The struggle to recover continues for Chesapeake (NYSE:CHK). Since the 2014-16 energy price collapse nearly forced the company into bankruptcy, Chesapeake stock has found itself mired in the single digits.
Indeed, its enormous debt and sometimes plunging oil prices affected the stock price. If oil prices remain near current levels and the company sells more assets, Chesapeake can stabilize its balance sheet.
However, one overlooked phenomenon could sabotage the higher oil prices needed to right its ship—the value of the U.S. dollar.
Chesapeake Stock and the Petrodollar
Investors sometimes refer to the U.S. dollar as the petrodollar. When the U.S. government ended the gold standard in 1971, the value of the dollar sank due to the country’s fiscal issues.
To stabilize the currency, the Nixon Administration struck a deal with Saudi Arabia in 1974. Under terms of the agreement, the U.S. dollar became the currency by which all oil would trade.
One side effect of this agreement became the dollar’s inverse relationship to the price of oil. If the dollar increased in value, the price of oil fell and vice versa. This negative correlation showed up almost immediately. Oil prices moved higher when inflation weakened the dollar in the 1970s, for example.
In more recent times, the dollar index, a measure of the U.S. dollar’s value, has increased from below 90 in March to almost 97 today. Though not a perfect correlation, this has begun to affect oil prices.
Since July, crude prices have fallen from almost $75 per barrel to about $66 per barrel. Natural gas prices have remained stable during this time. However, fear of further dollar increases has weighed on Chesapeake stock.
Investors do not have to go far back in history to see why. Between June 2014 and March 2015, the U.S. dollar index rose from below 80 to briefly above 100. In that same period, oil prices fell from above $107 per barrel to below $46 per barrel. Natural gas prices fell from the $4.75 range to around $2.75 per thousand BTUs.
Consequently, CHK stock fell from above $31 per share to below $14 per share. Chesapeake stock fell much further as once manageable debt loads suddenly became unbearable. These fears of bankruptcy took the stock below $2 per share by early 2016.
Doubts About Chesapeake’s Recovery
Fast forward to today where Chesapeake stock has staved off the immediate bankruptcy fears and returned to profitability. Still, holding about $9.2 billion in long-term debt weighs heavily on a $4.1 billion company.
The price-to-earnings (PE) ratio of around five likely shows that many investors still harbor doubts about a Chesapeake recovery.
Investors have a solid basis for this doubt. Chesapeake could again face danger if low oil prices wipe out company profits. Consequently, it could leave the company in a position where it struggles to service debt.
Such a challenge could easily take Chesapeake stock back below $2 per share or even to bankruptcy in more extreme cases.
In a weak dollar scenario, I would buy Chesapeake stock hand over fist. As the “Saudi Arabia of natural gas” the U.S. has positioned itself to become a natural gas powerhouse.
However, Chesapeake cannot provide this energy profitably at low oil prices. Moreover, economic contagion in countries such as Turkey and trade wars with China could send more investors into the dollar.
The dollar’s rise inspired me to close my own position in Chesapeake stock. I may buy back in if the dollar falls again. However, with the dollar remaining the most popular haven in an increasingly dangerous world, I want to stay away from Chesapeake stock or the energy industry in general.
The Bottom Line on Chesapeake Stock
Although analysts tend to look at different factors, the biggest danger to Chesapeake remains a strong U.S. dollar. Since the emergence of the petrodollar, higher energy prices have only occurred in times of dollar weakness.
A more dangerous world will likely send investors into the dollar and drive oil to low price levels. With its massive debt load, Chesapeake cannot afford a sustained period of low oil prices.
If oil prices resume their move higher, Chesapeake stock could become one of the better recovery plays. However, with bullish movements in the dollar pressuring oil prices, I have to recommend that investors avoid this company for now.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.