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Permalink Reply by DrWAVeSport Cd1 on October 6, 2011 at 3:50

Energy
The Two Sides of Aubrey
Forbes.com Christopher Helman, 10.24.11, 6:00 PM ET

 

 

BEFORE WE SIT DOWN to a dinner of steak and fries, billionaire wildcatter Aubrey McClendon handles the wine bottles arrayed on the table of Oklahoma City's well-worn Deep Fork Grill. "This one's okay, a $10 wine. Here's another $10 wine." He grins: "It's up to you, Chris: We can drink cheap wine, or we can drink good wine."

McClendon's proposition was rhetorical. He co-owns the restaurant and had already picked the wine, which was decanted two hours ahead of time. Only the royal stuff: a 1989 Petrus, a 1989 Haut Brion and, conspicuously, a 1982 Lafite Rothschild. Easily ten grand worth of tipple.

Erudite and confident, with rimless glasses pinned to a face that looks far younger than his 52 years, McClendon is charming. And he's not shy about spending money. Professionally, he's combined those attributes to stunning effect, building Chesapeake Energy into the nation's second-biggest producer of natural gas after ExxonMobil, pumping 3 billion cubic feet per day out of the 13.7 million acres it controls--a landholding roughly equivalent to West Virginia.

The more time you spend with McClendon, the more your head spins, less with classy spirits than dazzling stats. Chesapeake boasts a $17 billion market cap, on track to generate $2 billion in profits on $9.5 billion in revenues. It employs 12,000 people, including 4,500 land scouts scouring every acre of America for drilling potential and added 3,300 employees so far this year. FORBES estimates McClendon's personal fortune exceeds $1.2 billion, including his 2.5% personal stake in nearly every Chesapeake well, real estate and 19% of the NBA's Oklahoma City Thunder, which he helped move from Seattle to his hometown amid much acrimony. He is without a doubt the most admired--and feared--man in the U.S. oil patch.

But he's also the most reckless, the alpha wildcatter with an off-the-charts risk tolerance. It proved nearly fatal in 2008, when extreme leverage, aggressive financing and plunging oil and gas prices combined to crush Chesapeake shares by 80%. McClendon was forced to sell nearly all of his own shares to meet margin calls. The company had to write down billions.

Even as Chesapeake has rebounded heroically, acquiring and developing vast new shale formations responsible for boosting gas supplies to alltime highs, I've been critical of McClendon, called him everything from dangerous to overpaid and suggested that the company he built would fare better without him.

Determined to show otherwise, McClendon, who maintains that "a key to success in any walk of life is having a short memory and a thick skin," responded with the Bordeaux-fueled charm offense. He threw open the doors of Chesapeake, making available two dozen executives--the chief operating officer, general counsel, senior engineers, the pipeline chief, even Chesapeake's athletic director--as well as the mayor of Oklahoma City, the former state attorney general and the architect who helped design Chesapeake's beautiful campus. We took a helicopter out to a drilling rig. We filled up an SUV at a compressed natural gas station. Chesapeake even unilaterally moved me to a nicer hotel downtown (FORBES picked up the tab, of course).

He may have changed my room, but McClendon didn't entirely change my view of his company. What's impressive: He got off the mat to lead the charge of America's natural gas revolution. What's troubling: McClendon doesn't seem to have learned from his near-death experience.

MCCLENDON COULD HAVE had an easy life in the energy business. His great uncle Robert Kerr, a governor of Oklahoma, founded oil giant Kerr-McGee; his dad became an executive there. But after graduating from Duke with a major in history, a minor in accounting and a short stint watching a more-entrepreneurial uncle crash out during the 1982 oil bust, McClendon set out on his own as a landman. The lowest level of oil-business dealmakers, landmen scout acreage, figure out who owns the mineral rights and then lease it, paying the owner a bonus plus the promise of a royalty.

After too many bidding wars with another young landman, Tom L. Ward, the 23-year-olds threw in together, and in 1993 Chesapeake went public. (Ward split with McClendon in 2006 and started his own company, Sand-Ridge Energy. Ward sidesteps questions about disagreeing with McClendon: "I have no doubt they know what they're doing. They're a smart management team.")

Through the 1990s Ward and McClendon gobbled up land across Texas and Louisiana and utilized new horizontal drilling techniques. But they mostly came up dry--a huge problem when oil and gas prices slumped, especially as they were wildly leveraged, with debt levels exceeding assets. By the end of the decade company shares had lost 90% of their value.

