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Shale Boom Cash Hole Goes Much Deeper Than Chesapeake Energy


Chesapeake Energy (CHK) is often cast as the poster child for poor corporate governance, or drawn as a caricature of the reckless, megalomaniac, self-enriching CEO. Take your pick, but if you're an energy sector investor riding a recent rebound in shares of oil service companies banking on shale contracts, it's Chesapeake Energy's financial woes that should get your attention.

As activist investors like Carl Icahn pile into Chesapeake Energy and push for the second largest land driller in the US after ExxonMobil (XOM) to focus on closing a debt-fueled spending gap, the situation is indicative of the leverage levels at many US exploration and production companies.

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In fact, Chesapeake Energy's well-publicized funding gap isn't an outlier but emblematic of wider issues in the shale oil and gas boom that implies an industry-wide downturn is possible in coming quarters. In particular, it could spell earnings trouble for oil service stocks rigged to the still-high rig count across the US.

Oil and gas exploration companies are spending on drilling programs far in excess of cash coming into the their coffers, with average spending 43% higher than cash flow, according to Guggenheim Securities data.

The funding gap may create a big hangover for onshore rig contractors like Halliburton (HAL), Baker Hughes (BHI), Nabors Industries (NBR), Helmerich & Payne (HP), and Patterson-UTI Energy (PTEN). These companies may see earnings fall 30% short of consensus in coming quarters, according to Guggenheim's bearish analysis.

The largest shale players aren't oil giants with fortress balance sheets, but often smaller drillers that have been using low interest rates and a high-yield debt boom to finance drilling programs and rig contracts. Now, with debt ratios and spending deficits near cyclical highs, these companies may need to start pulling drilling rigs to conserve capital, creating pricing pressure on rental rates and usage. It's a trend that has been in place since late 2011, however, Guggenheim's point is that a recent bullish trade in the oil service stocks defies the likelihood of the rig count continuing lower as debt loads remain untenable.

"We continue to believe that the US rig count is in the process of a protracted correction," writes Guggenheim Securities analyst Michael Lamotte in a September 4 note to clients. "The key pillar of our thesis is the unsustainability of the growth in debt, which has allowed E&P capex to remain well above levels supported by cashflow since the second quarter of 2011," he adds.

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