Chesapeake-Energy Transfer Drama Should Increase Comfort In Midstream (OTCMKTS:CHKAQ)
As part of its ongoing Chapter 11 bankruptcy proceedings, Chesapeake Energy (OTCPK:CHKAQ) requested the overseeing court to modify some contracts that it has with Energy Transfer (NYSE:ET), among other midstream companies. Thus far, the court has been reluctant to allow this, which shows the overall stability that many midstream companies tend to have. This is particularly true for those companies operating long-haul interstate pipelines like Energy Transfer because these pipelines are regulated by Federal authorities. The fact that the court has been reluctant to allow even a bankrupt company to break pipeline contracts should be comforting to those investors that are worried about the impact that upstream bankruptcies would have on these companies.
As everyone reading this is no doubt well aware, the outbreak of the COVID-19 pandemic has had a devastating impact on the energy industry. As we can see here, the price of West Texas Intermediate crude oil has fallen from $61.18 per barrel at the start of the year to $40.64 per barrel today:
Source: Business Insider
The same basic thing was also seen in natural gas. At the start of the year, natural gas at Henry Hub was selling for $2.19 per thousand cubic feet. It sells for $1.84 per thousand cubic feet today:
The decline in energy prices was at least partly caused by the worldwide economic shutdown and stay-at-home orders. This was because these government actions resulted in less energy being consumed, leading to an oversupply of these resources. The economic law of supply and demand would therefore imply that prices should fall in such a situation.
As might be expected, these lower prices have caused the revenues of upstream companies like Chesapeake to decline because they make their money by selling these resources. The lower revenues make it more difficult for a company to support its debt. This is naturally more of a problem for companies that have a fairly high level of debt, such as many North American independent exploration and production companies. As of March 31, 2020, Chesapeake Energy had a current debt of $420 million and long-term debt of $9.472 billion, for a total of $9.892 billion. This compares to a shareholders’ equity of negative $3.945 billion. Clearly, then, this is a company with too much debt on its hands, which explains why the substantial price declines that we saw pushed the company into bankruptcy.
This high level of debt is part of the legacy of former CEO Aubrey McClendon. He believed that natural gas would be scarce and, thus, have a high price for decades. As such, he led the company on an expensive buying spree, and when that did not pan out, it left the company with a considerable amount of debt and insufficient asset values to back it. The coronavirus-driven price decline was essentially the nail in the coffin for the company’s asset valuations and ultimately pushed it into bankruptcy.
The primary way in…
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