But McClendon's landman background would prove fortuitous. Most energy company CEOs are geologists and engineers: For decades successful wildcatting meant figuring out where the oil and gas was. But technology has made finding and extracting the stuff easier, and birthed a boom in drilling shale--thin layers of rock a mile or more underground that reach for miles across the landscape. With enough estimated shale gas to satisfy 20 years of supply, industry greatness now revolves around grabbing vast amounts of land (the biggest field, the Marcellus Shale, stretches from New York to West Virginia). "I felt like I had a natural advantage over most of them," says McClendon, "because I understood how to put together a very formidable land machine to capture the flag in big plays."

McClendon's land machine was humming along in July 2008, when oil peaked at $147 a barrel and natural gas at $14 per thousand cubic feet. That summer he did a joint venture with Plains Exploration, valuing some of his property in Louisiana's Haynesville Shale at $30,000 an acre--a level unseen before or since. Its stock flying--it would soon hit $70--Chesapeake raised $2 billion in an equity offering.

Ever confident, McClendon doubled down: His personal balance sheet resembled Chesapeake's as he borrowed against his existing holdings to buy another 750,000 shares in that offering. Lousy timing: By October, as the economy imploded, with energy prices falling in lockstep, Chesapeake's stock price halved, and McClendon was hit with margin calls. As 30 million of his shares (more than 90% of his holdings) were liquidated, Chesapeake's share price halved yet again, down to $11. (A class action alleges the company didn't clarify the risks posed by McClendon's margin loans.) As his fortune vaporized, McClendon didn't flinch. "I never saw him blink," says Michael Stice, CEO of Chesapeake's pipeline company. "He was a rock."

It helped, of course, that McClendon's handpicked board quickly salved his hardship. For 2009 he was rewarded with a $100 million pay package, including a $20 million stock grant. The company paid another $12 million in cash to buy his personal collection of antique maps of the American Southwest. Most critically, he also got $75 million, over five years, toward an unusual perk that allows McClendon to invest his own capital (or in this case, the capital that the company gave him for this purpose) alongside Chesapeake for a 2.5% stake in every well the company drills. He can't pick and choose--it's all or nothing. He's been doing this since Chesapeake's founding, giving him personal well stakes worth some $500 million, key to his resurgent $1.2 billion fortune.

"You could say I'm the only CEO in America who truly participates alongside his company in the day-to-day business activity on the same basis as the company," says McClendon. Then he adds, a bit sanctimoniously, "Would we have had the financial collapse in 2008 if every CEO of a bank, of a mortgage company or a securities firm had been forced by his board to participate personally in some proportionate part of every loan made, every mortgage-backed security sold or every real estate deal financed by those firms?"

A fair point that Wall Street reformers have made--but one that mischaracterizes his own exposure. Yes, he and his shareholders are aligned when it comes to the wells. But McClendon's participation has nothing to do with Chesapeake's exposure above the ground, and it's those highly complicated land deals that present an enormous risk--and need a deeper look.

ON A HOT AUGUST MORNING a couple of Chesapeake execs and I take off in a helicopter heading out west from Oklahoma City. Rigs once again dot the landscape, but they're going after far deeper and trickier targets, like Woodford Shale or the Granite Wash, than drillers did back in the early 1980s heyday. This is Chesapeake's real estate grab at work.

McClendon's land machine starts with 4,500 agents supported by a unique database of 20 million property records, scanned from a century's worth of county courthouse ledgers. McClendon's team can figure out who owns title to land in prime shale territories--without the competition knowing they're looking. "It's hard to compete with them, they send an army," says Richard Hunter, vice president at Carrizo Oil & Gas, a smaller Houston rival. "You need to get there a couple days before they do."

Over the past five years Chesapeake has entered into 600,000 leases covering 9 million acres, paying out $9 billion in lease bonuses to landowners in the process--so much land that it would take Chesapeake 30 years to drill it all. And the more new shale plays uncovered, the more land McClendon continues to acquire. Chesapeake has piled on $10 billion in long-term debt and raised billions more through financial finagling to gobble up its acres. McClendon argues it's money well spent because there's only a small window to get good acreage for low prices. As Jeff Mobley, his investor relations spokesman, explains: "If we lived within cash flow we'd miss the opportunity."

