GMI Ratings Governance Update | Chesapeake Energy Corp.

Chesapeake Energy Corp. (CHK) downwardly revised its earlier estimates about the value of its natural gas and oil properties by more than $2 billion in the three months ended September 30. The U.S. energy company’s high risk of delivering such surprises has been manifest for years and continues.

Chesapeake explained its need to adjust estimates as primarily due to a decline in natural gas prices, and also included an updated evaluation of leased properties in which the company had not found proven reserves. The sum of Chesapeake’s losses including estimate revisions amounted to nearly $2.1 billion during the September quarter compared to its profit of $879 million the same period last year.

To be sure, Chesapeake isn’t the only one. Some rivals, such as Canada-based Encana, also revised their estimates of properties this month while noting the decline in gas prices.

But when Mr. McClendon needs to change what he said, he does so against a backdrop of warning signs that make it hard to feel conviction about his explanations. It doesn’t help that Chesapeake spent more money on its operations than it gained in revenue during the September quarter, suggesting that the company’s problems go beyond external factors such as gas price fluctuations. CFO Nick Dell’Osso explained on a conference call that Chesapeake had experienced costs because it took more time than anticipated to remove oil rigs from properties starting in mid-to-late spring.

 An analysis of Chesapeake statements shows that Mr. McClendon tends to present his performance in the best possible light at the risk of disappointing later, rather than taking a conservative stance. Chesapeake’s financial statements reflect an AGR ® score of 6, indicating higher accounting and governance risk than 94% of comparable companies. As we pointed out in May, Chesapeake’s AGR score has reflected aggressive accounting since June 2011.

One recent contributor to the low score is new litigation this spring, after Reuters published reports that Mr. McClendon borrowed as much as $1.1 billion in unreported loans over the last three years and secretly ran a $200 million hedge fund that traded in the same commodities that Chesapeake produces.

Even before such headlines, Chesapeake’s financial statements looked risky. For example, the money that Chesapeake said it expected to collect within a year has amounted to more than 20% of the trailing twelve-month average of its total sales in every quarter since March 31, 2011, while the industry median has never been above 15.9% during the same time frame. Such build-ups in accounts receivable can signal possible revenue recognition issues.

In 2007 we also warned about Mr. McClendon’s unusually high compensation — an indicator that his board allows him significant freedoms. And the following year we noted that his 2008 bonus was structured to partially offset his obligations to the company under the Founder Well Participation Program that Reuters called attention to in recent months. More detail is available in this article.

Chesapeake, which was rated a “D” in 2007 on its environmental, social and governance (ESG) risk overall, is more recently an “F”. Whether Mr. McClendon will need to revise another estimate down the line is an open question.

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