The Frackers: The Outrageous Inside Story of the New Billionaire Wildcatters (33 page)

Even skeptical members of Chesapeake’s board of directors were wowed by the deal, deciding that McClendon’s push into shale formations was as shrewd and lucrative as he had promised it was going to be.

In July 2008, the Energy Department reported that U.S. gas production had jumped 8.5 percent to 1.86 trillion cubic feet, the highest monthly output since May 1974.
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It was becoming clear that shale formations might change not just companies, but the country itself.

Despite growing production, natural gas prices leaped to $13.58 per thousand cubic feet in the first week of July, while crude hit a record $145 a barrel amid frenzied speculative trading by investors sure that supplies wouldn’t be able to satisfy demand from emerging markets.

McClendon shared the belief. On a conference call to discuss his company’s second-quarter results, he predicted that natural gas prices would stay in a “$9 to $11 range.”

“We’re pretty confident that much below $9 you’d see a drop-off in drilling activity,” he said, something that would keep prices elevated.

Rising energy prices and enthusiasm over the Plains deal helped Chesapeake hit an intraday record of seventy-three dollars a share on July 2, up from forty at the beginning of 2008. Chesapeake took advantage by selling over $1.5 billion of new shares to investors, part of the $2 billion it sold that year to bolster the company’s balance sheet. McClendon was the largest buyer of these new shares.

•   •   •

O
ne day that summer, Marc Rowland, Chesapeake’s chief financial officer, left his office in search of his boss. He walked past the cubicles of three executive assistants they shared and found McClendon’s door closed, as usual.

Rowland knocked and entered. After discussing some corporate business, he delivered some advice. “Aubrey, you should sell some stock,” he told McClendon.

Rowland had been paring his own cache of Chesapeake shares, selling over a hundred thousand shares in the second quarter of 2008 alone, as if he had a premonition some bad news was coming. He also had been pushing the company to issue more shares, to raise cash while the stock was still hot. He urged McClendon to do the same, or at least enter into a transaction with a bank to hedge his position using financial derivatives. “You never know” when something bad could happen, Rowland told McClendon.

Rowland had been gently repeating this advice to McClendon for several months. Once more, McClendon waved him off with a smile. You’re being “too conservative,” he teased.

By then, McClendon was telling Wall Street analysts that the entire energy industry had been transformed. Instead of drilling down and just hoping to find gas, shale production had become as reliable as an assembly line. “We consider ourselves to be in the gas manufacturing business,” he told analysts. “We think that’s pretty impressive and hope you do as well.”

Mark Papa and EOG were looking for crude. Two months earlier, Bob Simpson, the hard-charging executive running XTO, Chesapeake’s biggest natural gas competitor, had spent almost $2 billion to buy over 350,000 acres full of oil in the Bakken from Tim Headington’s Headington Oil.

But McClendon believed in natural gas. When Eads offered Chesapeake an opportunity to buy some oil wells around that time, McClendon turned it down. Over the spring and summer of 2008, McClendon doubled down, spending about $200 million for another four million shares of his company, like a salesman backing up the truck for his own product. McClendon predicted to Swanson that the stock would hit $100 a share.

In early July, McClendon’s thirty-three million shares were worth a staggering $2.3 billion—all from an initial investment of just $50,000 made with Tom Ward nineteen years earlier. Including his other investments and holdings, McClendon was worth more than $3 billion. He had become one of the wealthiest men in the nation. He was all in.

•   •   •

T
om Ward, Chesapeake’s departed cofounder, was just as confident about the outlook for energy. Shares of Ward’s new company, SandRidge Energy, were soaring as investors bet it was the new Chesapeake.

Ward began 2008 with more than thirty-three million shares, worth a heady $1.2 billion. It wasn’t enough, though. He spent about $200 million to buy nearly five million additional shares of his company in the first six months of 2008, showing as much self-assurance as McClendon.

Even Ward didn’t have that kind of cash lying around, so he borrowed much of the money for the shares. He had grown up without much money, had come to rely on debt, and didn’t view it as any big deal. “If I wouldn’t have taken on debt I would still be on a tractor,” he explains.

