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June 29, 2020

Fracking firm files for bankruptcy, it’s time for oil and gas to pay its debts

By Market Line

The fracking industry pioneer Chesapeake Energy has filed for bankruptcy protection as its debts become too large to manage anymore.

Chesapeake was one of the very first companies to start using the controversial extraction technique fracking, which forces water and chemicals at high pressure deep underground to release pockets of energy. At its peak the company was valued at $37bn, today that value is just $115m.

Chesapeake in many way has become a victim of its own success, too many fracking firms joined in the feeding frenzy and oil and gas prices became unfavourable, particularly for a firm with too much debt on the books and an increasingly unattractive profit margin.

Successive global crisis have shocked the oil and gas market and Covid-19 has caused perhaps the killer blow for many firms like Chesapeake.

The business model for fracking firms was never financially prudent

The business model included large amounts of borrowing and a significant buildup of debt in order to put in place thousands of extraction sites and service them. Chesapeake was particularly vigorous in the market and aggressive acquisition of drilling rights was its modus operandi.

Many other firms followed Chesapeake’s model and now the entire fracking industry in the US which although responsible for making the US a net exporter of gas, is also highly unstable as a business proposition. Over the last five years over 200 oil and gas companies have filed for bankruptcy.

Chesapeake in particular has lurched from one crisis to another and in 2013 its Chief Executive McClendon, was forced to resign amid accusations he had conspired to rig the bidding process for oil and gas contracts for several years. The company has been paying millions of dollars since then to settle charges of bids rigging.

In 2015 the fracking industry crashed and Chesapeake reported a quarterly loss of over $4bn. In Q1 2020 Chesapeake lost $8.3bn as its struggles continued, the board was doubtful at the beginning of the year that the firm could continue operating.

Fundamentally, fracking struggles to compete with other modes of oil and gas extraction

The major problem that the industry has is that using fracking as an extraction method is more expensive than conventional methods of extraction. In countries such as Saudi Arabia where the cost of extraction can be as low as $10 a barrel, the industry can handle significant declines in the oil price, but in the fracking industry it can cost $60 a barrel.

This means that during a price crash, fracking firms have to cease operations immediately or risk producing at a huge loss. It is possible that in world where oil and gas reserves are declining rapidly that in future fracking firms may become more viable as convention sources run dry, but right now the two do not function well side by side.

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