Investors are bidding a very fond farewell indeed to Aubrey McClendon, CEO and co-founder of Chesapeake Energy (CHK). It’s hardly surprising that they are elated to see him depart; while the broad stock market has rallied since mid-2009, Chesapeake’s stock has floundered, falling even more dramatically than those of its peers in the energy exploration and production sector.
How much of the company’s fall from grace is McClendon’s fault, and how much can be laid at the door of market forces? Well, Chesapeake and other producers can’t control natural gas prices (Chesapeake is the second largest U.S. producer of the stuff) except by choosing to shut in capacity or bring new gas wells online. Still, McClendon throughout his tenure at Chesapeake has clearly favored expansion: acquiring new production assets and being a prime mover in the new ‘fracking’ technologies that have made it possible to access so much in the way of new gas reserves until now trapped within unreachable shale rocks.
Last year’s big downturn in the price of natural gas brought the chickens home to roost. Chesapeake had spent heavily on expanding its operations and seen its debt levels climb to finance that. But then the laws of supply and demand kicked in, exacerbated by the nature of the commodity and the structure of the natural gas pipeline and storage network across North America. It isn’t easily possible to transport the gas to a facility where it can be liquefied and then loaded onto ships to transport to markets where demand is more robust and prices are higher. The company’s debt has remained high (although low interest rates helped blunt the impact on Chesapeake) while the company’s high capital spending levels couldn’t be covered by cash flow from operations.
Governance problems didn’t help the company in the eyes of investors. Chesapeake allowed McClendon to purchase a small stake in company-operated wells, but to do so, he had to borrow – and ended up getting the money he needed from a firm that invested in Chesapeake itself: a big conflict of interest. Federal regulators took an interest in these dealings, along with Chesapeake’s board. “Philosophical differences” with whose members prompted McClendon’s departure.
Some of the pop in Chesapeake’s stock price since news of McClendon’s departure became public earlier this week can be traced to relief, but another part of it is due to speculation that Chesapeake’s existing asset sales, undertaken to pay down debt, will culminate in the entire company going on the auction block. At least one analyst has upgraded his rating on the stock to “buy”, citing that possibility. But the bottom line for investors is that the festivities likely will be short-lived. Chesapeake still hopes to sell another $4 billion of assets, with speculation that the total may be closer to $8 billion. Even with the uptick in natural gas prices, how eager will potential buyers be to bid anywhere close to ‘full value’ for those assets? Chesapeake’s exposure to natural gas prices remains largely unhedged, so any future downturn could put a crimp in cash flows, revenues and profits. In short, McClendon’s departure removes one person from the scenario – someone whose recent decisions may appear flawed – but doesn’t change the fundamental context in which Chesapeake must do business. Going long at this point in time – especially in the wake of the recent jump in the stock price – would be a high-risk gamble.
Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at firstname.lastname@example.org.
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