The Frackers: The Outrageous Inside Story of the New Billionaire Wildcatters (42 page)

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cClendon’s sunny disposition belied clouds forming on the horizon. Natural gas prices finished 2011 below three dollars per thousand cubic feet, down 30 percent in a year. At those prices, Chesapeake couldn’t make money drilling some of its shale plays. The Haynesville Shale in Louisiana, for example, required gas prices of approximately $3.50, while Chesapeake’s wells in the Barnett needed prices of about $4.50.

The company kept drilling away, though, to avoid losing its leases. Chesapeake closed 2011 at twenty-two dollars a share, down by one-third in five months, a reminder that for all of Aubrey McClendon’s boasts and big plans, his company’s fate was tied to the price of gas.

Natural gas prices kept falling in January 2012, dropping to about $2.50 per thousand cubic feet, the lowest level in twelve years, partly due to a record warm winter. Aubrey McClendon had been among those most responsible for the remarkable amount of gas production in the country. Yet he and his staff seemed among those most surprised by the very phenomenon they helped create.

More than eight trillion cubic feet of gas would be produced in 2012, up from over two trillion in 2008. Chesapeake itself would pump 1.1 trillion cubic feet in 2012, up from 775 billion cubic feet in 2008, as all the fracking and horizontal drilling in shale paid off.

In January, in his State of the Union address, President Barack Obama declared that there was enough natural gas buried in the United States to “last one hundred years,” and that a booming gas industry would lead to hundreds of thousands of American jobs.

In January, Chesapeake announced it would slash spending on gas drilling by half and shift to produce more oil from the Eagle Ford, Utica, and elsewhere. The company eventually promised to raise about $9 billion before the end of 2012 to fund drilling and reduce debt.

McClendon stayed upbeat, predicting gas prices would rally. Part of the reason prices were so low was that winter temperatures were especially mild, raising the possibility of higher prices when it got colder, he said.

“This won’t last long,” McClendon told a colleague one day, referring to natural gas prices. But they fell to $1.91 on April 19, 2012, a move that felt “pretty scary,” a board member says.

By then, McClendon was dealing with a new headache. It emerged that entities controlled by McClendon had borrowed more than $1 billion from a private equity firm called EIG Global Energy Partners. McClendon had used the money to cover the cost of the 2.5 percent stake in wells that Chesapeake drilled. McClendon had talked about the well perk in media interviews and it was mentioned in security filings. But few investors had focused on the arrangement until Reuters broke news of the loans, and some viewed it as excessively generous.

Much more important was that McClendon had borrowed the billion dollars from EIG even as Chesapeake was negotiating to sell EIG hundreds of millions of dollars in assets. People close to McClendon and EIG insisted the firm didn’t cut McClendon any breaks on the terms of the loan. At the same time, there were a limited number of firms who knew Chesapeake’s acreage and could write a big check like that, another reason McClendon likely turned to EIG.

Still, it looked really bad that McClendon was borrowing so much cash from a firm looking to buy assets from his company, and the Securities and Exchange Commission opened a probe of the well purchase arrangement. The probe was still ongoing as of August 2013.

The resulting outcry over the loan was such that a week later, Chesapeake’s board of directors, which long had given McClendon virtual carte blanche, said they would review his personal financial interactions with firms dealing with Chesapeake. The company also announced that the well perk would end in 2014.
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The spotlight remained fixed on McClendon as additional news reports provided details of the hedge fund he and Ward had helped advise years earlier to invest their money. Then the
Wall Street Journal
reported that several banks had lent McClendon money while also receiving lucrative work as underwriters or financial advisers for Chesapeake.

As Chesapeake shares fell and criticism grew, McClendon became the butt of some jokes. To defend himself against the parade of accusations, bloggers said he should try “the George Costanza defense.” They were referring to the classic episode of the television comedy
Seinfeld
when Costanza is fired for having sex with his cleaning lady on his desk. Costanza pleads ignorance, asking, “Was that wrong? Should I not have done that? ’Cause I’ve worked in a lot of offices, and I tell you, people do that all the time.”

In May 2012, with gas prices still around $2.50 and Chesapeake shares down to about seventeen dollars, shareholders began to get antsy. Investors including O. Mason Hawkins, whose $34 billion mutual fund firm, Southeastern Asset Management, was Chesapeake’s largest stockholder, forced McClendon to step down as chairman, a remarkable turn of events for an executive who had wielded so much power, and commanded such respect, just months earlier.

