Post-Chesapeake, associated gas risk grows

The firm's fall into bankruptcy came as little surprise, but a revival in US gas sector fortunes is becoming harder to call, writes Jason Womack

Houston, 3 July (Argus) — The long-expected bankruptcy of US shale gas pioneer Chesapeake Energy may be an outlier for a sector that has learned to live within its means, but recovering tight oil and associated gas output could add pressure to an already weak US gas market.

Chesapeake filed for Chapter 11 bankruptcy protection in late June, as collapsing energy prices challenged its ability to carry over $9bn in debt. The firm will eliminate about $7bn of this under the bankruptcy plan and has secured $925mn in debtor-in-possession financing. It will continue to operate through the process.

Oklahoma-based Chesapeake was an early champion of using horizontal drilling and hydraulic fracturing to coax gas from shale formations. Led by its outspoken co-founder and chief executive, the late Aubrey McClendon, it developed one of the largest portfolios of US shale assets, became the biggest producer of US natural gas by volume and lured billions of dollars in investment into the shale industry.

Chesapeake and others sought out new fields, armed with easy access to capital and a simple pitch — that the US, through the development of shale formations, could unlock energy independence and wean itself off foreign oil and gas. But the sector's success brought a new challenge. The US in 2011 surpassed Russia to become the world's top gas producer, but the deluge of domestic gas pushed prices lower and made the going tougher for producers.

Chesapeake tried to pivot, shifting away from gas and focusing on higher-value natural gas liquids and oil. McClendon in 2011 predicted that shale could make the US the world's biggest oil producer by 2020. It reached that milestone in 2018. But by 2012 Chesapeake had over $16bn in debt and was hamstrung by low natural gas prices, as its cost to acquire, retain and develop properties far outpaced its cash flow. McClendon stepped down in early 2013 following differences with the board.

His successor, Doug Lawler, put a stop to the strategy of endless acquisitions, and began selling assets, cutting costs and funding only wells that generated high returns on investment. But a belated effort to boost liquids output through the $4bn acquisition of Eagle Ford-focused oil producer WildHorse in February 2019 proved a step in the wrong direction, with growing pressure on oil prices.

Chesapeake last year produced about 2.3bn ft³/d (65mn m³/d) of gas, making it the sixth-largest US producer after EQT, ExxonMobil, Cabot, BP and Antero. Among leading gas independents, Cabot is a favourite with sector investors because of its record of sustained free cash flow generation, unlike Chesapeake.

US shale industry asset impairments may top $300bn this year, raising the prospect of an acceleration in bankruptcies, consultancy Deloitte says. Apart from Chesapeake, most of the rising number of bankruptcies in the sector this year have been among oil-focused producers.

Null throttle

Low gas prices of around $2/mn Btu at the start of the year prompted US producers to throttle back growth plans before the crude price crash forced wider shut-ins in the oil sector. A drop in US associated gas output has made gas producers more optimistic in recent months about the prospect of US oversupply easing by next year. Nymex futures prices for January 2021 have approached $3/mn Btu, even as prompt-month prices remain below $2/mn Btu.

But gas prices will likely face headwinds again if the recent recovery in US oil prices proves sustained — reviving tight oil output, and associated gas production with it — while a drop in LNG exports leaves more supply stranded in the US. The US oil heartland of the Permian basin is also the country's second-largest gas producing field, and its associated gas output was by some estimates up by 1bn ft³/d in June from May. Demand for US LNG fell by 2bn ft³/d over the same period.