NEW YORK (TheStreet) -- Chesapeake Energy (CHK) is often cast as the poster-child for poor corporate governance, or drawn as a caricature of the reckless, megalomaniac, self-enriching CEO. Take your pick, but if you're an energy sector investor riding a recent rebound in shares of oil service companies banking on shale contracts, it's Chesapeake Energy's financial woes that should get your attention.
As activist investors like Carl Icahn pile into Chesapeake Energy and push for the second largest land driller in the U.S. after ExxonMobil (XOM) to focus on closing a debt-fueled spending gap, the situation is indicative of the leverage levels at many U.S. exploration and production companies.
In fact, Chesapeake Energy's well-publicized funding gap isn't an outlier but an emblem of wider issues in the shale oil and gas boom that imply an industry-wide downturn is possible in coming quarters. In particular, it could spell earnings trouble for oil service stocks rigged to the still-high rig count across the U.S.
Oil and gas exploration companies are spending on drilling programs far in excess of cash coming into the their coffers, with average spending 43% higher than cash flow, according to Guggenheim Securities data.The funding gap may create a big hangover for onshore rig contractors like Halliburton (HAL), Baker Hughes (BHI), Nabors Industries (NBR), Helmerich & Payne (HP) and Patterson-UTI Energy (PTEN). These companies may see earnings fall 30% short of consensus in coming quarters, according to Guggenheim's bearish analysis. Many large shale players aren't oil giants with fortress balance sheets, but often smaller drillers that have been using low interest rates and a high-yield debt boom to finance drilling programs and rig contracts. Now, with debt ratios and spending deficits near cyclical highs, these companies may need to start pulling drilling rigs to conserve capital, creating pricing pressure on rental rates and usage. It's a trend that has been in place since late 2011, however, Guggenheim's point is that a recent bullish trade in the oil service stocks defies the likelihood of the rig count continuing lower as debt loads remain untenable. "We continue to believe that the U.S. rig count is in the process of a protracted correction," writes Guggenheim Securities analyst Michael Lamotte in a Sept. 4 note to clients. "The key pillar of our thesis is the unsustainability of the growth in debt, which has allowed E&P capex to remain well above levels supported by cashflow since [the second quarter of 2011]," he adds. With the process already underway, the question is just how dramatic the shale-drilling pullback will be. In recent months, the U.S. onshore rig count has fallen by 90 rigs or 5%, according to Guggenheim Securities calculations. In July, Haliburton, the world's second largest oil service company and the most-reliant on U.S. shale drilling for earnings, reported falling North American-based contracting earnings and margins on a 17% drop in its rig count, but the company also forecast a North American uptick in 2013. Speaking earlier this week at a Barclays energy conference, Halliburton CFO Mark McCollum said a decline in North American activity will likely impact third-quarter profit margins between 2.5 and 3%. In Baker-Hughes latest weekly update on U.S. activity, the rig count continued lower, down by 74 rigs from the same period last year.
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV