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S&P rewards shale driller Chesapeake with credit upgrade for spending cuts

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S&P rewards shale driller Chesapeake with credit upgrade for spending cuts

Chesapeake Energy Corp.'s campaign to stop spending more cash than it takes in from operations bore some positive fruit March 5 with an across-the-board, one-notch credit upgrade by S&P Global Ratings.

Ironically, Chesapeake's size, established as the company ran up $10 billion in debt during the land-grab stage of the U.S. shale revolution, will be key to it keeping the rating stable or earning further credit upgrades, S&P credit analyst Paul Harvey said in a research update.

"This breadth and scale of operations has provided [Chesapeake] with the flexibility to focus drilling activity on only the more profitable assets during periods of low commodity prices and to divest noncore assets without hurting its operational performance," Harvey said.

S&P Global Ratings upgraded Chesapeake's corporate-level credit rating from B- to B, with a stable outlook. Ratings for the company's underlying secured and unsecured debt each moved up a notch, as did the rating for its preferred stock.

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Chesapeake stock, which lost 45% over the past year, caught a tailwind from the ratings upgrade, moving up 5.7% to $3.13 in midafternoon ET March 5. The stock has had a history of head fakes over the past year, moving up on positive earnings news only to rejoin the decline line two or three weeks later.

S&P said that while Chesapeake has reduced its lease operating costs, its future is capped by its overwhelming exposure to low-priced natural gas instead of higher-priced oil.

"To lower its exposure to natural gas, Chesapeake has focused spending on its more oil prone Eagle Ford and Powder River Basin assets, while selling noncore natural gas and high-cost oil assets," Harvey said. "This has led to natural gas falling to about 65% of production in 2017 compared with around 75% in 2016. ... Nevertheless, we expect its exposure to natural gas will limit profitability relative to more oil-weighted peers."

While Harvey said it is unlikely that Chesapeake's rating will improve again in the next 12 months, given natural gas prices, he expects the driller to keep selling off assets to pay down debt, provided those assets are not contributing significantly to Chesapeake's cash flows.

An unexpected rise in oil and natural gas prices would set up Chesapeake for another upgrade if it continues to pay down debt and the extra cash improves funds from operations to 20% of debt. At the end of the fourth quarter of 2017, that ratio was 12%.

Continued negative free cash flows due to capital spending and natural gas prices below $2.50/MMBtu could have Chesapeake looking at a downgrade, S&P Global Ratings said. The rating agency would like to see spending kept below $2.2 billion in 2018. Chesapeake's most recent guidance has the company nosing under that wire with $2.175 billion as the midpoint of its spending forecast. The consensus estimate of analysts surveyed by S&P Global Market Intelligence is for Chesapeake to spend just over $2 billion in 2018.

S&P Global Market Intelligence and S&P Global Ratings are owned by S&P Global Inc.