Chesapeake Energy Corporation’s Latest Problem

Chesapeake Energy, and peers Range Resources and SM Energy are all feeling the pinch of low NGL prices.

Matthew DiLallo
Matthew DiLallo
Jun 29, 2015 at 1:15PM
Energy, Materials, and Utilities

The continued weakness of oil and gas prices is having a noticeable impact on Chesapeake Energy's (NYSE:CHK) stock price. It's not helping matters that analysts are turning more bearish on the company as those weak prices are continue to put pressure on its cash flow, which will then widen the gap between cash flow and capex. That said, while oil and natural gas get all the attention, a growing problem for Chesapeake Energy, and peers Range Resources (NYSE:RRC) and SM Energy (NYSE:SM) is the continued slide of the prices of natural gas liquids, or NGLs. 

No bottom just yet
While the price of oil has clearly bottomed and found firmer footing in the $60 per barrel range the same can't be said for natural gas liquids. SM Energy recently highlighted this issue after it warned that NGL price declines would lop $25 million off of its budgeted revenue for 2015, or about 1.5%. The reason NGL prices are having such a meaningfully impact is not only due to the fact that NGL prices fell 36% to $16.67 per barrel from the fourth-quarter to the first-quarter, but as the following slide shows, NGL's were 23% of SM Energy's production last quarter.

Source: SM Energy Investor Presentation. 

As that slide also notes SM Energy's NGL production has grown at a brisk pace over the past year as production is up 35%, which isn't that far behind its oil production growth of 43%. This growth coming at the wrong time as its NGL price realizations have actually been nearly been nearly cut in half over the past year. While SM Energy expects NGL prices to be flat in the second quarter and potentially increase in the second half, current prices are having a noticeable impact on its bottom line at the moment. 

The continued weakness in NGL prices is expected to also have a big impact on revenue and cash flow at Chesapeake Energy and Range Resources. Analysts estimate that Chesapeake Energy's 2016 cash flow could be reduced by 3% if NGL price weakness doesn't abate while Range Resources cash flow would take a 5% hit next year. That would exacerbate Chesapeake's free cash flow deficit, which is projected to be $2.1 billion this year and $2.7 billion in 2016.

For Range Resources, its issues with NGLs are evidence by the just looking at its first-quarter results. In the first-quarter the company's net NGL sales totaled $59.8 million, or 18% of its revenue, which is a significant drop from the $135.5 million, or 24% of revenue, that the company realized from its NGL production in the previous year's first-quarter. That slump is coming even as NGL production jumped 20% year-over-year to 5.4 million barrels for the quarter. That said, natural gas is driving the bulk of Range Resource's growth as gas production is up 30% year-over-year.

Big growth driver
While the slump in NGL pricing is having a noticeable impact on all three companies, it has the potential to have an even greater impact on Chesapeake Energy because NGL production had been the company's biggest growth driver and now represents 10% of overall production. This is as its NGL volumes grew by 19% quarter-over-quarter, which was ahead of both oil and gas at 17% and 12%, respectively. Further, NGL production in 2014 grew a stunning 42% against just 7% growth for oil production and just 6% natural gas production growth. This growth has been driven primarily due to the fact that Chesapeake Energy's best drilling acreage is located in liquids rich parts of shale plays. 

For example, the company's Eagle Ford shale production contains a higher percentage of NGLs than other producers in more oil rich sections of the play. Recently, Chesapeake's production mix from that play has been approximately 15% NGLs, along with 21% gas and 64% oil, whereas other producers in the more oil-rich window are seeing production mixes of just 10% NGLs, 78% oil, and just 12% gas. As a result their economics aren't being affected as deeply by weak NGL prices as Chesapeake's. Not only that, but Chesapeake Energy's other core growth asset is the Utica Shale, which is a very liquids rich play. Currently, Chesapeake is seeing a production mix of 30% NGLs, against 60% gas and 10% oil. With the company spending more than half of its capital in these two plays in 2015, it means that liquids will continue to be a greater portion of Chesapeake's production, and its growth. This is why the decline in NGL prices is having a more noticeable impact on its bottom line than the decline is having on more oil focused producers like SM Energy. 

Investor takeaway
While NGLs production is important to both SM Energy and Range Resources, their growth is instead driven primarily by oil and natural gas, respectively. That's not the case at Chesapeake Energy as NGL production has been its biggest growth driver. As a result, the continued slide in NGL prices is a troubling issue for the company given that it's investing half its capital this year into its NGL-rich acreage.

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