Chesapeake Energy Asset Sales Could Breach Bank Debt Rules

(Chesapeake Energy story updated to reflect Chesapeake statement on Eagle Ford VPP asset monetization plan being unaltered, Argus Research and Sterne Agee analyst comments)

NEW YORK (TheStreet) -- The latest cause for Chesapeake Energy's share spiral can be summed up this way: the company is damned if they do (sell the assets it needs to sell) and damned if they don't.

It's a Catch-22 involving the way that exploration and production company debt covenants with banks are written at a time when the company needs to sell assets to close a big funding gap.

In its 10-Q filed on Friday afternoon, Chesapeake Energy said that low gas prices and a need to hold oil and gas assets as collateral against its outstanding debts could delay some planned oil and gas asset sales that were part of a $14 billion divestiture program to rebuild the company's waning finances.

"While asset monetizations enhance our liquidity, sales of producing natural gas and oil properties adversely affect the amount of cash flow we generate and reduce the amount and value of collateral available to secure our obligations, both of which are exacerbated by low natural gas prices," said Chesapeake Energy in the filing.

"As a result, we may delay one or more of our currently planned asset monetizations, or select other assets for monetization, in order to maintain our compliance. Continued compliance, however, is subject to all the risks that may impact our business strategy."

The disclosure sent Chesapeake Energy shares tumbling in late Friday trading, adding to a recent share swoon on revelations of co-founder and chief executive Aubrey McClendon's compensation and weaker than expected first quarter earnings.

Oil and gas company debt agreements are typically based on a ratio involving balance sheet strength and proven reserve levels. Chesapeake's proven reserve levels are facing two headwinds: (1) any asset sales that lead to lower levels of proven reserves; (2) the low natural gas pricing environment.

Banks use a 12-month rolling price of natural gas in setting debt covenants, and in 2011, it was at $4.50. With natural gas now below $2.50 those bank pricing assumptions are likely to be re-assessed. In addition, the E&Ps will have to remove assets - or impair them - per Securities and Exchange Commission accounting rules: if they don't plan to drill for an uneconomic asset due to pricing, they can't keep that asset in their proven reserves.