As with other levered financial concoctions, that dicey strategy works only if the price of the underlying asset stays high. When the market booms, it's fine. Consider the Eagle Ford Shale play in south Texas, where Chesapeake spent $1.7 billion to acquire 700,000 acres in 2010. The industry fell in love with the spot because much of it contains "wet" gas rich in liquids like propane and butane that sell for a big premium to natural gas. In November 2010 McClendon forged a joint venture in which China's state-owned Cnooc paid $1.1 billion upfront for a one-third stake in Eagle Ford and pledged to put up $1.1 billion more to pay for drilling costs. Presto! Chesapeake got back nearly all its initial investment, hitched a ride on drilling costs, yet still managed to hang on to two-thirds of the play.

Since 2008 McClendon has raised more than $10 billion through asset sales and $6 billion in drilling carries via similar joint ventures with the likes of BP, Statoil and Total. He's raised billions more issuing stock (expanding shares outstanding by an average 12% a year versus 2% for the industry). But it's still not enough, and the difference comes from borrowing--Chesapeake's debt-to-capital ratio of 40% is the highest in its peer group.

It gets more exotic from there, as Chesapeake avails itself of innovative financial tools on a massive scale. Chesapeake is set to raise some $500 million this year in the IPO of a royalty trust, where investors buy the rights to future proceeds from specific fields. And they are big in options and derivatives, collecting premiums today by selling call options down the road. Such hedging has generated $7.7 billion in realized gains since 2006. But some contracts, like selling 2015 crude oil calls at $85 per barrel, undermine the company if oil prices soar again.

More notably, it's raised $6 billion from so-called volumetric production payments, or VPPs--selling the rights to 15 years or so of future production from a particular field in exchange for cash upfront. Chesapeake's peers don't often engage in such odd financing; they don't need to. "No one's done as many as we have," boasts finance chief Domenic Dell'Osso. Adds investor relations guy Mobley: "If there's incremental value to be gained, we're willing to be more complicated."

SOME CHESAPEAKE SKEPTICS compare the company to Enron, something that sends the usually affable McClendon into a "highly insulted" rage. "We are the definition of the anti-Enron," he says. "They sold all their oil and gas assets; that's all we have." In the largest sense McClendon is correct: Enron is a two-syllable synonym for fraud, and as much as Chesapeake's tactics can be criticized, they are transparent, and I've never found anything or heard anyone that suggests illegal behavior.

Instead much of the similarity is cultural: Just as Enron in Houston a decade ago, Chesapeake is the surging company in an energy-reliant town, popping its name on the local pro sports arena, filling up the skyline (McClendon's campus feels more like a university, with 20 low-slung buildings, mostly in Georgian style) and gobbling up the local smartest guys in the room. Some of those comparisons also stem from complicated accounting. Sharp-penciled analysts like Phil Weiss at Argus Research and Bob Brackett of Bernstein Research both consider those VPPs to be off-balance-sheet debt--loans to be repaid in gas instead of cash. Through them, Brackett says, Chesapeake is "effectively helping to achieve [its promised] debt reduction by sweeping debt from onto off-balance-sheet vehicles." (The company disputes this.)

S&P and Moody's also consider VPPs to be off-balance-sheet debt. Last year, when Chesapeake used VPP proceeds to retire debt, Moody's balanced that out by counting the VPP as new debt. It also tagged Chesapeake on retiring $2.6 billion in debt with proceeds from issuing convertible preferred stock, counting it as 50% equity and 50% debt. Audit Integrity, a watchdog group, ranks Chesapeake's accounting "aggressive." Carl Icahn saw the danger. In 2010 the activist investor bought a 6% stake for $1 billion and agitated for slashing the debt. By the spring, he'd convinced McClendon to sell $5 billion in assets and sold his own shares--for a $500 million gain.

The land business amounts to a shadow company within Chesapeake, sucking in some $6.5 billion in cash a year for land acquisitions and spitting out $5 billion in proceeds from acreage sales. That's almost as much cash in and cash out as the supposedly core oil-and-gas business (see table, p. 90). But you wouldn't know it from the income statement. No land acquisitions or sales show up there. That's because Chesapeake uses the so-called full-cost accounting method rather than the more common "successful efforts." Full cost is legit, but it has the effect of obscuring the extent of Chesapeake's land deals and the impact of the debt load it carries to finance them. Instead of being listed as expenses deducted from revenue, all of Chesapeake's big costs--of land and drilling and its $700 million a year in interest payments--are capitalized on the balance sheet.

