Gas pioneer Chesapeake embarks on oil quest to escape poor investment rating

CHICAGO (Bloomberg) -- Chesapeake Energy, the number two U.S. natural gas producer, thinks it has a one-word answer to its debt issues: oil.

Chief Executive Officer Doug Lawler is focusing 60% of the Oklahoma City-based driller’s 2017 budget on crude oil projects, mostly in south Texas, Oklahoma and Wyoming shale fields. The company plans about 320 new crude wells this year, compared with 90 for gas, Lawler said. The hoped-for result: oil output, set to grow 10% in 2017, could grow by double that rate next year.

Lawler, the former deep-water exploration chief for Anadarko Petroleum, has been striving to bring the gas producer back on its feet after inheriting suffocating debt, collapsing cash flow and wilting reserves three and a half years ago. Lawler’s emphasis on crude derives from the fact that oil fetches three or four times more money on an energy-equivalent basis.

“He likes to set big goals and this is the biggest one of all,” said James Sullivan, senior analyst at Alembic Global Advisors in New York, one of six analysts following the company with the equivalent of buy ratings on Chesapeake’s stock.

Chesapeake is expected to post its first profit since the end of 2014 when it reports fourth-quarter results on Feb. 23. Excluding one-time items, the company is forecast to disclose per-share profit of $0.06.1, based on the average of 27 analysts’ estimates compiled by Bloomberg. That would compare with a loss of $0.16 a share for the final three months of 2015.

The company lost a cumulative $18.5 billion over the past seven quarters, struggling with a combination of rock-bottom gas prices and strangling debt obligations. More than $21 billion in field write-downs during that period bled Chesapeake’s balance sheet as faltering prices dimmed the likelihood those assets would ever generate profits.

As activist investor Carl Icahn’s hand-picked choice to replace Aubrey McClendon in 2013, Lawler let go of two out of every three employees, repurchased company bonds at cut-rate prices and dismantled complex financial instruments that were his predecessor’s forte. In January, the company restored dividends on four classes of convertible preferred stocks, though the payout on common shares remains suspended.

A key step in Lawler’s plan to convince credit rating companies to bestow investment-grade blessings will be funding operations without having to borrow any money, a state known as cash-flow neutrality that he expects to reach in 2018. Moody’s Investors Service rates Chesapeake’s long-term debt Caa1, or seven levels below investment grade. S&P rates the company B-, six levels into junk territory.

“We still have had this target about achieving investment-grade metrics,” Lawler said during a Credit Suisse event on Feb. 14. “And this still is a long-term target for the company. But we have a plan in which we believe we’ll be achieving that in the next few years.”

Gas Baggage

The company has a long way to go before crude supplants gas as its main product. The furnace and factory fuel that Chesapeake was instrumental in unlocking from North American shale fields during the last decade still comprises about 85% of its production. In fact, Chesapeake produces so much gas that only Exxon Mobil has a bigger stake in U.S. gas markets, according to the Natural Gas Supply Association.

Earlier aspirations to make Chesapeake an oil producer sputtered because the company’s precarious cash position forced it to devote scarce dollars to gas fields that needed sprucing up to make them suitable for sale, Alembic’s Sullivan said. That left Chesapeake too poor to exploit holdings it suspected were rich in crude but had yet to be drilled.

Still, Lawler telegraphed his growing crude bias last year when he agreed to give up the company’s entire Barnett Shale portfolio and exit the birthplace of the shale revolution to escape almost $2 billion in onerous pipeline contracts.

The Barnett region of North Texas is famous for the gassy content of any wells drilled there. By the time Chesapeake walked away, the Barnett has shriveled to just 10% of the company’s output, overshadowed by mammoth deposits in the Marcellus and Utica shales in northeast U.S.

“Now they have room that will allow them to deploy capital to higher-return” oil projects, said Jason Wangler, an analyst at Wunderlich Securities in Houston with a “buy” rating on Chesapeake shares.