In mid-May, McClendon, who remained Chesapeake’s chief executive officer, spoke to several hundred Chesapeake employees, trying to keep the staff calm amid the firestorm.

“I encourage everybody to inhale,” McClendon said. “I’m fine. You’re fine. And we’re in the middle of a pretty unprecedented media firestorm. . . . I would not have wished the past month on my worst enemy.”

McClendon thought there might be a way to give life to Chesapeake shares. He had heard that Carl Icahn had renewed interest in Chesapeake, and he arranged to visit the billionaire in New York.

Icahn’s reputation for pressuring underperforming companies preceded him; a friend, investor Wilbur Ross, once said that Icahn is “especially good at terrorizing people.”
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But Icahn had deep respect for McClendon and already had made a killing a year or so earlier in the stock. The winnings allowed Icahn to view McClendon in a slightly better light than some others. Icahn bought Chesapeake again in 2012 because he viewed the stock as being inexpensive, rather than ideal for a shakeup.

Still, as they dined in Icahn’s 14,000-square-foot apartment in the Museum Tower on West 53rd Street, Icahn made it clear that he thought McClendon had to change the way he ran Chesapeake. “Look, you’ve got to sell assets,” Icahn told McClendon, according to someone familiar with the conversation. “You’re a brilliant guy and all, but you’ve got to sell.”

McClendon promised to ramp up the company’s efforts to reduce leverage. By then, Chesapeake had more than $13 billion in debt on its balance sheet and total obligations of close to $24 billion, according to rating agencies.

Soon, Icahn disclosed a 7.6 percent stake in Chesapeake, helping Chesapeake’s shares rise a bit. But financial pressure grew on McClendon. In June, he pledged his personal “oil and gas memorabilia” against a loan from billionaire George Kaiser, according to securities filings.
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News also emerged that McClendon had mortgaged his 20 percent stake in the Oklahoma City Thunder basketball team to secure other loans.
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That debt was in addition to the $846 million that he had borrowed by the end of 2011 to pay for his slice of the drilling costs of Chesapeake wells, according to securities filings.
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The normally outgoing McClendon turned more pensive. “It was gradually wearing him down,” says a Chesapeake executive. “He was less gregarious, walking with his head down, as if he was thinking.”

In June, Chesapeake raised its bet on the Utica formation by ramping up drilling in the area, although it eventually would prove to have less oil than optimists like McClendon expected, adding to investor unhappiness.

“Assets weren’t being sold fast enough,” says a major investor.

Soon, Hawkins and Icahn forced Chesapeake to replace four of its nine directors with their own representatives. Together with Louis Simpson, the former Geico executive who had challenged McClendon with questions about the company’s debt a year earlier, five of the company’s nine board members were unhappy with McClendon.

It was clear that Aubrey McClendon’s days at Chesapeake were numbered.

•   •   •

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atural gas prices dropped throughout 2010 and 2011. Oil prices went the other way, though, climbing from seventy-nine dollars a barrel to ninety-nine dollars.

The price moves made Tom Ward look good. In late 2008, Ward had shifted his company’s focus from natural gas to oil. After buying Forest Oil’s wells in West Texas’s Permian Basin in late 2009, SandRidge Energy paid $1.6 billion in April 2010 to buy another oil company called Arena Resources. Rivals were enamored with drilling in dense, shale oil formations, as they tried to catch up to Continental and EOG, but Ward was buying more inexpensive, traditional U.S. oil wells, viewing them as better deals.

Ward wasn’t nearly done wheeling and dealing. In 2010 and 2011, he and his team profited by selling parcels of their newly acquired land at a big gain; they also raised cash through complex joint ventures and stock sales.

SandRidge also spent $400 million to purchase two million acres in the Mississippian Lime, the formation in northern Oklahoma and southern Kansas. These were aging oil fields, but to Ward they seemed overlooked and attractive. With oil at nearly $100 a barrel, he wagered that SandRidge could profit using horizontal drilling and multistaged fracking techniques, while also employing sophisticated methods to remove water and free up oil from the wells.