Ward also continued to actively trade in his brokerage accounts, even as he ran his new company. One day, when a SandRidge employee phoned an investment bank to discuss a potential hedge of the company’s gas production, he got an odd response.

“That’s funny,” the banker told the SandRidge staffer. “I just got off the phone with Tom. He was trading his own book,” or making moves in his own trading account.

“Please don’t tell me that,” the employee told the banker. “Ahhhhh.” He indicated that he was putting his fingers in his ears to prevent learning any more about his boss’s wheeling and dealing.

The staffer knew Ward had done nothing illegal by playing commodities with his own money. Nonetheless, it made him uncomfortable that his boss was trading in the same markets as his company, the employee says. It didn’t feel right.

By then, SandRidge had become the country’s fifth most active driller of new gas wells. Production was up nearly 100 percent in the first six months of the year and shares were soaring. Ward’s own stock was worth more than $2.5 billion, boosting his net worth to more than $3 billion. All that borrowed money seemed well spent.

•   •   •

I
ndications were growing that significant amounts of natural gas might come from U.S. shale formations. Oil from shale still seemed like a waste of time, though, no matter what Hamm and Continental were doing up in North Dakota.

After all, the U.S. Geological Survey, a government arm, had estimated that just 151 million barrels of oil were buried in the Bakken, enough to satisfy less than eight days of the nation’s consumption of oil and petroleum products. That figure hadn’t been updated since 1995, so it was quite stale. But everyone knew North Dakota only was producing about 140,000 barrels of crude per day. That was up from about eighty thousand five years earlier, making the state the eighth largest producer in the nation. But it wasn’t like the state had tapped a gusher.

Even some of those drilling in the Bakken, such as John Hess, didn’t seem especially enthusiastic. He ran Hess Corp., a company that had been early to discover oil in North Dakota. It began building its holdings in the Bakken in 2005, controlling about 570,000 acres by 2008. But in March, when Hess, the son of company founder Leon Hess, spoke with
Newsweek
columnist Fareed Zakaria about “new frontiers” in oil, he didn’t utter a word about the Bakken.

Instead, Hess, who had studied Arabic and Farsi, pointed to the Gulf of Mexico, Brazil, and West Africa. Hess had become an advocate for energy conservation and alternative fuels, and he seemed concerned about supplies, no matter what was going on in the Bakken.

“It’s hard to see how we can meet” growing demand, Hess told Zakaria. “It’s hard to see any relief in sight.”
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But news emerged on April 10, 2008, that shocked those skeptical about U.S. oil. That afternoon, the USGS released a fresh survey estimating that North Dakota and Montana had 3 billion to 4.3 billion barrels of “undiscovered, technically recoverable oil” in the Bakken formation, a twenty-five-fold increase from the government’s previous guess. The Bakken had more crude than any formation in the lower forty-eight states, the USGS was saying. Harold Hamm, Leigh Price, and others who believed in the region were right after all.

Jaws dropped, even in North Dakota. Kathleen Neset had graduated from Brown University with a geology degree and moved to the Williston Basin in 1979 to become one of the few women in senior positions in local fields. She fretted that her town of Tioga, with about one thousand residents, was withering. Schools had closed and young people were moving away.

New drilling by Hamm and others in Williston and other cities in the area had raised hopes of a revival, but locals had seen so many boom-and-bust cycles that many remained dubious. The government’s updated numbers, which earned front-page coverage and a banner headline in the local
Tioga Tribune,
seemed proof that a rebirth for the region was imminent.

“It was wow!” Neset recalls. “We knew it was big but this confirmed it. . . . It was extraordinary.”

The figures caught the attention of large domestic companies and international giants; stock investors began searching for companies with big positions in North Dakota. In the middle of July, Continental’s stock soared past eighty dollars from thirty-five. A year earlier, investors had balked at the company’s IPO and Brian Hoffman had sold his shares, fearing what was ahead. Now Wall Street was throwing money at the company.

For Jeff Hume and Jack Stark, the Continental Resources senior executives who had spent more than eight years trying to unlock the mysteries of the Bakken, the updated numbers from the government felt like validation. “We were pumped,” Stark says.

