Can McClendon and Chesapeake Energy Suppress Urge to Splurge?

• The Company: Chesapeake Energy, the largest U.S. natural gas producer.
• The Filing: FORM S-4 (Registration Statement) with the SEC on December 9, 2008.
• The Finding: Aubrey McClendon, Chief Executive Officer of Chesapeake Energy, told investors on a conference call on Monday that the the natural gas company’s revised operating and capital budget for 2009 and 2010 could be funded with internally generated cash flow. It is important to note, however, that cash flow from operations and revolving bank credit lines have historically been insufficient to fund all of Chesapeake’s annual expenditures.

The Upshot: McClendon said Chesapeake had adequate liquidity and should close the year at between $2 billion and $2.5 billion of cash on hand. The primary source of liquidity used to fund operating and capital expenses remains cash flow from operations. During the nine-months ended September 30, existing production threw off $4.3 billion in cash; however, as the company was binging on acquisitions and expanding its drill bit program (spudding 1,453 gross wells through September), Chesapeake actually chewed up about $4 billion in cash! Ergo, Chesapeake plans to cut its drilling budget — for the fourth time since September — by $2.9 billion in 2009 and $2.2 billion in 2010. In addition, the company announced plans to raise cash through additional asset sales and possible joint ventures.

Against a backdrop of lower energy prices, Chesapeake is looking to offset anticipated lower cash flow through in-place gas hedges, too. Management has currently hedged approximately 76 percent and 50 percent of anticipated 2009 and 2010 production through swaps and collars at an average floor price of $8.20 per thousand cubic feet and $9.50 per thousand cubic feet, respectively.

Since March, the company has relied on the capital markets and asset monetization transactions to raise more than $11.65 billion of new capital, and up to $4.6 billion through joint ventures, to fund drilling and completion costs in the Haynesville, Fayetteville and Marcellus Shales. The company also has a shelf registration on file with the SEC, which will enable the company to issue up to 25 million shares of its common stock — if needed — in connection with the acquisition of assets or businesses.

Although the company has about $12 billion in debt, it is in full compliance with debt covenants, and no sizeable debt matures until November 2012 (when the first $864 million comes due).

The Question: If natural gas prices remain below $8.00 per thousand cubic feet, will the company’s ability to access capital — and bring future production online — become restricted due to ceiling test write-downs of existing reserves?