The Boom (29 page)

The second week of October 2008 was abysmal for anyone invested in the global stock market. The Dow Jones Industrial Average fell 18 percent, it worst five-day span since the depths of the Great Depression. On Friday, the tenth of October, the Dow—a group of the market’s largest, most important companies—traveled a vertiginous path in its most volatile day ever. Even in this market, Aubrey McClendon had a particularly bad week.

Shortly before noon on that Friday, Chesapeake disclosed that McClendon had been forced to sell off virtually all of his shares in the company. He had borrowed substantial amounts of money from brokerage firms, using the value of his 33.5 million shares in the company as collateral. When the value of these shares fell, triggers embedded in these loans were crossed, forcing McClendon to pay back his lenders. McClendon had maintained a margin account for years, using his Chesapeake shares as collateral to trade stocks, bonds, and commodities. He had entered the week with a 5 percent stake in the company worth $2.32 billion a couple of months earlier. His stake in Chesapeake had always been a point of pride. He linked his personal wealth to shareholders because he was a shareholder. After the sales, he owned $32 million in Chesapeake shares. “I got caught up in a wildfire that was bigger than I was,” McClendon said over that weekend.

His financial house in tatters, McClendon borrowed $30 million a week later from Centaurus Capital, the Houston hedge fund that traded in natural gas and other commodities. Centaurus was run by John Arnold, a thirty-six-year-old former Enron whiz kid trader and billionaire hedge fund manager. As collateral for the loan, McClendon put up his stake in a Centaurus fund. The filing, in the Oklahoma County Courthouse, went unnoticed for years. In retrospect, it is a stunning document. Aubrey McClendon, the CEO of one of the largest natural gas producers in the United States, was investing in a hedge fund that amassed enormous profits trading natural gas. The fund owned considerable gas assets.

This debt was the first, but not the last, that McClendon accumulated beginning in late 2008. He borrowed from individuals and firms with large energy-trading operations. He pledged his ownership stake in the Oklahoma City Thunder to Bank of America. To George Kaiser, he pledged his venture capital company, then a half interest in some of his privately held oil and gas wells, and later his collection of petroleum memorabilia. To Goldman Sachs, he pledged a large portion of his wine collection, which ran seventy-eight pages and included two six-liter bottles from the famed La Tâche vineyard in Burgundy and more than two hundred bottles of cabernet sauvignon bottled in 1983 by Château Margaux.

That “more” was McClendon’s governing philosophy is clear from even a cursory look at both his and the company’s assets. Chesapeake had acquired leases to drill on more of the United States than any other company had ever amassed—15.3 million acres—and bought a large three-story office building in Oklahoma City just to house all of the land records. Along the way, Chesapeake started buying up property in northern Oklahoma City for a corporate headquarters. Starting with a single building, Chesapeake snapped up 111 acres and built a dozen three-story redbrick buildings, with gray roofs and white dormer windows. The campus fitness center was state of the art, with squash courts and a basketball court good enough for the New Orleans Hornets of the NBA to use when they evacuated following Hurricane Katrina in 2005. Chesapeake also built a shopping center across the street, attracting the first Whole Foods Market in the state.

McClendon had also personally gone on a buying and building spree—much of which became collateral for his debts. He acquired an ownership stake in a television station and several restaurants in Oklahoma City. He created a large tree farm and opened a roadside restaurant on Route 66 with a sixty-six-foot-tall soda bottle that lights up at night called Pops that sells five hundred different varieties of soda. Near where his wife grew up in Michigan, he planned a massive lakeside development and ended up in a lengthy battle with the local township over zoning. Near Gull Lake, Minnesota, he housed his collection of eighteen antique wooden-hull motor boats, including a 1936 Ditchburn yacht valued at $1.5 million. He acquired a vacation home in Bermuda and planned another in Hawaii.

His largest personal collection, however, was the stake in wells he built through the Founders Well Participation Program, the perk that allowed him to purchase a 2.5 percent stake in nearly every well that Chesapeake drilled. In 2008 it drilled 1,733 wells. McClendon elected to participate—and the bill for his participation kept growing. He was likely already the largest single owner of oil and gas properties in the United States. Four years later, Chesapeake disclosed that his small slices of thousands of wells produced the equivalent of the 147 million cubic feet of natural gas a day, enough to supply all residential customers in Connecticut or Kentucky.

For many executives, the fall of 2008 was a humbling time, a time to reassess business strategies and survive the financial storm. Chesapeake charged forward, but investors were increasingly unhappy. In late November, just a few hours before the market’s Thanksgiving holiday, Chesapeake filed forms with the federal security regulators to allow it to issue $1 billion in new shares. Shares prices plunged when trading reopened. Within a few days, Chesapeake reversed itself and said it would slash spending. “These filings were a mistake,” McClendon said in a conference call with investors. “I apologize for that and ask your forgiveness for it.”