But many of those working in the Bakken fields were stupefied by the government’s estimate. They weren’t seeing “recovery rates,” or levels of oil flowing from wells, indicating that such a high estimate was possible. Continental was getting well under a thousand barrels a day from each of its Bakken wells, about half as much as some thought they should be seeing from the most promising ones. The government’s figures seemed too high to some of these field hands.

Back in Oklahoma, the USGS’s figures irritated Harold Hamm. He was sure investors and industry experts were still underestimating the Williston Basin’s potential. He insisted to a friend that there was more crude in the Bakken than the government’s geologists were saying.

Hamm was an upbeat guy, but his confidence stemmed from something else. Continental was getting more excited about the Three Forks formation, a zone just below the Bakken. Hamm and his staff suspected these new layers might be full of oil, just like the Bakken.

He ordered his landmen to lease even more acreage in the formation. It still was expensive to drill wells there, and they still weren’t pumping a tremendous amount of crude, but oil prices were zooming so it seemed worth it.

“We felt very confident,” Hamm recalls.

•   •   •

M
ark Papa was beginning to focus on oil, trying to catch up to Harold Hamm.

Throughout the first half of 2008 Papa, the chief executive of EOG, sat in his Houston office poring over data showing climbing natural gas production from various U.S. shale formations. But when he read reports from Wall Street analysts, or spoke with others in the business, almost no one was worried that growing supply might outstrip demand. Most were reassured by rising natural gas prices.

Papa thought they were all wrong. He couldn’t figure out why Aubrey McClendon and others weren’t shifting away from natural gas like he was. EOG seemed to be making progress in the Bakken, but an industry member cautioned Papa that the formation was a one-of-a-kind “freak discovery,” and that other shale oil regions in the country were unlikely to be very productive.

Papa bit his lip, unwilling to share that his staff was scouring the country for shale oil formations that seemed similar to the Bakken. He hated divulging what he and his company were doing. He knew McClendon was bragging about how Chesapeake was gobbling up shale acreage, but that wasn’t Papa’s style. He remembered how Enron, EOG’s former parent, was full of show-offs who boasted that they were going to change the world. The Enron executives made sure everyone knew they were the smartest men in the room, but the company had suffered an embarrassing demise.

Papa’s employees guarded corporate information like it was a state secret. Local officials in North Dakota griped that EOG wasn’t quick to share how the company was faring with local wells, unlike the more outgoing Harold Hamm. That made it more difficult for the officials to trumpet the region’s progress. Papa didn’t really care. Only recently had EOG begun to tell its own shareholders about the activities in the Bakken. Even then, the details were few and far between.

EOG needed to be more clandestine than ever, Papa told his troops. His geologists had identified an area in South Texas called the Eagle Ford Shale that seemed worthy of drilling. EOG aimed to lock up 200,000 acres. After accumulating that kind of holding, Papa and Thomas were sure rivals would make their own push into the area, sending prices higher.

“The rest of the industry doesn’t need to know,” Papa told a member of his exploration team.

But as EOG’s landmen accumulated leases in the Eagle Ford, paying an average of just $400 an acre, few competitors emerged. Papa couldn’t believe it—everyone was still chasing gas, not oil. He raised his goal, telling the landmen to lease 300,000 acres and then 400,000.

EOG hadn’t drilled a single well in the Eagle Ford, though. The executives thought they could get a lot of oil from the region’s rock, but they hadn’t tested their theory. Rival company Petrohawk had drilled a well in the Eagle Ford, but Papa and Thomas didn’t want to stop and test their own wells. It would be too expensive to lease it later on, they calculated. They had to grab acreage now.

EOG spent over $100 million on land, hoping it would yield meaningful amounts of oil. It was a dangerous move in any market. It would turn out to be a huge risk in one about to crumble.

•   •   •

I
n early 2008, leasing and drilling activity grew heated in the Marcellus Shale, a region stretching across New York’s picturesque Finger Lakes region to northern and western Pennsylvania, eastern Ohio, and through parts of Maryland, West Virginia, and Virginia. The area seemed to have more gas than any other that drillers had come across, making it an obvious target for Aubrey McClendon and others in the lead in the shale race.