Spending spree and aggressive land grab may cost Aubrey McClendon his company


Chief Executive Officer, Chairman, and co-founder of Chesapeake Energy Corporation Aubrey McClendon walks through the French Quarter in New Orleans, Louisiana in this file photo taken March 26, 2012. McClendon has come under scrutiny since Reuters reported on April 18 that he had borrowed $1.5 billion against stakes he received in wells drilled by Chesapeake. (SEAN GARDNER/REUTERS)
July 7, 2012

Aubrey McClendon tried to eat healthy on the morning of Jan. 10, 2007. No home fries, he told the waitress at the International House of Pancakes in Oklahoma City. Order the special with grits, she suggested. He’d save 25 cents.

Across from him sat Ronnie Irani, a local petroleum engineer. Irani says he was trying to persuade McClendon, the chief executive of Chesapeake Energy, to join him in staking a claim to more than 5 billion barrels of oil trapped beneath Wyoming’s Powder River Basin.

And here was McClendon, the billionaire co-founder of one of the largest natural gas companies in the United States, saving a quarter on breakfast.

“I had to go to somebody who could move fast and think big,” Irani says. “He was a perfect choice.”

Irani had just founded his own firm after 26 years working for other people. The Mumbai-born oilman says he needed a partner to keep competitors from muscling him aside. McClendon, whose voracious appetite for natural gas acreage had made him an industry legend, knew how to seize control of new energy prospects. He was Irani’s first pick.

In Irani’s maps, McClendon saw the chance to join the pantheon of 19th-century oil titans, such as John D. Rockefeller and Ludvig and Robert Nobel, the Swedish brothers who once dominated Russia’s oil industry.

‘Sweep of history’

Within weeks, Irani, 55, and McClendon, 52, had penned a preliminary agreement to buy 1 million acres of oil leases in eastern Wyoming. They planned to move in quietly, before their competitors noticed.

“When you look at the sweep of history in this industry, those who move first to lock in big new acreage positions when technology changes emerge as the winners,” McClendon says.

McClendon won the land grab, but his ambitious bid to dominate the American oil rush may cost him his job and his company. The secret deal McClendon struck with Irani helped kick off a five-year buying binge that spanned the United States and pushed Oklahoma City-based Chesapeake’s debt to a crippling $12.6 billion. The company has put as much as $20.5 billion in assets on the auction block to fill a gaping cash shortfall.

As Chesapeake careens toward financial ruin, corporate governance scandals have shattered investor confidence in McClendon’s leadership. In April, the board said it was reviewing McClendon’s personal ventures with Chesapeake financiers.

SEC inquiry

In May, the directors said they would name a new chairman to replace McClendon and disclosed that the Securities and Exchange Commission had opened an informal inquiry. Shareholders have sued. McClendon apologized to investors in May.

Corporate raider Carl Icahn demanded more. In June, after amassing a 7.6 percent stake, Icahn forced Chesapeake to replace four of its nine directors with people picked by him and Southeastern Asset Management, Chesapeake’s largest shareholder.

“Aubrey was swinging for the fences,” says Terry Whitaker, a longtime Wyoming oilman who once owned some of the acreage Chesapeake bought in the Powder. “That’s what a wildcatter does. And most wildcatters die broke.”

The very acreage McClendon so prizes has undermined Chesapeake’s efforts to dig out of debt. Chesapeake expects to spend up to $7 billion this year uprooting rigs from natural gas prospects and redirecting them to more lucrative oil fields.

Natural gas falls

Paying for its drilling program has become tougher as natural gas, which accounted for 81 percent of Chesapeake’s sales volume last year, fell to its lowest price in a decade in April. The cost to protect the company’s bonds from default — a measure of the perceived risk that the company won’t make good on its debt — increased 54 percent this year to June 14.

McClendon also bet his own fortune in deals that entangled the company in his private financial empire. He used a perk that gave him a 2.5 percent stake in Chesapeake’s wells as collateral for massive personal loans.

