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Haynesville Divestment Could Raise $1.25 Billion For Chesapeake Energy


I'll admit I was wrong; the drop in natural gas prices outweighed the positive impact of higher crude prices on Chesapeake Energy Corporation's cash flow generation.

As Henry Hub jumped from under $2/Mcf in June to a range of $2.70-$2.90/Mcf in Q3, there is ample room for CHK's cash flow generation to recover.

Ongoing operating costs continue to move lower, with the possibility of midstream contract renegotiations still in the works.

After increasing its Haynesville position in July for $87 million, Chesapeake Energy Corporation aims to sell off 150,000 net acres in the play.

As some analysts put the value of that acreage up to $1.25 billion, this is an asset sale that could really put near-term liquidity concerns to rest.

First, I'll admit it was erroneous for me to state in my earnings preview article that higher crude oil prices and stronger natural gas prices in June (versus weak Henry Hub pricing during most of Q2 2016) would boost Chesapeake Energy Corporation's (NYSE:CHK) cash flow generation relative to Q1. I was wrong, as Chesapeake Energy's operating cash flow moved lower to $176 million in Q2 compared to $263 million in Q1 due to weaker realized natural gas prices outweighing the favorable impact of higher crude prices.

There are reasons to believe that Chesapeake's cash flow streams will move higher in Q3 as the full impact of Henry Hub's rally is felt, which I will get into below, but it's important to note that Chesapeake Energy is still not generating enough cash flow to cover its expenditures. Chesapeake spent $456 million on its capital expenditures last quarter, which included $63 million of capitalized interest.

Including the impact of hedges, Chesapeake Energy realized $44.31/barrel of oil, $12.88/barrel of natural gas liquids, and $1.97/Mcf of dry natural gas, equivalent to $16.43/BOE, in Q2 2016. Compare that to $37.74/barrel, $11.44/barrel of NGLs, and $2.29/Mcf of dry natural gas, which was equivalent to realizing $16.93/BOE, that the company fetched in Q1 2016 and it's apparent its realized prices didn't receive a material boost from WTI rebounding (hedges played a big role as well). Around 75% of Chesapeake's production streams is dry natural gas, making Henry Hub, not WTI, the biggest influence on its ability to generate cash flow.

Below is a graph that helps highlight why there are reasons to expect Chesapeake Energy's cash flow to materially improve during the third quarter of this year. Since June, Henry Hub spiked up from under $2/Mcf to almost $3/Mcf. While America has seen its operated oil rig count rise over the past six consecutive weeks, the number of operated natural gas rigs fell by five last week to 81. Considering how America's natural gas sector is based on domestic fundamentals due to export constraints and massive amounts of low cost supply warding off most imports of natural gas (except in certain regions), having the natural gas rig count stay below the ~100 level even after a bounce in Henry Hub is a big positive.

Henry Hub Natural Gas Spot Price data by YCharts

Other ways Chesapeake is seeking to bolster its cash flow streams is by continuously cutting costs. The firm's G&A and LOE cost per BOE produced has fallen down to $4.07/BOE in Q2 from $4.14/BOE in Q1 and $4.64/BOE in Q4 2015. For the full year, the upstream player aims to bring down its G&A and LOE cost per BOE to $3.90-$4.30 compared to $5.17/BOE last year. Bringing down ongoing operating costs is one of the few levers Chesapeake can pull that, for the most part, it is in control of.

Divestiture update

When companies don't have a lot of liquidity and need to raise cash to service upcoming debt maturities, they turn to asset sales to make ends meet. Chesapeake Energy noted that it had received $964 million (after closing adjustments) this year in cash from divestitures, and raised the amount the company expects to pocket for the rest of the year. An additional $106 million is being withheld until certain conditions are met, and the company expects to receive the majority of that this quarter.

Those deals are a big part of why Chesapeake has a chance to avoid bankruptcy, but keep in mind, some of those proceeds have gone to reducing the complexity of the company's balance sheet. Chesapeake has been buying back volumetric production payments at advantageous prices. During Q2, Chesapeake bought back four VPPs for $259 million and now has only two remaining. One of those is in the Mid-Continent and the other is in Kentucky and West Virginia, with both of those VPPs not ending for several more years.

From Chesapeake's 10-Q:

A VPP is a limited-term overriding royalty interest in oil and natural gas reserves that [I] entitles the purchaser to receive scheduled production volumes over a period of time from specific lease interests; [ii] is free and clear of all associated future production costs and capital expenditures; [III] is non-recourse to the seller (i.e., the purchaser's only recourse is to the reserves acquired); [iv] transfers title of the reserves to the purchaser; and [V] allows the seller to retain all production beyond the specified volumes, if any, after the...