The Rise and Fall of Wildcatter Aubrey McClendon
March 2, 2016
Aubrey McClendon, co-founder and former CEO of Chesapeake Energy was indicted yesterday by a federal grand jury alleging that he conspired to rig the price of oil and gas leases in Oklahoma between 2007 and 2012.
Details of the allegation seem pretty straight forward and will be well publicized in coming months. The focus of this article will not be the allegations of wrong doing or the man's guilt or innocence but rather a step back for a broader look at the man and his accomplishments as well as his short comings.
Like most things in life the boundaries between right and wrong are not always well defined. In most cases concerning individuals their actions paint a mosaic and it's up to us to determine after looking at their work, if what they have done is predominately good or bad.
I have followed the rise of Aubrey McClendon through the years, sometimes with intrigue and admiration and at other times with disdain and distrust.
Chesapeake Energy, named after his love for the Chesapeake Bay region of the United States, was co-founded in 1989 by Aubrey McClendon and partner Tom Ward with a $50,000 initial investment and a vision to create the countries greatest driller. After 4 short years the company went public in 1993 with a value of $25 million dollars.
There were ups and downs throughout the 1990's as the company refined it's strategy to almost exclusively natural gas drilling. Aubrey McClendons ambitions to become the #1 driller and biggest producer of natural gas in America quickly became apparent.
In 2007 Chesapeake energy was named "Best Managed Oil and Gas Company" by Forbes Magazine and was ranked #51 on Fortune Magazines " 100 Best Companies To Work For List" in 2014.
Chesapeake Energy's rise to the nations number one spot as most active driller and #1 natural gas producer came following McClendon's understanding of the break through technology developed by Texan George Mitchell who unlocked the potential of oil and gas reserves from tight formations such as shales and granite washes using horizontal drilling and hydro-fracturing practices in the Barnett Shale.
For some time Chesapeake was quietly acquiring leasehold in the Barnett Shale while refining extraction techniques proving these type wells could be drilled quickly and profitably usually recovering the cost of drilling in the first year of production and returning a handsome profit to the company and shareholders.
The sum of these profits soon became apparent as Chesapeake Energy released this information to shareholders. The "Great Land Grab" as Aubrey McClendon described it was on!
Leasehold in tight formations that were previously considered almost worthless became very valuable. The natural gas drilling boom was underway not only heating our homes with energy produced in America but with it came high paying jobs for the educated as well as the under educated. Soon, through hard work everyone was able to grasp their version of the American dream.
The bidding war for leasehold that began in the Barnett Shale of north Texas soon spread to the Haynesville Shale of western Louisiana. Previously common middle class land and mineral owners were thrust up to the status of multi-millionaires over night. Not only were landowners getting "up front" lump sum payments of millions of dollars for the right to drill and produce small parcels of land , they were also receiving sometimes 20%-25% of the monetary value of the natural gas the well produced over its lifetime! For several years natural gas production boomed out of control as mild winters reduced demand for the fuel. Underground storage was quickly filling.
The need to drill wells faster and cheaper funded the advanced technology of horizontal drilling. Drill bit design changed, downhole motors and directional tools advanced, even the newer drilling rigs were redesigned to be moved quickly from location to location reducing the costs of the entire drilling operation.
As the boom continued Aubrey McClendon realized that there would soon be a shortage of drilling rigs available to contract the work out to. In many situations contractors were scabbing together all the parts and pieces of everything in their junk piles to fabricate a rig that could be put out in the field drawing a dayrate to operators like Chesapeake Energy and others commanding prices of $20,000 per day and more. Even rig moving trucking companies were back logged causing expensive delays.
To counter this, Aubrey McClendon and Chesapeake Energy then purchased the Hodges Trucking yard in Oklahoma City and began fabricating their own state of the art drilling rigs that rivaled anything anyone had produced prior to that time. The designs were original, the rigs were expensive, little cost was spared in their multi-million dollar production. To defer costs to Chesapeake share holders McClendon built the rigs then sold them to an investment group while procuring an 8 year lease on each rig for Chesapeake. The new drilling company took on the name NoMac Drilling. Their rigs eventually numbered in the hundreds.
