Chesapeake Oil and Gas Industry

Chesapeake Energy Corporation ( NYSE: CHK ) , headquartered in Oklahoma City, Oklahoma, owns 1.1 trillion three-dimensional pes tantamount of proved oil and gas militias, one of the largest stock lists of onshore U.S. natural gas { Chesapeake Annual Report, 1998, p. 1 } . Recently, Chesapeake finished the transmutation from an aggressive geographic expedition company focused on developing short-reserve life, to a lower-risk, longer reserve life natural gas manufacturer.

Chesapeake s operations are focused on developmental boring and bring for thing belongings acquisitions. These operations are concentrated in three major countries: the Mid-continent, the onshore Gulf of Mexico and far northeasterly British Columbia, Canada .

Management Team

Aubrey K. McClendon is Chesapeake s Chairman of the Board, Chief Executive Officer and Director. Tom L. Ward is the President, Chief Operating Officer and Director. McClendon met cofounder Tom Ward in the 1980 s. Both were independent oil manufacturers; they teamed up in 1983  . They each have more than 16 old ages of experience in the oil and natural gas industry. All other members of the direction squad have multiple old ages of experience in the industry.

Competitive Environment

Chesapeake has concentrated on spread outing its retentions in natural gas since the company s incorporation in 1989. Chesapeake thinks that natural gas will be the fuel pick of the twenty-first century. The company has been extremely competitory in both its geographic expedition activities and attempts to increase its stock list of undeveloped leasehold land. This combination should enable Chesapeake to stay a competitory force in the energy bring for thing industry.

New engineering in the oil and gas industry has made geographic expedition and production more profitable. This is cardinal for the endurance of American concerns that compete with OPEC and other foreign trusts that have really low production costs. New engineering, including 3-dimensional imagination, which has greater declaration than the antecedently bing engineering, will enable Chesapeake to observe militias more accurately. Besides, horizontal boring has enabled companies to run out more than one modesty at a clip. With net incomes going to be squeezed within this industry, new engineering is necessary to assist American concerns compete on a planetary graduated table.

Economic Climate

The oil and gas industry is genuinely a planetary market. The industry boosted additions in 1999 from increased production efficiency and a lessening in the current supply. U.S. houses, along with OPEC, have voluntarily reduced their entire production, which has increased the monetary value. OPEC presently supplies about 40% of the universe oil production. If OPEC chooses to bring forth at a lower end product, Chesapeake could easy increase production with its low production costs and immense militias. Many other states are emerging as rivals, such as the former Soviet Union and Latin American states. The going addition in supply from other states would potentially saturate the market, doing lower monetary values and lower net incomes. Demand is expected to lift merely somewhat more than two per centum through the twelvemonth 2005.

The mentality for this industry is for increased competition domestically (from smaller companies) and internationally from emerging states. The U.S. has superior engineering, which will assist maintain net incomes up as supply additions and demand remains comparatively changeless.

Natural gas makes up 72% of Chesapeake s gross. They normally sell the merchandise to 3rd parties and are non dependent on any one purchaser. Less than 10% of their gross are generated from two purchasers.

Governmental Regulations Operational and Labor Relations

The oil and gas industries are capable to considerable authorities ordinance. These Torahs and ordinances are chiefly directed toward the handling and disposal of boring and production waste merchandises and waste created by H2O and air pollution control devices [ Chesapeake 10-K, 1998, p. 10 ] . The oil and gas industry is accountable to legion authorities bureaus, including the Environmental Protection Agency, the Department of the Interior, the Department of Energy, the State Department and the Department of Commerce. Virtually every facet of operations is capable to complex and of all time altering ordinances.

The oil and gas industry is tightly regulated in respect to labour dealings by authorities section and bureaus, including the Occupational Safety and Health Association ( OSHA ) and the National Labor Relations Board ( NLRB ). Some provinces have their ain province sponsored occupational safety programs, while the balance must follow with federal OSHA ordinances. Some of the subjects covered under OSHA include personal protective equipment, risky communicating ( HAZCOM ) and safety procedure preparation.

Chesapeake had 453 employees as of March 15, 1999. None of these employees were represented by organized labour brotherhoods. The company considers its employee dealings to be good . Unocal employed 7,880 people as of December 31, 1998, of which 575 were represented by assorted U.S. labour brotherhoods.

Both companies are capable to new Torahs and ordinances sing the environment and labour. Chesapeake and Unocal can non foretell what inauspicious fiscal conditions the new Torahs and ordinances will convey. However, short-run and long-run costs will increase as companies improve bing operations to go and stay compliant with authorities ordinances. As a consequence, all companies in petro-chemical industries are sing enormous trouble runing profitable concerns. Several concerns have ceased operations as a consequence of increased ordinance coupled with hapless net income borders.

Chesapeake is at a higher hazard sing this scenario since most of its operations are domestic. Unocal, although a U.S. based company, operations are concentrated chiefly overseas, and hence experience increased lenience sing environmental and labour ordinances.