The effect is that net income looks higher (or lower, depending on the deal). If Chesapeake used successful efforts, the proceeds of selling land would flow through the income statement and end up as higher earnings per share--$14 billion since 2008. Instead that $14 billion is deducted from its carried costs, effectively reducing its cost basis on the rest of its acreage. This is how Chesapeake can boast the industry's lowest cost reserves.

The accounting method also hides mistakes--like the $325 million Chesapeake spent buying land in Michigan in 2010 that didn't pay off. Chesapeake now faces 100 lawsuits for trying to back out of some leases.

Even when the company finds gas, it sometimes doesn't pay to drill. For instance, the company needs natural gas prices of only $2.25 per thousand cubic feet to break even in the Marcellus (prices are currently around $4). But in Louisiana they need $3.50 and in Texas, $4.50. Yet McClendon's crews have been drilling at a breakneck pace in the latter two, even at a loss.

Why? Use it or lose it: Chesapeake must contractually sink at least one well on each leased section within three years or forfeit the rights. Extrapolate this across the nation's gas plays and it's easy to see why prices may stay low and why McClendon's land machine, the heart of Chesapeake's greatness, could take the company over a cliff.

THE OTHER POSSIBILITY, the tantalizing one that makes McClendon such a magnetic figure, is that he could solve America's short-term energy needs. Shale plays are thought to hold enough gas to satisfy 20 years of U.S. demand, and McClendon tirelessly boosts plentiful, clean-burning natural gas as a magic bullet that can rid America of dirty coal and imported gas. He has taken his case to state houses, Congress and the public, through his ubiquitous TV ads. Listening to him proselytize, while sipping the finest wine on Earth, it's easy to forget the epic paychecks or that Chesapeake has twice gone into cardiac arrest on his watch. "We have found something that can liberate us from the influence of OPEC, that can put several million Americans back to work, liberate us from $4 gasoline," McClendon says. "Is it too good to be true? Sometimes it seems that way."

---

The Script: Wild Cat

ACT I
Rejecting a comfy path at Kerr-McGee (founded by his great uncle), McClendon struck out on his own as a land speculator, buying leases to drill for oil and gas. He succeeded, failed and succeeded again.

ACT II
Over three decades he built an awesome land machine, gobbling up 13.7 million acres to drill mostly for natural gas--a fuel that is plentiful, cheap, clean and, McClendon says, can power America.

ACT III
But McClendon leveraged his company--and himself--dangerously; the 2008 recession devastated both. Chesapeake has come back--but it’s taking many of the same risks. Will history repeat?

 

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Permalink Reply by DrWAVeSport Cd1 on October 6, 2011 at 4:24

GHShalers can read "Q&A" Interview with A. McClendon and Christopher Helman @

http://blogs.forbes.com/christopherhelman/

 

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Permalink Reply by Hopeful About Natural Gas on October 6, 2011 at 15:48

Great interviews!  Thanks for posting this.  I must admit that I am undecided if Aubrey is a prophet or a (fill in the blank) .  Clearly shale gas would not be where it is today without him.

However, I did learn in these interviews that he studied accounting in school and sees himself as more of a financial/numbers man rather than the old style of O&G professional.  That may account for the bewildering array of subsidiarity companies around CHK.  It's one accountant's day dream and another's nightmare to figure out.

 

I knew zero about NG three years ago but I have really enjoyed learning about the human characters in this business.  Aubrey is a 110% American.  Only America could have produced him (like Steve Jobs, although they are very different politically).  I hope Aubrey pulls off the shale gas revolution and it does what he hopes it will.  Aubrey will either succeed big or fail big.  Either way it promises to be a heckva fireworks show :)

 

-- HANG 

(one of these days i am going to remember to check out what the anacronym could mean when i choose a screen name!)

 

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Permalink Reply by DrWAVeSport Cd1 on October 7, 2011 at 7:50

--HANG,

(Your moniker is memorable as is its acronym, IMHO.  I wouldn't change it, especially considering the "hanging" on shale mineral owners do!)  LOL

Per this Forbes "Aubrey" article, I agree with your impressions.