Chesapeake’s shares dropped fell by 59 percent in 2008, and McClendon exited the year with a dented ability to convince investors that he could guide the company in the right direction. But the Chesapeake board members decided to reward McClendon. In early 2009 they gave him a new five-year contract and a onetime $75 million “retention” bonus. The money would help him pay his obligations to the Founders Well Participation Program. The company also agreed to buy McClendon’s collection of antique maps for $12.1 million. The board’s generosity made McClendon the highest-paid CEO in the United States in 2008.

The maps, the special retention bonus, and other problems came to a head in June, when the pro- and anti-McClendon camps gathered for Chesapeake’s annual shareholders’ meeting. These events are usually highly scripted affairs, a cavalcade of praise for the executives. That year’s meeting was tempestuous. One longtime investor assailed McClendon for confusing rising gas prices with his own success. “Your greed and your ego took over, and you bet the farm that your success would continue,” said Jan Fersing, a Fort Worth businessman. “So, your two-billion-dollar fortune was not enough; you wanted more. But this time your hand got stuck in the cookie jar, and you couldn’t let go until your own cookies were taken in the process. And after your embarrassing losses, but with a carefully picked and extremely well-compensated board of directors, Chesapeake shareholder funds were partially used to cover your losses.”

McClendon remained calm.

“I’ve worked one hundred hours a week, at least, since 1989 building this company. I’ve sacrificed a lot to do that. I sacrificed five hundred million dollars that I lost last fall as a result, not because of bad decisions but because of things beyond my control in this country’s economy and with regards specifically to natural gas prices. So, I’m sorry that you find me as egocentric and greedy. But, I’ll tell you there’s not a harder-working guy out there who thinks every day about how to create shareholder value,” he replied.

After a couple more shareholders praised Chesapeake, the final member of the audience spoke. “Hi. My name is Ralph Eads. I’m a longtime shareholder of the company. Virtually everybody in my family owns the stock. It’s been, for like some of the other folks here, transformative for me. I am a longtime professional in the oil and gas business; I know a lot about the industry, and I know a lot about this company. And I’ll just say it is the finest company, and Aubrey is the finest CEO. And I’m here today—I made the trip from Houston—to thank the board for the compensation arrangement they did with Aubrey. It kept him—it will keep him in the saddle for the next five years, and that will make everybody in the room and all the shareholders a lot of money. So, I know it was a difficult decision for you guys, and controversial, but I want to tell you I appreciate it a lot. Thank you.”

McClendon thanked him for his comments, without noting his longtime friendship or business relationship, and moved on.

Chesapeake continued its strategy of spending more than it brought in—and closing its funding gap by selling off assets. Over the next couple years, it sold six volumetric production payment deals for $3.6 billion. These agreements with large Wall Street banks provided Chesapeake immediate cash in exchange for future gas production from its wells. Chesapeake used the cash it received to fund a still-ambitious growth campaign. As Chesapeake did more VPPs, the amount of gas it promised to deliver grew—as did its obligation to pay to pump this gas and deliver it without getting any money. Few paid attention to these deals. One exception was Pawel Rajszel, a young security analyst in Toronto, who issued a scathing report to his clients in April 2010, arguing that these deals put the company in significantly more debt than it cared to acknowledge. Pointing out that Enron had pioneered the VPPs a decade earlier, he wrote, “Due to what we consider an accounting loophole, Chesapeake is effectively able to hide its VPP liabilities from its balance sheet—something even Enron Oil and Gas Company did not do.” While investment professionals didn’t pay much attention to Rajszel’s prescient warning, Chesapeake’s debt-rating agencies agreed these deals should be accounted for as debt. McClendon spent considerable time trying to change their minds. When he didn’t, he told investors these debt watchdogs were wrong. “They see VPPs largely as debt, which is kind of nutty,” he said in 2010.

Chesapeake also sold off assets and, with the help of Ralph Eads, lured foreign investors as partners in Colorado, Pennsylvania, Louisiana, Arkansas, and Texas. Beginning with a deal to sell 20 percent of its acreage in the Haynesville Shale, in northern Louisiana, to Plains Exploration & Production Company for $3.16 billion, McClendon attracted buyers for the land he had built up. By the beginning of 2012, he had struck deals to sell off minority positions in Chesapeake assets worth more than $20 billion. Other companies copied this strategy of bringing in joint-venture partners, but Chesapeake pioneered the practice and was the most active. Chesapeake was good at using its landmen to snap up acreage in newly discovered shale fields before anyone else and then selling off a chunk to companies from China, France, or Norway to recoup its investment—sometimes even before it drilled more than a handful of wells. By 2011, the shale revolution had succeeded at finding too much natural gas. Prices were falling. After promising investors it would live within its means, McClendon said that Chesapeake needed to capture new opportunities. And it kept spending more than it made, leasing and borrowing and selling what it could.