Revenues and reserves were rising, and the Mississippian formation was emerging a winner, but investors remained unimpressed. SandRidge shares hit thirteen dollars in April 2011, but they fell back to about eight dollars by the end of the year. Some big holders were getting impatient, just like at Chesapeake. SandRidge had finished its first day of trading in 2007 at thirty-two dollars a share, and it hit sixty-eight dollars in 2008. But the stock finished 2011 at 90 percent below those heights.

Something else was beginning to concern shareholders: Ward was selling some of his holdings of the company. In October 2010, Ward sold six million shares, netting over $35 million. By the end of the first quarter of 2012, he held just over twenty-four million SandRidge shares, down from nearly thirty-two million in the same period in 2009, according to securities filings. The company was handing Ward shares as compensation, but he was selling even more of the stock, worrying some investors that his interests weren’t fully aligned with his company’s.

Ward didn’t see what the big deal was. He still controlled about $190 million of SandRidge stock in early 2012, or almost 6 percent of all shares. But as the stock flatlined, investors began to grumble.

SandRidge was a relatively small company, with a market value of less than $3.5 billion at the end of 2011, and yet Ward was being paid as if he ran an oil giant. He received compensation totaling $47 million in 2010 and 2011, making Ward among the highest-paid energy executives in the country.

In Ward’s view, SandRidge was set up to be a major energy company. It wasn’t there yet, but it had to spend top dollar to hire and retain talent if it wanted to compete with major oil companies. Ward felt he deserved his own hefty payout because he had raised over $6 billion for the company over two years. He also insisted that he could get much more if he left and started a new venture, perhaps with the backing of a private equity firm. He had directed the Mississippian discovery and was sure he could leave the company and make more by drilling the area on his own. Besides, a number of sizable gas-focused companies had fallen by the wayside during that period, but SandRidge was still growing, thanks to Ward’s shift to oil.

The arguments didn’t sway some big investors. Executives of a New York hedge fund called Mount Kellett Capital Management, run by a former Goldman Sachs executive, began calling Ward, asking why SandRidge was spending so much on acreage that would be costly to drill. Norman Louie, a Mount Kellett executive, told Ward that the holdings seemed “too much for you to handle.” Ward responded that the push into Kansas and Oklahoma would pay off.

Mount Kellett, which grew its position in SandRidge to more than 5 percent of the company by late 2011, or almost as many shares as Ward held, was always polite with Ward, and the firm kept its complaints private. But the hedge fund executives were losing patience.

In February 2012, Ward shocked shareholders when SandRidge announced the $1.3 billion purchase of Dynamic Offshore Resources, a company producing oil in the Gulf of Mexico. SandRidge had been focused on onshore wells, and Ward had spent his career working on domestic wells. All of a sudden, the company was spending big bucks to buy a company with mature, offshore oil wells.

SandRidge shares tumbled 11 percent on news of the deal. Ninety minutes after the deal was announced, Norman Louie, the Mount Kellett executive, along with a colleague, Marcus Motroni, got on the phone with Ward.

“I don’t know why you’re doing this,” Louie said, sounding irritated. “You’ve never operated in the Gulf of Mexico.”

Ward calmly explained that SandRidge was paying a cheap price for assets pumping large amounts of oil and that the deal would lower the company’s ratio of debt to cash flow, a key metric for the company’s lenders.

The Mount Kellett executives weren’t assuaged. Operating in the Gulf of Mexico is more difficult and time-consuming than drilling in the United States, they said.

“Why don’t you digest this and get back to us,” Ward said, ending the call.

By the summer of 2012, SandRidge shares were weakening once again, falling to just above six dollars a share. The company regularly beat quarterly earnings expectations and the Mississippian oil field in Kansas and Oklahoma was pumping out impressive amounts of crude.

But the field was turning out to be a bit less successful than Ward originally hoped. Shareholders weren’t thrilled that SandRidge said it likely wouldn’t be “cash-flow positive,” or taking in more than it was paying out, until 2017.

In late 2011, TPG-Axon Capital, a hedge fund run by another ex–Goldman Sachs star trader, Dinakar Singh, bought SandRidge shares of its own. In the spring of 2012, as Singh and his team debated purchasing more SandRidge shares, they invited Ward to visit TPG-Axon’s midtown Manhattan offices. Singh grilled Ward, asking him if he operated as aggressively as his old partner, Aubrey McClendon.