Chesapeake will not be able to obtain enough money from asset sales to make its debt payments in July and August. Consequently, bondholders probably would also not be interested in making a deal with Chesapeake that would enable the company to avoid bankruptcy.
But if the production reduction deal is followed and China does step up its purchases of fossil fuels, I think oil could rebound to $30 to $35 at the end of May and $40 to $45 at the end of June as demand climbs. In such a scenario, I think Chesapeake could make enough asset sales and/or deals with bondholders to keep CHK stock from reaching zero. But, again, I only see a 20% to 30% chance of that scenario unfolding.
Investors who are upbeat on a rebound of the economy are better off investing in more stable companies like Exxon Mobil (NYSE:XOM) or Chevron (NYSE:CVX). Those companies will definitely stay afloat and will likely deliver a pretty large payoff in 12 months. Chesapeake, by contrast, is very speculative. But on the other hand, it could deliver a truly huge return.
Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been GE, solar stocks, and Snap. You can reach him on StockTwits at @larryramer. As of this writing, he did not own any of the aforementioned securities.