Story has it that back in the beginning Nomac Drilling was previously named "Advanced Drilling Technologies". After acquiring Advanced Drilling, Aubrey decided to build several more rigs. They entered in to a contract with a guy named Mac McCallister. He was supposed to deliver 5 rigs the first year and only delivered one which is known today as Nomac Rig 2. When Chesapeake didn't get the result promised, they got out of the contract through a long legal battle with Mac McCallister. Aubrey, deciding to change the company name apparently stated he never wanted to do business with a guy named Mac again so he laughed and said lets go with NoMac. The capital M was later made lower case with the traditional upside down triangle filling the gap in the letter M.
McClendon continues to grow Chesapeake and masterfully secures state of the art rigs to drill for Chesapeake Energy as well as their own rig moving trucking company. Chesapeake Energy could now not be held hostage to the high day rates and delays associated with using outside contractors.
During this period of unprecedented growth McClendon realized he needed the greatest people in the industry on his side and he was able to achieve this by offering his employees the best pay and benefits of anyone in the industry. At a time when most companies were willing to match an employees 401K with 5% in company stock Aubrey McClendon and Chesapeake Energy were matching employee contributions with 15% in CHK stocks. Few had any doubts they were working for a leader in the industry. Other incentives included great health care, yearly bonuses and other incentives. McClendon was second to none at taking care of his employees.
The tight formation plays expanded as it was soon discovered that more and more areas of the United States contained shales and granite washes that could now be unlocked with the new drilling and extraction technologies and produced profitably. The "Land Grab" continued to places like the Marcellus Shale of the northeast in Pennsylvania, the Fayetteville in Arkansas, the Eagle Ford of south Texas as well as other expanding plays in places like Ohio and Colorado. Soon McClendon realized that at current and future levels of production, a glut was in store for the future of natural gas. That glut would be reflected in market prices. The $13 per MMCF that producers were fetching when Chesapeake was at $74 dollars a common share could not be maintained without expanding America's uses for natural gas.
McClendon's business plan and strategy has been brilliant up to this point. In 2007 McClendon tirelessly advocated the use of natural gas as a transportation fuel while eventually attacking "coal" as a dirty fuel in large advertisements in national newspapers sponsored by the American Lung Association. McClendon's attack was in direct violation of the unwritten creed that ""no energy industry should attack another". The consequences were catastrophic. Aubrey's continued attack came at a time when the EPA and the Obama administration were trying to kill the coal industry. In 2011 McClendon earned the "Lump Of Coal" award from the American Energy Alliance for his efforts in aiding and abetting the Obama administration in their quest to destroy coal producers. Coal at the time was the predominant fuel used to generate electricity. Switching electric generators from coal to natural gas could create a demand that could sustain natural gas into the future.
In 2011 The American Energy Alliance writes;
“In 2007, when anti-coal propaganda was surfacing all over Texas, it turned out that Aubrey McClendon was funding it. In recent days, he’s been at it again. An anti-coal ad campaign sponsored by the American Lung Association that features a coughing baby in a dirty carriage has been airing across the country. The money for the ad, of course, came from Aubrey McClendon."
The derogatory "Lump Of Coal" award had previously been reserved for Senators John Kerry and Lindsay Graham for their tireless effort to impose the largest tax increase in American history in the form of the cap-and-trade energy tax. (according the the alliance)
Although unsubstantiated, there is little doubt that the coal industry fired back quietly through the use of their political machine in retaliation, starting the "anti-fracking" campaigns that quickly gained momentum and continue today. Even though producers had previously been fracking wells safely for over 60 years the political machine of big coal represented it as new and dangerous technology that was doing irreparable damage to individuals and the environment. That charade continues today as the Obama administration continues attempts to destroy both industries.
