Bankruptcy Cripples the Industry as Leverage Ratios Skyrocket: Gas Outlives Coal—For Now

April 2016

Chesapeake Energy, the second largest U.S. natural gas producer, and Peabody Energy, the largest U.S. coal producer, were simultaneously standing on the edge of a financial cliff at the end of Q1 2016. The latter has since fallen and filed for Chapter 11 bankruptcy, while Chesapeake remains, clinging to a lifeline.

Key Details

  • Chesapeake achieved aggressive growth by consistently outspending its cash flow to increase production in new plays. The accumulated debt was then paid for by selling off older assets
    • This strategy was sustained until 2015 when natural gas prices touched a 14-year low and crude prices followed
    • On April 11, Chesapeake avoided bankruptcy by negotiating for the reaffirmation of its $4B borrowing base and the postponement of its next credit facility redetermination until June 2017
    • According to the company’s most recent investor presentation, Chesapeake plans to close on up to $1.7B in asset divestitures in 2016, while reducing its capital budget by more than 50%, selling off its inventories, and repurchasing significant portions of its debt
  • Peabody’s downfall originated with its pursuit of metallurgical coal assets during the commodity’s peak in 2011. This led to debt-funded, multibillion dollar investments in Australian assets just before met coal prices fell more than 75% due to decreasing Chinese demand
    • Despite record domestic production in the following years, Peabody’s cash flow problems became more severe as decreasing electric power demand also drove down thermal coal prices
    • After failing to close its most recent deal with Bowie Resources in February, Peabody filed for Chapter 11 bankruptcy on April 13. The filing included most of the company’s U.S. operations but excluded its Australian subsidiaries
    • The next day, Peabody secured $800M in debtor-in-possession financing to sustain its operations for up to 18 months
    • As a result of Peabody’s filing, the 12-month rolling average loan default rate for the coal sector rose to almost 70%
  • Both companies will continue operating through their restructuring. Peabody will reduce its production to trim down domestic surplus, while Chesapeake will look to maintain its business as usual despite selling core assets

Implications

The underlying market conditions Chesapeake and Peabody have faced were similar, and their current positions reflect the market’s expectations for the future. The electric generation industry’s transition from coal to gas and renewables will continue, and the coal sector will suffer. It remains to be seen if gas demand will increase enough, and in time, for Chesapeake to be able to spend its way to prosperity.

More Information

Bloomberg: Chesapeake pledges almost everything it owns to secure debt

SNL Financial: Midstream update – 2015 financials substantially eroded as bleak ‘new normal’ unfurled

SNL Financial: Interfuel dislocation – natural gas poised to steamroll over coal in fuel race

SNL Financial: Peabody bankruptcy pushes coal loan default rate beyond peak to nearly 70%

Seeking Alpha: Capital Structure Arbitrage: the curious case of Peabody Energy

This report is part of the Gas Minute series. To view all featured Minutes, please click here.

Contributing Author: Chris Becker

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