I read more about Mr. McClendon and his multitude of financial endeavors than anyone ever needed to.  No wonder, CHK picks up a hefty tag for Mr. McClendon's personal accounting needs.  I would charge three times the amount! LOL   IMO, his accountants are being underpaid.  LOL

I am always quite conflicted with this individual who I like to call "The Man Who Would Be King."  He has the "chutzpah" and energy that this "shale gas revolution," as you say, needs in order for its success.  But, he also is the picture of an ADHD personality, the all-over-the-place, all-the-time, constantly moving, constantly changing, all consuming, self-important, my-way-or-the-highway behaviors.  Did I hit all the bases with that one? LOL

I never get the impression that Mr. McClendon sees anything through the eyes of his stakeholders.  He only sees things one way...HIS way.  Bad problem, in my opinion. 

I tend to look at His or Any CEOs' Stakeholders (once a Company goes Public) as the true providers of the assets, the opportunites, the avenues for which Corporations become successful.  Not the CEOs.  And, yet, the game-changers are truly necessary too.  So what's my beef?

Equity in the use and distribution of the "Publicly-Held" assets, opportunities and avenues used by CEOs to become the controllers of 99+% of the world's wealth.   Mr. McClendon operates like a sole proprietor, the ship sails on his command, or the ship sinks on his command.  Dangerous and inappropriate, to say the least. 

I demand good faith efforts of CEOs to run Publicly-Held Business for the benefit of their Stakeholders first.  Save the world second.  And, line their own pockets a distant third.  IMHO, alone.

Mr. McClendon seems to be lining his own pockets first, saving the "energy" world second, and leaving the stakeholders last.   He doesn't compromise, he sues.  He IPOs more vertically integrated subsidiaries than I can comprehend, and blurs the financial waters so no direct lines can be followed, and these subsidiaries are "netting out" stakeholders into the poorhouse...again, IMHO.  And, to top it off, one would need a Frac truck to carry around all the Partnerships and Private Company venture books Mr. McClendon is owner/part owner of.  

I don't believe the "books," and I don't believe Mr. McClendon has the altruistic desire necessary for the "shale" story to become what he "professes" in the public domain, that his desire for "shale" is to become.

Ergo, my prediction for "The Man Who Would Be King."         

Hopeful About Nat Gas...Here's "Hoping" I am wrong.

DrWAVeSport Cd1  10/7/2011

 

  

 

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Permalink Reply by Hopeful About Natural Gas on October 7, 2011 at 10:11

Aubrey may have ADHD??   You might be onto something there.  His risk taking, occasional brilliant strategies, his desire to change the world, his swinging for home runs instead of singles and doubles and his creative changes to O&G operations would all argue for ADHD.

 

One thing I thought was interesting.  Aubrey denies he is interested in making history as much as he is in making profits for the shareholders.  Nope.  I think he's motivated by history but the shocks of the past several years have drilled into him the notion that corporations exist for the benefit of their shareholders.  It is a knee jerk statement that he's learned to say to a business audience (Forbes)  Aubrey wants to be remembered like Steve Jobs or Walt Disney and others who changed their industry.  His eye is far down the road.  I like that myself, but I can see how it conflicts with the goals of shareholders who want profits next quarter.

 

I got a kick out of his passion for expensive wines.  I live in a wine growing area and can't stand the stuff.  Wine is a terrible use of good grapes that could be making peanut butter and jelly sandwiches :)

 

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Permalink Reply by bryan on October 12, 2011 at 7:16

Driven individuals such as Aubrey create a great deal of stress and heartache for those they become involved with.  Many failures and many successes.  His failures left many broke and heartbroken, I'm sure.

Okay.  I'll just come right out and say it:  He's probably a jerk.

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Permalink Reply by DrWAVeSport Cd1 on October 12, 2011 at 12:45

Bryan,

Thank your for putting "it" so nicely.  LOL

Maybe, the "jerk," will "donate" the remaining millions of $$$$, he and his 'family' members received over the past half dozen years in Oklahoma tax CAPCOS funds....

Peek in on the "prowlingowl.com," for a complete history and look for the MILLIONS in tax moneys that McClendon received and how the "scam" worked...

It is truly nauseating to read.  There, my GHS friend, lies the "oxymoron."

Maybe "The Two Sides of Aubrey," would be more apply tagged  "The Two Faced Aubrey." 

DrWAVeSport Cd1 10/12/2011

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