McClendon's strategy to increase uses for natural gas were largely ineffective and the end result has been damage to both industries. The glut arrived in 2008, markets crashed with the housing bubble burst and failure of Lehman Brothers. Chesapeake Energy stock tumbled from $74 dollars a share to around $9 per share almost overnight. Aubrey McClendon at the time was one of Chesapeake Energy's largest shareholder with over 30 million shares. In October 2008 McClendon was forced to sell more than 90% of his stock to meet margin calls, wiping out most of his $2 billion fortune. The dumping of McClendon’s 30 million shares into an already bearish market drove down Chesapeake shares further.
During the height of the natural gas boom Aubrey McClendon was a philanthropist donating millions to many worthy causes and as a collector of the finer things in life that included a vintage map collection and fine wines. as the Board of Directors at Chesapeake work to help McClendon some begin to accuse the CEO of using the company as his own personal piggy bank.
According to Forbes at the time, Christopher Helman writes;
"To help him claw back his fortune–and, says Chesapeake, to reward McClendon for $1 billion worth of joint venture deals he had landed earlier in the year–the board granted him a $110 million pay package that included $75 million to buy interests in Chesapeake wells, a $20 million stock grant, and $12 million to buy his map collection. Other perks from the package included $600,000 for the private use of the corporate jets, nearly $600,000 for accounting services and $131,000 for personal “engineering support.” Chesapeake also agreed to pay $4.6 million to sponsor the NBA’s Oklahoma City Thunder, of which McClendon owns one-fifth."
Soon many seemed to feel McClendon was pillaging the coffers of shareholders to win back his fortune. Lawsuits and litigation followed as Chesapeake Energy engaged in multiple settlement negotiations. Adding to McClendon's problems was his participation in the "Founders Well Participation Program" which many felt unfairly compensated McClendon with additional income from wells drilled by Chesapeake.
Founder Well Participation Program
"On June 10, 2005, our shareholders approved the Founder Well Participation Program (the “FWPP”) which permitted the Company’s two founders, Aubrey K. McClendon and Tom L. Ward, to continue participating as working interest owners in new oil and natural gas wells drilled by the Company. The FWPP is a continuation of the well participation program previously administered through the founders’ employment agreements and initiated by the Company in connection with its initial public offering in February 1993. Mr. Ward’s participation rights terminated on August 10, 2006, following his resignation as a director and the President and COO of the Company. As discussed in “Compensation Discussion and Analysis,” the Company believes the FWPP fosters and promotes the development and execution of the Company’s business. Mr. McClendon has participated in all wells drilled by the Company since its initial public offering in February 1993, except during the five quarters from January 1, 1999 to March 31, 2000.
Under the FWPP, Mr. McClendon is permitted to participate in all of the wells spudded by or on behalf of the Company during each calendar year. In order to participate, prior to the beginning of each year Mr. McClendon must provide written notice to the members of the Compensation Committee of his election to participate in the FWPP and the percentage working interest which he proposes to participate with during the year. His working interest percentage may not exceed a 2.5% working interest in a well and is not effective for any well where the Company’s working interest after Mr. McClendon’s participation election would be reduced to below 12.5%."
After many months of scrutiny Aubrey McClendon was forced to step down as CEO of Chesapeake Energy in 2013.
Chesapeake Energy later spun off their corporation Nomac Drilling and others into a separate company under the name "77 Energy " while McClendon went on to found his own private energy company American Energy Partners in April of 2013.
In today's Wall Street Journal McClendon states;
“The charge that has been filed against me today is wrong and unprecedented,” All my life I have worked to create jobs in Oklahoma, grow its economy, and to provide abundant and affordable energy to all Americans. I am proud of my track record in this industry, and I will fight to prove my innocence and to clear my name.”
Following in the footsteps of great wildcatters and entrepreneurs like James D. Rockefeller and Andrew Carnegie, America needs men like Aubrey McClendon to dream, innovate, inspire and perform at extraordinary levels to keep feeding the fires of American Exceptional-ism that have made America the greatest country in history.
I hope McClendon is able to clear his name for himself and for America.
UPDATE: Sadly I have to report that Aubrey McClendon was killed in an Oklahoma City car crash during the writing of this article. I received the details shortly after publishing.