He relied on some of the same lenders, investors and advisers who have been instrumental in Chesapeake’s expansion, such as Goldman Sachs, EIG Global Energy, Wachovia and Jefferies Group, where McClendon’s former Duke University fraternity brother Ralph Eads serves as vice chairman and head of the firm’s energy investment banking section. Eads, through a Jefferies spokesman, declined to comment.

In April, McClendon revealed that he had borrowed $846 million as of the end of 2011 to pay his slice of Chesapeake’s drilling costs. McClendon has also leveraged his extensive wine collection, his fleet of vintage boats and his share of future oil and gas production, property records show.

“The funny thing is that I don’t consider myself a gambler at all,” McClendon says. “I think a gambler is somebody who just closes their eyes and rolls the dice. And we don’t do that.” McClendon made his remarks for this story on April 21 and since then has declined to comment.

McClendon, tall and rangy with a distinctive mane of unruly blond hair, was born into an oil family. His great-uncle was Robert S. Kerr, a onetime Oklahoma governor and U.S. senator who co-founded energy company Kerr-McGee.

After graduating from Duke with a bachelor’s degree in history, McClendon bought oil acreage to flip to larger companies. His toughest competitor was Tom Ward. Tired of bidding up prices on each other, McClendon and Ward banded together in 1983 and in 1989 formed Chesapeake with just $50,000 between them.

Unconventional reservoirs

In the early 1990s, McClendon and Ward spotted the potential of unconventional natural gas reservoirs, vast layers of rock rich with trapped hydrocarbons that were just beginning to open to development because of advances in technology.

“It requires a completely different mentality and a completely different approach to land acquisition than in the old days,” McClendon says. Chesapeake went public in 1993 at $1.33 a share. By mid-1996, the stock had pushed above $30.

Then the company’s key venture, a natural gas prospect called the Austin Chalk, which straddles the border between Texas and Louisiana, fell short of expectations. Shares plummeted to 75 cents in 1998. McClendon and Ward tried to sell the company. Finding no buyers, they began borrowing heavily to acquire new prospects.

Starting in 2000, Chesapeake went on a six-year buying spree, spending $6 billion to acquire natural gas acreage in states including Arkansas, Kentucky, Louisiana, Oklahoma, Pennsylvania, Texas and West Virginia. McClendon quickly became the best-known proselytizer of the shale gas boom.

“When is enough enough?” Duane Grubert, then an analyst with Fulcrum Global Partners, asked McClendon during a 2005 conference call. “I can’t get enough,” McClendon responded in part. “We sleep a little easier knowing that we’ve got this enormous backlog.”

By the end of 2006, 10 months after Ward left the company, Chesapeake had amassed more than 11 million acres and a backlog of 26,000 drilling sites. The company had also racked up $7.37 billion in debt.

“I live in a world where you have to have a thick skin and a short memory, and we were criticized a lot during that time,” McClendon says. “But we knew we were making the right decisions.”

In early 2007, under pressure from shareholders to make the investments pay, McClendon declared the land grab over and promised to turn Chesapeake’s focus to getting the gas out of the ground. Instead, he kept spending, convinced that Chesapeake had to find oil to survive.

“Some people thought we should just be satisfied with what we had,” McClendon says. “But I knew that we needed more balance.”

Irani couldn’t have timed his pitch to McClendon better. After graduating from the University of Oklahoma with a bachelor’s degree in petroleum engineering in 1980, Irani worked for Woods Petroleum, where he drilled for crude in the Powder.

He later worked for Louis Dreyfus Natural Gas and then for Dominion Resources, leading exploration and production for its western division. Irani says he decided to try to find oil for himself and established RKI Land & Mineral in 2005.

He paid close attention to new drilling techniques being pioneered in North Dakota, where producers had cracked into the Bakken shale with spectacular results. Sitting in his ninth-floor office north of downtown Oklahoma City, Irani says he asked himself, “Where’s the next Bakken?”

Irani, a compactly built man with receding black hair, remembered the Powder. Big oil companies had largely abandoned drilling in the basin’s traditional reservoirs. Irani estimates that modern technology could unlock 5 to 7 billion barrels of oil in just one of the Powder’s many layers of oil-bearing rock.

