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Rating Action:

Moody's moves Chesapeake Energy's outlook to positive

09 Aug 2010

New senior notes rated Ba3

New York, August 09, 2010 -- Moody's Investors Service changed Chesapeake Energy's (CHK) rating outlook to positive from stable. Moody's also assigned a Ba3 rating to CHK's pending $1.6 billion two-tranche offering of senior unsecured notes due 2018 and 2020. Moody's affirmed CHK's Ba2 Corporate Family Rating (CFR), its SGL-3 Speculative Grade Liquidity rating, and its existing debt ratings. Net proceeds will retire up to $1.5 billion in existing notes under a tender offer launched August 3, 2010.

The positive outlook reflects a reasonable expectation that CHK's announced deleveraging plan may lead to a one notch upgrade in twelve to eighteen months. CHK has a significant distance to travel before achieving leverage suitable for an upgrade, partly because we grant 50% equity credit to CHK's convertible preferred stock. Furthermore, the firm's heavy capital outlays relative to operating cash flow, its reliance on very large property monetizations to fund the shortfall, and its comparatively low level of 2011 hedging imply that substantial leverage reduction is unlikely to come from organic debt reduction. Instead, substantial leverage reduction would more likely rely on the slower process of drill bit-driven production and proven developed (PD) reserve growth relative to debt.

The Ba2 CFR is supported by CHK's very large and diversified property base, notably large and diversified drilling inventory, drilling capital spending carry from its joint venture partners, sound 2010 hedge coverage, the substantial work already done to improve its leverage profile, strong production growth trends and multiple pending property monetizations. Second quarter 2010 production grew sequentially by 8%.

However, the ratings are restrained by still high leverage, heavy capital outlays relative to cash flow in spite of drilling capital spending carries from joint venture partners, reliance on very large asset monetizations to supplement operating cash flows, weak natural gas prices and a low level of 2011 hedging, a penchant for aggressive growth, and a highly complex financial structure. CHK will continue to outspend operating cash flow as it now accumulates and develops unconventional oil and wet gas acreage.

Having surged into prolific unconventional gas plays with massive capital outlays and watched natural gas prices fall sharply under the pressure of the production response of many competitors following that same strategy at the same time, CHK is embarked on a new costly emphasis into wet gas plays wherein revenues are supplemented by natural gas liquids. This is not without risk as many firms are also pursuing this strategy, resulting in a growth in natural gas liquids production and in a wider discount of natural gas liquids prices relative to crude oil. This sequence of events has prevented CHK from having free operating cash flow for meaningful debt reduction. While it is in the process of producing and monetizing its gas shale plays, CHK is now making heavy capital commitments to establish one of the largest unconventional oil and wet gas portfolios in the country. On the other hand, the new surge into wet gas plays is adding further price and value diversification to CHK's portfolio.

The twelve to eighteen month timeframe for an upgrade reflects the fact that CHK's leverage reduction strategy started from particularly high leverage on daily production and proven developed reserves. CHK still carries high leverage after retiring debt with $2.6 billion in convertible preferred stock proceeds, in part because we only grant the preferred stock 50% equity credit. CHK also retired debt with volumetric production payment (VPP) proceeds, although Moody's counts VPP's as debt and adds the sold reserves back for leverage calculations. VPP's also encumber all reserves from the leasehold from which they were carved.

Pro-forma June 30, 2010 Debt / PD Reserves (as adjusted for Moody's standard adjustments) was $11.56 /barrel (bbl), Debt / Average Daily Production of $33,921/bbl, and Debt plus FAS 69 Development Capex / Total Proven Reserves of $10.43/bbl. However, these leverage levels are down since its prior peaks, when Debt / Proven Developed Reserves was $12.60/ bbl, Debt / Average Daily Production approximated $43,000/bbl, and Debt plus FAS 69 Development Capex / Total Proven Reserves was $12.15/bbl. As a result of the slight change in the amount of secured versus unsecured debt in the capital structure, the LGD statistics on CHK's senior unsecured notes was changed to LGD4-67% from LGD4-69%.

We will assess the degree to which the net effect of property monetizations, associated divested production and reserves, debt reduction and capital reinvestment generate sustainable leverage reduction. The challenge for firms engaged in oil and natural gas unconventional resource plays, especially during ramp-up phases, is to generate production growth commensurate with the very high start-up and ongoing capital costs. Accordingly, it can be challenging to reduce leverage on production.

Moody's last rating action for CHK was January 28, 2009 we assigned a Ba3 senior unsecured note rating to a new note offering and affirmed CHK's ratings.

The principal methodology used in rating CHK was the Global Exploration and Production (E&P) rating methodology which can be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating CHK can also be found in the Rating Methodologies sub-directory on Moody's website.

Chesapeake Energy is headquartered in Oklahoma City, Oklahoma.

New York
Steven Wood
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Andrew Oram
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Investors Service
250 Greenwich Street
New York, NY 10007
USA

Moody's moves Chesapeake Energy's outlook to positive
No Related Data.
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