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Chesapeake Energy Corp. (CHK) Chief Executive Officer Aubrey McClendon is banking his turnaround of the industry’s biggest debtor on a rebound in natural-gas prices that no Wall Street analysts tracked by Bloomberg expect will happen.
A day after directors said they’ll strip him of the chairman’s role as they investigate potential conflicts of interest in his personal finances, McClendon laid out a plan to shrink a $12.6 billion debt pile, cut costs and remake the second-biggest U.S. gas producer into an oil company. At the core of his plan is a rebound in gas by 2014 to $5 per thousand cubic feet, more than double today’s level.
McClendon may not be able to wait two years for the company’s fortunes to improve. Southeastern Asset Management Inc., holder of one of every seven outstanding Chesapeake shares, notified the U.S. Securities and Exchange Commission yesterday that it may initiate talks with management and third parties about taking steps to boost the share price or sell the company outright.
“There seems to be little acknowledgment by management or the board that the company faces a major financial crisis,” Jon Wolff, an analyst at International Strategy & Investment Group LLC in New York, said in a note to clients. Chesapeake needs a “drastic reduction” in spending and to grow its oil production faster, Wolff wrote.
Chesapeake stock plunged (CHK) to the lowest in three years yesterday while the cost to protect against losses on its debt surged to the highest since September 2009. The shares rose 2.7 percent to $17.19 at the close in New York today.
Chesapeake reserves rose 9.9 percent in 2011 to the equivalent of 3.13 billion barrels of crude from oil and gas wells in U.S. shale fields such as the Marcellus in Pennsylvania, the Utica in Ohio and the Eagle Ford in Texas.
Southeastern may be agitating for a seat on Chesapeake’s board to exert more control over the CEO, Tim Rezvan, an analyst at Sterne Agee & Leach Inc., said in a telephone interview.
“I don’t know if anyone can secure that ship now,” said Rezvan, who rates shares of Oklahoma City-based Chesapeake “neutral.”
McClendon has been using personal stakes in thousands of company-operated wells to obtain hundreds of millions of dollars in loans to fund his required share of drilling costs. Some of that money came from financiers that also do business with the company, setting the stage for potential conflicts of interest.
“The question is: Did Aubrey commit securities fraud and is he going to lose his job?” Rezvan said.
Calls to Southeastern requesting comment were not returned.
McClendon and the company have said he’s done nothing wrong, though directors agreed last week to review the CEO’s personal transactions. Directors said on May 1 that they’ll abolish the perk that allowed McClendon to buy up to 2.5 percent of almost every well the company drilled.
“As previously announced, the Board is reviewing financing arrangements between Mr. McClendon and third parties that may have relationships with the company, and it would be inappropriate to comment on his personal investments at this time,” Michael Kehs, Chesapeake’s vice president for strategic planning, said today in an e-mailed statement.
The SEC has opened an informal inquiry into the company, Chesapeake said today.
The SEC is looking into whether McClendon failed to disclose possible conflicts of interest, a person briefed on the matter said, asking not to be named because the matter isn’t public.
McClendon also ran a private hedge fund within Chesapeake that traded energy and other commodities independently of the company’s risk managers for several years during the last decade.
It was a so-called long-only fund, which means it never bet on price declines in any of the commodities it traded, said a person familiar with the arrangement who asked not to be identified because the information wasn’t public. Reuters reported the existence of the hedge fund yesterday.
Chesapeake posted an unexpected $71 million first-quarter loss May 1 and cut cash flow estimates for this year and next. The company’s net debt expanded by $2.4 billion during the first three months of this year to $12.6 billion, the highest in its peer group, according to data compiled by Bloomberg.
McClendon told investors during a conference call (CHK) yesterday that he can pull the Oklahoma City-based company he co-founded 23 years ago out of its doldrums in 2014 with $7 billion in free cash flow, assuming gas rises to $5 and oil averages $100 a barrel.
The prospect of $5 gas in 2014 is an unlikely one, according to analysts surveyed by Bloomberg. Bob Brackett with Sanford Bernstein Co. had the most optimistic estimate of gas rising to $4.75 per million British thermal units, a measure roughly equivalent to a thousand cubic feet, according to data compiled by Bloomberg.
Gas futures traded on the New York Mercantile Exchange are expected to average $4.29 per million Btus in 2014, according to estimates from seven analysts in the Bloomberg survey.
McClendon, 52, said that if gas prices fail to rise enough to support his 2014 cash-flow target, the company will sell more of its oilfields and other assets to raise cash. Chesapeake’s auction block already holds $20.5 billion in sale items, up from $17.5 billion it planned to sell three months ago.
U.S. gas prices tumbled 70 percent in the past five years as innovative drilling techniques allowed explorers to tap reserves locked in previously impenetrable shale rock formations from Texas to Pennsylvania. Gas output from U.S. wells jumped 21 percent during that period, reaching a record 28.6 trillion cubic feet in 2011 and far outpacing demand growth for the fuel, Energy Department figures showed.
McClendon told investors the glut won’t persist. Prices are so low that explorers such as Chesapeake, which produces more gas in the U.S. than anyone except Exxon Mobil Corp. (XOM), have no choice but to idle gas rigs or move them to drill oil prospects.
As that migration to oil continues, gas supplies will shrink and prices will rebound, according to a slide presentation that accompanied McClendon’s conference call with investors yesterday.
“Maybe some people will think you should just sit there and be stuck in the mud of $2 gas prices,” McClendon said during yesterday’s call. “‘But we don’t believe that’s the way to go.”
The cost of protecting Chesapeake’s debt against default yesterday climbed to the highest since August 2009 as it had the biggest one-day advance, 21 percent, since December 2008.
The company’s five-year credit default swap increased 127 basis points to 730.45 basis points, according to according to CMA, which is owned by CME Group Inc. and compiles prices quoted in privately negotiated markets. The swap has gained 276 basis points this year, the biggest increase among energy companies, followed by Spain’s Repsol YPF SA, which had its Argentine unit expropriated.
Chastened by media reports questioning his use of personal stakes in company wells to obtain loans, McClendon apologized yesterday to investors for the “distractions.”
“We are eager to leave behind the controversies in the past few weeks and focus all of our energies on delivering on these key objectives during the remainder of the year,” McClendon said.
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