HUGE Scandal Leads to New Chesapeake Crash

Chesapeake Energy Corp. (NYSE:CHK) sold off sharply in late trading today after the Wall Street Journal broke news that it had $1.4 billion in previously unreported liabilities over the next decade through off-balance-sheet financial deals. Most of that liability, according to the WSJ, occurs this year and next. The news compounds concerns over the company’s ability to raise cash to cover its operating costs and to move into the more lucrative oil business and natural gas prices continue to fall.

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Chesapeake has a number of volumetric production payments, or VPPs, with Wall Street banks that require it to deliver specific amounts of oil and natural gas each month through 2022. VPPs are essentially debts with interest payments made in fuel rather than cash. While Chesapeake has told investors how much the deals will bring in for the company, it hasn’t provided details about the costs to fulfill them.

The WSJ reviewed 10 VPP documents, filed in four states, finding that Chesapeake’s liability for those costs is far larger than investors and analysts had previously believed. Those costs amount of $300 million in 2012 and $270 million in 2013, according to the conveyance documents detailing the volumes the company must produce each month and the company’s own financial data. The documents show roughly another $800 million is expected between 2014 and 2022.

Chesapeake has confirmed the $300 million liability for 2012, but said it was manageable. “Operating costs on those properties are very competitive” with other oil and gas producers, said head of investor relations Jeff Mobley. However, Mobley would not comment on future liabilities.

Chesapeake is trying to dial back its capital spending to bring it more in line with revenue. The company reported a $71 million net loss for the first quarter, a $2.46 billion increase in debt from the previous quarter, and said it spent $2.51 billion more on drilling wells and leasing property than it brought in from its operational cash flow.

Analysts have complained about the lack of transparency at Chesapeake, which still contends that it doesn’t have to disclose the operating cost liability associated with the VPPs because it isn’t required under accounting rules. Until the WSJ report, analysts had struggled to estimate the liabilities, making it hard to evaluate the company as a whole.

Other analysts are concerned that Chesapeake is relying too heavily on asset sales and complex financial deals like VPPs to bridge the gap between its cash flow and its spending, limiting its future flexibility. Chesapeake has pledged roughly 15 percent of projected production through the end of 2013.

“They are definitely borrowing from tomorrow to help fund that gap today,” said Arun Jayarem, a Credit Suisse AG analyst. And that doesn’t leave much room for error.

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