Overview

During the last two old ages, Chesapeake Corporation took a important hit in footings of net incomes, stock monetary value and recognition evaluations. Positive 1996 net incomes turned to a loss in 1997 and tumbled to a bigger loss of $ 10 per portion in 1998. This net incomes diminution caused the stock monetary value and recognition evaluation to plump. The company besides faces a category action case stemming from alleged misdemeanors of federal securities Torahs. Top direction and managers are accused of utilizing insider information to sell personal retentions in the company at unnaturally hyperbolic monetary values.

Chesapeake had really dissatisfactory old ages in 1997 and 1998 as evidenced by the autumn in the stock monetary value. The company underwent a significant repositioning to increase natural gas retentions and cut down hazard. As a consequence of this repositioning, Chesapeake incurred considerable debt and is dependent on the market monetary values of oil and natural gas to increase, and in consequence, better net income borders. Additionally, in 1997, Chesapeake changed their financial twelvemonth terminal from June 30th to December 31st.

As portion of the repositioning, Chesapeake increased long term debt over $ 400 million to a sum of $ 920 million, coupled with a short-run liability of $ 25 million. This increased adoption drastically reduced the company s ability to obtain extra funding. Standard & A; Poor s and Moody s placed Chesapeake on reappraisal with a negative mentality. The ability to run into duties for this extra debt will depend on the production and fiscal public presentation of the company, market monetary values of oil and natural gas, and general economic conditions.

Common Size Income Statement Analysis

Chesapeake had an highly big write-off of assets ( damage ) as a consequence of reduced oil and gas monetary values during the past few old ages. This charge increased operating costs by over $ 1.2 billion during 1997-98 with 72% of that cost coming in 1998. The plus write-down, combined with disbursal additions in production, selling and involvement, were the chief subscribers of entire operating costs to be over three times entire gross. The consequence was 1998 EBIT of ( $ 920 ) million, and a non-existent ROE, since the company had a net loss nearing $ 1 billion. Unocal s ROE was 5.9% in 1998 and 25.1% in 1997.

The damage cost reported by Chesapeake is questionable because of the really big sum that was charged. In position, Unocal with over $ 5 billion in belongings assets recorded an impairment charge of $ 97 million during 1998. If oil and gas monetary values rise in the close hereafter, the damage costs may be reversed giving the feeling that the company is making really good. Future investors of Chesapeake equities should see this fact prior to doing any investing determinations.

Common Size Balance Sheet Analysis

Chesapeake had a $ 140 million decrease to both sides of the balance sheet. The repositioning of the house focused on increasing stock list of natural gas militias, the fuel of pick for the twenty-first century . Oil and gas belongings about doubled from 1997 to 1998, numbering $ 2.2 billion. However, about $ 1.6 billion was depreciated, depleted and amortized. Additionally, hard currency decreased about $ 100 million, short-run investings were liquidated, and paid-in capital exceeded $ 1.1 billion over the past two old ages to supply extra hard currency for purchases

of gas militias. As a consequence, entire belongings, works and equipment was 85% of entire assets in 1998 compared to 77% in 1997. In comparing, Unocal s PP & E was 66% and 64% of entire assets severally.

Long-run debt increased over $ 400 million in 1998, numbering $ 920 million compared to $ 510 million in 1997. The $ 920 million was 113% in relation to entire liabilities and proprietors equity of $ 813 million. In 1998, current liabilities were $ 131 million compared to current assets of $ 118 million. This resulted in a decreased current ratio of.90 from a 1997 ratio of 1.42. The Unocal current ratios during 1998 and 1997 were 1.01 and 1.29 severally.

Cash Flow Statement Analysis

Chesapeake has relied chiefly on hard currency flow through funding activities during the past few old ages. Cash flow from operations was about $ 95 million in 1998 and $ 180 million in 1997, while hard currency flow from funding was $ 365 million and $ 278 million severally. Gross sales accounted for $ 378 million in 1998 and look to be lifting about 35% yearly from 1996 and 1997. However, an accurate comparing is unavailable because of the alteration in the company s financial twelvemonth terminal.

Low oil and gas monetary values forced Chesapeake to borrow, sell equity, and neutralize short-run investings in order to go on operations and put in oil and gas belongings. The company is dependent on the rise of monetary values during 1999 to go on operations and supply stockholder wealth. The company has several limitations from being able to borrow extra finances. Additionally, the monetary value of stock has dropped from a high of $ 34 in 1996 to a depression of $ .63 in 1998. This has farther reduced the company s ability to bring forth hard currency.

Liquid

The current ratios for Chesapeake Energy are as follows: 1.00 ( June 96 ) , 2.03 ( June 97 ) , 1.42 ( December 97 ) , and.90 ( December 98 ) . Current liabilities remained changeless over this period, runing from a high of 19% ( June 96 ) to a depression of 15% ( June 97 ) , with the current degree at 16% of entire assets. Extreme degrees of alteration in current assets caused the current ratio to fluctuate drastically. Current assets declined from a high of $ 297 million ( 31% of entire assets ) to a current depression of $ 117 million ( 15% of entire assets ) . This diminution in current assets caused the impairment of the current ratio.

