One of the longest-running dramas in corporate oil and gas history finally came to a climax on Sunday when management for Chesapeake Energy announced it would seek Chapter 11 protection under the U.S. bankruptcy code. The company has traveled a long and winding road to reach this point.
Rumors about the company’s pending bankruptcy have run rampant over the past year as it teetered on the financial brink. But in reality, Chesapeake’s financial troubles go back much further, to the early years of this century, when founder and former CEO Aubrey McClendon famously made a bet on natural gas continuing to be a scarce resource in high demand whose price would remain strong for decades. Based on that market view, the company then went on a buying spree for the next several years, buying up natural gas assets and companies at very high prices. In one acquisition in which the company I worked for – Burlington Resources – was the second high bidder, Chesapeake’s winning bid was $3 per MMBTU equivalent higher. That’s a lot of excess capital deployment.
None of his assumptions about the future for natural gas turned out to be accurate, of course, but it must be pointed out that McClendon certainly was not alone in making them. For example, I personally played a leadership role in a 2003 National Petroleum Council study which attempted to project natural gas supply, demand and prices through the year 2025. The study was led by ExxonMobil and Anadarko Petroleum (acquired last year by Oxy), and included participants from many other industry companies, the Energy Department, the Department of Interior and environmental NGOs.
The fundamental conclusions and projections of that study basically supported McClendon’s view of natural gas remaining a scarce resource with pretty high commodity prices as far as the statistical models we used could project. It was in fact the prevailing common wisdom in the industry at that time.
The NPC study projected that imports of Liquefied Natural Gas (LNG) would in fact have to make up an increasingly high percentage of U.S. natural gas supply. That incredibly wrong projection led to the building of a series of LNG import facilities in the U.S. and helped compel ExxonMobil to invest billions in its own fleet of new LNG tankers to help supply America’s coming needs.
Today, 17 years later, the advent of gigantic shale natural gas resources like the Marcellus shale, the Haynesville, the Eagle Ford and the Permian Basin mean that U.S. producers must export a prodigious amount of natural gas in an effort to keep the supply and demand curves somewhat in balance. But remember, that study – and McClendon’s assumptions – came at a time before those major shale plays had been discovered. The only natural gas shale being developed during that time frame was the Barnett Shale in North Texas, where Chesapeake was a pioneering operator.
While other operators held similar views about the future for U.S. natural gas, Chesapeake was without doubt the most aggressive in terms of pursuing new reserves. In addition to arguably over-paying for acquisitions of other companies or their assets, Chesapeake became infamous for radically driving up lease bonus prices in every new shale play, in the process running up a prodigious level of corporate debt. At one point, Chesapeake’s corporate debt exceeded that held by ExxonMobil, a company many times its size.
As natural gas prices collapsed in the late ‘00s, McClendon next turned to sales of his own company’s assets or portions of working interests in big play areas as a means of continuing to finance and pay down that debt. He sold shares of the company’s working interests in the Barnett, the Eagle Ford, the Marcellus and the Haynesville to various other players, like BP and CNOOC, but every sale also meant less and less cash flow coming into the company itself. Many in the business during that time joked about it being a sort of a pyramid scheme in which the debts would ultimately end up outstripping the company’s income and ability to pay.
McClendon also made the decision in 2010-11 to shift Chesapeake’s gas-heavy asset mix to one more heavy in liquids. That strategic decision certainly helped during a time of $100 oil prices, but the bust of 2015-16 and the current COVID-19-related price collapse ultimately proved to heavy a burden for current CEO Doug Lawler – who was brought on board in 2013 – and his management team to navigate. A company that once had a market cap of over $37 billion at one point in May saw its market cap drop as low as $200 million. A company that once employed over 8,000 individuals today employs around 2,300.
Thus, the long-expected lurch into the Chapter 11 process begins today. Hopefully, the company will come out of the other end of it in a healthier financial position and most of its current employees will be able to keep their jobs. Chesapeake’s long and winding road still has a ways to go.