“Our industry was shrinking, and there were no big ideas left except overseas or offshore,” Irani says. “Then the shales came along, and we had to think big again.”

When Irani laid out his maps on the table at the IHOP in 2007, McClendon was so intrigued that he called his office to cancel his next meeting.

The prize

“I knew we had to get busy,” McClendon says. The two signed a final contract in May 2007, naming the project after “The Prize,” Daniel Yergin’s chronicle of the race to control the world’s oil. McClendon gives a copy to every new Chesapeake hire.

To camouflage their growing position in the Powder from competitors, Chesapeake and Irani bought land through third-party brokers. In February 2007, Irani paid as little as $11 an acre at a federal auction. As word of Chesapeake’s involvement leaked out, bids climbed as high as $910 an acre in December 2007.

Chesapeake paid extravagant prices to drive off competitors, says Wayne Neumiller, manager of North Finn in Casper, Wyo. He has drilled in the Powder since the 1970s. As acreage grew more expensive, Neumiller says, he and his partners at American Oil & Gas sold Chesapeake its leases for $600 to $800 an acre.

McClendon quickly expanded Chesapeake’s land grab. In March 2008, the company announced five new oil prospects, ranging in size from 100,000 to 1 million acres, in four states. On July 2, 2008, as oil and gas prices surged, Chesapeake’s shares reached a record $74.

Margin call

Then came the crash. The global financial crisis dragged Chesapeake’s shares below $30 in October 2008, while the company’s capital spending accelerated to a record $7.3 billion in the third quarter.

That month, McClendon, who’d been buying Chesapeake stock with borrowed money, was slammed with a massive margin call that forced him to sell almost all of his 5.8 percent stake in the company, SEC filings show. Chesapeake didn’t disclose the names of the lenders or the amounts of the loans.

The cash crunch brought Chesapeake’s land acquisitions to a screeching halt. By the second quarter of 2009, the company’s spending dropped to $1.06 billion, company records show.

Then in August 2009, the Prize Project struck oil on the Wagonhound Ranch near Douglas, Wyo. The well produced as much as 900 barrels a day, an encouraging result, Irani says. McClendon met with Irani on Oct. 15, 2009.

“He said, ‘Well, I think we should kick it back up again,’ ” Irani says.

Chesapeake’s buying spree resumed in late 2009. By the third quarter of 2010, debt had grown to $10.8 billion. Concerned about the company’s rising burdens, Icahn amassed a 5.8 percent stake in December 2010 and pushed Chesapeake to cut costs and pay off debt.

Chesapeake sold a third of the Prize Project in February 2011 for about $4,750 an acre to CNOOC, China’s largest offshore oil producer. That helped the company whittle its obligations to $9.07 billion by March 2011.

Icahn sold his shares, and Chesapeake’s efforts faltered. In May, Icahn once again got involved, disclosing that he owned 7.6 percent of the company. In a May 25 letter filed with the SEC, Icahn wrote, “Corporate governance reforms cannot, in our view, be led by directors whose irresponsible actions have brought this company to the edge of the proverbial cliff.”

McClendon replaced

Icahn and Southeastern in June gained sway over the board. Chesapeake named former ConocoPhillips chairman Archie Dunham on June 21 to lead its board. Icahn didn’t return a call seeking comment.

Irani, meanwhile, says his investors, whom he describes as private-equity people who know the energy business, have been pleased with results in the Powder. The best wells have produced as much as 1,450 barrels of oil equivalent a day. Irani says he’s piecing together new prospects in other states.

McClendon insists that Chesapeake shareholders will one day appreciate his vision. He credits Chesapeake with spearheading a revival of U.S. oil and gas production that has brought the nation closer to energy independence than it has been in 20 years.

“I’m paid by our shareholders to be a leader, not a follower,” McClendon says. “If I wanted to always do the most popular thing, then I’d be a follower.”

McClendon’s determination to seize the prize that made the fortunes of oil titans before him has cost him control of the company he co-founded. Even if the oil land grab reaps the riches he predicts, McClendon might not lead Chesapeake long enough to savor the victory.

The full version of this Bloomberg Markets article appears in the magazine’s August issue.

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