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Chesapeake Facing Breach of Debt Covenants, Says Moody's

Chesapeake Energy Corp. has to sell "at least" $7 billion worth of assets this year to avoid a breach of debt covenants and a credit downgrade, a senior analyst with Moody's Investors Service said Thursday.

However, the producer still may exceed debt restrictions in the second half of the year because its revolving credit facility covenants limit debt to four times earnings before interest, taxes, depreciation and amortization, said analyst Peter Speer.

Chesapeake obtained a $4 billion unsecured loan in mid May from Goldman Sachs Bank USA and affiliates of Jefferies Group Inc. to cover an expected 2012 cash flow shortfall (see Daily GPI, May 16). CEO Aubrey McClendon has said the company plans to pay off the loan this year and secure needed cash for 2013 by selling up to $9-11 billion in assets this year, including the Permian Basin portfolio, which is expected to sell for up to $8 billion.

However, the producer still may exceed debt restrictions in the second half of the year because its revolving credit facility covenants limit debt to four times earnings before interest, taxes, depreciation and amortization, said analyst Peter Speer.

"Even $7 billion in asset sales could place Chesapeake's covenant compliance for its revolving credit facility in some doubt, and the company would still face a significant funding gap in 2013," Speer wrote. "Asset sales much below $7 billion, meanwhile, would likely lead to a downgrade."

In early May Moody's downgraded Chesapeake to "negative" (see Daily GPI, May 10). Speer at that time pointed to the large capital funding gap for this year because of low natural gas prices and the company's planned increase in spending.

"The negative outlook reflects the escalating execution risk of Chesapeake's plan for funding its large capital spending budget, rising leverage metrics and accompanying liquidity concerns," Speer wrote. "The company's already diminished cash flows are vulnerable to further declines in natural gas prices, and it remains dependent on completing asset sales and other financing transactions with third parties to maintain adequate liquidity and fund its transition toward higher liquids production."

Meanwhile, Chesapeake has put a "for sale" sign up on its Woodbine assets in Texas, which at only 57,000 net acres are considered a bit player in the company's U.S. portfolio. The announcement comes just a week after the company said it would sell a portion of its Denver-Julesburg Basin properties, which some analysts believe may fetch up to $1 billion (see Daily GPI, May 29).

McClendon in early May had mentioned the Woodbine as a possible asset to be monetized through a sale or joint venture this year. The leasehold extends across portions of the Central/East Texas counties of Madison, Leon, Houston, Grimes and Robertson.

Chesapeake's net production volumes in the Woodbine from October through March were 348 b/d and 870 Mcf/d. Average net cash flow from January through March was $825,000/month.

The Woodbine formation, a long-time oil target, historically had been vertically drilled, and vertical wells had recovered more than 46 million bbl of oil. Today the tight sand formation is being reworked using horizontal drilling and hydraulic fracturing. Producers are targeting depths of 8,000-9,000 feet, mostly for crude oil, "with liquids-rich casinghead gas and low water ratios," according to Chesapeake.

Initial production rates of 600-1,200 boe/d are being reported by producers, Chesapeake said. In addition to Chesapeake, producers now testing wells in the play include Apache Corp. and Encana Corp. McMoRan Exploration Co. CEO Jim Bob Moffett, a respected geologist, calls the Woodbine a "synonym" in Texas for the prospective Tuscaloosa Marine Shale.

The Woodbine "directly underlies the Eagle Ford Shale and overlies the Buda formation," Chesapeake said. Porosity is 8-16%, with gross thickness of 75-120 feet. Chesapeake's horizontal well completions to date have addressed "the wide variation in permeability and porosity."

Chesapeake's Woodbine leasehold, which totals 76,830 gross acres, includes 3,899 net acres within produced pooled units, with most of the leases offering a two-year option to renew. Less than 2,500 net acres expire this year.

The producer has a 90% working interest in four operated horizontal wells and a 100% stake in five operated vertical Subclarksville and Bossier wells. It also has a 14% interest in a nonoperated Subclarksville well. Average leasehold net revenue interest is 77.1%.

A prospectus is available from Meagher Energy Advisors. The bid date is June 28 with an effective date of June 1. Closing is tentatively scheduled for July 26.

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