The acerb trial ratios are as follows: 94 ( June 96 ) , 2.00 ( June 97 ) , 1.37 ( December 97 ) , and.81 ( December 98). As antecedently mentioned, current liabilities remained changeless. Net histories receivable remained level as a per centum of entire assets: 9% in 1996, 7% in 1997 ( Both June & A; December), and 9% in 1998. Marketable securities were sold off during the past three old ages, diminishing from 11% ( $ 104 million ) of entire assets to zero. Cash decreased from 13% ( $ 124 million) of entire assets in 1997 ( both June & A; December ) to 4% in 1998. The combination of terrible lessenings in both hard currency and marketable securities are the grounds that the acerb trial ratio decreased so dramatically.

The speedy ratios are as follows: 96 ( June 96 ) , 2.00 ( June 97 ) , 1.38 ( December 97 ) , and.86 ( December 98 ) . As mentioned antecedently, current liabilities remained changeless and current assets declined. As with the current ratio, the chief ground for the impairment of the speedy ratio is the continued loss of current assets.

The above ratios and the grounds for their hapless tendencies indicate Chesapeake is presently in a liquidness crisis. This, in combination with the increased debt liabilities, is an utmost warning to both investors and direction. This status besides adds to the intuition that assets are being sold off to fund current debt duties.

The house s ability to run into its duties with hard currency, as they come due, is approximated by the hard currency flow liquidness ratio. As antecedently mentioned, solvency improved and so deteriorated as indicated by the current and speedy ratios. The tendencies are confirmed when looking at hard currency flow. From 1995 to 1997, Chesapeake s hard currency flow liquidness improved from 1.47 to 1.8. 1997 to 1998 showed a big bead in liquidness from 1.8 to 0.95. The company s fiscal statement information gives an indicant as to why.

From 1995 to 1997, short-run solvency improved from 1.47 to 1.8. When looking at the information, hard currency from operations rose from $ 55 million in 1995, to $ 139 million in 1997. The 1997 rise was due to a alteration in the accounting period. During this same period, hard currency on manus rose from $ 56 million to $ 123 million and marketable securities rose from zero to $ 13 million. While hard currency was increasing, current liabilities rose from $ 75 million to $ 153 million. Current liabilities doubled during this period, while hard currency flow increased 150% . The larger addition in hard currency flow, comparative to short-run duties, histories for the betterment in solvency during the 1995 to 1997 period.

During the 1997 and 1998 periods, liquidness deteriorated as shown by the lessening in the hard currency flow liquidness ratio from 1.8 to 0.95. The information indicates that hard currency from operations dropped about 32% to $ 95 million. When looking at the Cash Flow Statement, the big lessening in operating hard currency is chiefly due to the big net loss incurred during the period. At the same clip, hard currency dropped 76% to $ 30 million while marketable securities fell to zero. Much of the hard currency appears to hold gone to fund the company s payables and accumulated liabilities. Current liabilities were reduced 15% to $ 131 million. The larger decrease in hard currency flow relative to current duties histories for the impairment in short-run solvency.

The hard currency flow information confirms that Chesapeake s liquidness suffered terrible impairment. A decrease in current liabilities is a good mark, but the small sum of hard currency generated and being used to fund current duties is non plenty. Cash assets are being used to fund these duties every bit good.

Leverage

In comparing to the industry debt ratio of.31, Chesapeake ended with a debt ratio of 1.31 in 1998 compared to.71 in 1997. The long-run debt to entire capitalisation ratio increased from.64 in 1997 to 1.37 in 1998, while the industry norm was.44. The enormous addition in debt was attributable to significantly lower oil and gas monetary values during the past three old ages, and a failed boring venture known as the Louisiana Trend. The company was forced to neutralize assets and take on a significant sum of debt to run into operational disbursals and increase oil and gas field militias. Chesapeake was added to the Standard & A; Poor s CreditWatch with negative deductions  in December of 1998.

The low monetary value of fuel during financial old ages 1996 through 1998 was the primary ground for Chesapeake s problems. The debt incurred has compacts curtailing the company from seeking extra debt and from paying dividends to preferable stock holders. Principal on a big part of the outstanding debt is non due until 2004 letting the company clip to better operations. This will besides give fuel monetary values a opportunity to lift, which is deciding to the company s endurance.

The industry norm for times involvement earned is 5.2, while Chesapeake s operating net income was ( $ 856 ) million. The ratio equated to good below zero in 1997 and 1998. In 1998, involvement payments were more than $ 68 million.

The fiscal purchase index could non be computed since there was non a return on equity. Chesapeake overextended their recognition by well financing with debt and has jeopardized their ability to do obligated payments for their debt and fixed costs.

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