Chesapeake Energy’s (CHK: chart, web, Y!) massive debt structure is finally coming back to haunt them, as they reported a noncash charge of about $1.7 billion on falling natural gas prices.  As the countries largest natural gas producer, Chesapeake lost $866 million, or $1.51 per share for the 4th quarter as compared to a profit of $0.33/share a year earlier for the same quarter.

Revenue was up about 33% to $3 billion for the quarter.

Chesapeake has already slashed its drilling and acquisition budget, and have been selling off reserves in Oklahoma and Arkansas for the last several months.  Unfortunately, it’s a terrible time to be forced to sell off assets to raise money in the patch due to declining oil and gas prices.

The company is finally starting to moderate production at 2.32 bcf per day which was about the same as the previous quarter.

Unfortunately, while they may be trying to cut back production, they also need to keep drilling to maintain leases.  So they are forced to drill but can’t produce due to economic conditions in the gas market, and lack of storage.

Luckily, the company did have a $380 million gain on its hedging programs, but that alone isn’t enough to offset the debt service and the increasing overhead.

Corner Office Comments

This isn’t over, and the bleeding is going to continue for Chesapeake for the next several quarters.  Their “growth at all costs” mentality is starting to turn on them, and Aubrey McClendon is starting to find out that borrowing money to sustain growth works great until you hit the downturn in the energy cycle.

I always like the “yeah but” statements that accompany any loss.  The company says that if you can look past the one-time charge, it would have made $0.73 per share in profit.

And if you look past the cost of paying my mortgage, I would have ended up with an extra $12,000 in my pocket last year.

The company needed to start eliminating debt while buying up some of the common shares 12 months ago when gas prices were high.  Now that natural gas prices are starting to settle into typical warm season trading ranges in the doldrums of winter, Chesapeake is finding it more difficult to maintain a positive cash flow.  “Growth at all costs” be damned.

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Investing Chesapeake Energy, CHK

Almost like clockwork, Chesapeake Energy (CHK: chart, web, Y!) offered up $1 billion worth of new shares after the markets closed on Wednesday.  The stock is sitting down 21% this morning after shareholders absorb their latest dose of dilution.

I can’t say I’m surprised, as Chesapeake has been forced to come up with cash anyway the company can.  It really all started when CEO Aubrey McClendon was forced to liquidate his entire portfolio of Chesapeake shares after a brutal margin call.  The $1.6 billion paper loss due to hedged oil and gas that was below market prices in the second quarter didn’t help either.

This is a company that is on thin ice financially, and in this writers opinion, it’s due to poor management of debt and over extension of credit.  Sound familiar?

That’s not to say Chesapeake will go under, and it would look like a decent takeover candidate if it weren’t for the debt structure.

I see the company continuing to sell off nonproductive assets through 2009, and depending on how the energy markets play out over the next 8 months, the company will flounder to stagnation by the beginning of 2010.

Energy, Finance, Investing Aubrey McClendon, Chesapeake Energy, CHK, debt, dillution

Sometimes you have to go with your gut, and when your gut ends up being right, you get this warm and fuzzy feeling that you may actually know a thing or two.

Frequent readers of The Corner Office Blog know that I’ve been bearish of Chesapeake Energy (CHK: chart, web, Y!) due to their huge amount of debt (and the pilfering of shareholders to pay off that debt by diluting the stock) when commodity prices were at record highs.

I’ve owned CHK before and have made money off the stock, but when credit started tightening over the last year to 18 months, I knew CHK would end up with a target on its back just due to the debt alone.

Well, it seems the debt has come back to haunt Chesapeake, along with an in-house trading philosophy that ended up costing the company $1.6 billion on paper, and forced CEO Aubrey McClendon to sell all of his own companies shares involuntarily.

Here’s how it all went down.

Chesapeake was making money hand over fist when commodity prices were high, just like any other player in the field.  Then, their trading operations made the gamble that the run on oil and gas wouldn’t continue.  So the company bought options and other financial vehicles to lock in the current rates (around $120/bbl for oil at the time) to protect from what they saw as an expensive downside risk (also known as hedging).

So what happened?  Oil continued to rise to a high of just over $145/bbl in July of this year.  That’s actually a good thing for Chesapeake, right?  Not necessarily.  Since Chesapeake hedged their oil at $120, they were only getting paid $120 for every barrel they pumped, not $145 that was the current market price.  Again, they’re still making boo-coo bucks at $120 oil, but they could have been making more.

The fact that they could have been making more shows up as a loss on the balance sheet.  All in all, Chesapeake could have made as much as $1.6 billion more if they had not hedged their oil and gas at lower prices.  So this goes as a loss on the books for the second quarter.

What effect does the debt have?

Creditors typically want to see that their their loans are safe, and as such they write in certain conditions that if met, they reserve the right to call the note.  Sort of like having a margin call if you can’t maintain the margin requirements. Read more…

Energy, Investing, Oil & Gas CHK, hedging, margin, oil and gas