The Frackers: The Outrageous Inside Story of the New Billionaire Wildcatters (26 page)

They had no idea how wrong they would be.

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harif Souki was getting closer to his destination.

It was 2000 and Souki was driving a rental car from the city of Corpus Christi, Texas, to a nearby tract of land that seemed perfect for his company’s first terminal for imported liquefied natural gas.

Souki was still a novice when it came to turning supercooled LNG into natural gas for American consumers and businesses. And Souki’s company, Cheniere Energy, didn’t have nearly enough money to build a plant to convert any gas. But in the front seat next to Souki was Charles Reimer, a veteran of the LNG business and Cheniere’s new senior executive. Reimer was lending Souki crucial encouragement and guidance.

Souki had spent a year scouring maps for possible sites for a facility, examining nearly a dozen possible locations on both coasts of North America, from Canada down to Mexico. He first considered spots near major cities on the West Coast. But Cheniere needed some serious space. Any site would need forty-foot-deep channels and harbors wide enough to allow a 1,000-foot-long, 160,000-ton LNG tanker to turn around.

Souki worried that environmental activists in that part of the country would block any huge terminal. Working with an engineering professor at the University of Houston, he examined areas on the East Coast, where natural gas prices were higher and population centers within close reach. The land seemed too expensive for a tiny company like Cheniere, however.

Eventually, Souki and his team of five newly hired LNG specialists settled on the Gulf Coast, where local leaders welcomed oil and gas jobs. The region also boasted an extensive network of natural gas pipelines, thanks to the multitude of industrial facilities, which figured to make it easier for Souki’s company to move and store gas from its proposed plant.

The choice was met with derision. There was already so much natural gas coursing through the Gulf Coast that there seemed little need for additional supplies from Souki’s company, industry experts said. Importing gas to America seemed silly; importing it to the Gulf Coast seemed even more absurd. When Souki shared his idea at a major industry conference there was disbelief. “You’re going to build a plant on the Gulf Coast with all the gas there?” an audience member asked him. “Isn’t that like bringing coal to Newcastle?”

The audience cracked up like they hadn’t heard anything so clever in weeks.

Souki shrugged off the ridicule. He wasn’t prepared to share details of his prospective terminal or defend it, so he turned the other cheek. Besides, he had gotten used to the putdowns. “They could think I was an idiot, I didn’t mind,” he recalls.

Eventually, Souki found a perfect site near Corpus Christi, the nation’s fifth largest port, and agreed to an option to lease a huge tract of land in that coastal South Texas city.

As Souki and Reimer drove their rental car to the site, ready to sign the deal, their spirits were sky high. Just as the two executives crossed a nearby bridge, though, Souki noticed something that gave him pause.

“Charles, how tall are the ships?” he asked Reimer, referring to the size of the tankers that would haul LNG to their prospective plant.

“One hundred and sixty-five feet,” Reimer told him.

“How tall do you think this bridge is?” Souki wondered aloud.

Reimer didn’t have a clue. Souki circled back to the bridge’s entrance and read a marker listing its height: 135 feet. Souki and Reimer looked at each other, mouths agape. They were about to spend $200,000 of their company’s precious cash to lease acres of land near a bridge so low that LNG ships wouldn’t even be able to reach their terminal. Souki wiggled his way out of the lease deal, barely averting a monumental blunder.

A few months later, he found a better spot, this one in Freeport, Texas, next to one of the largest chemical plants in the world. If his strategy was going to work and demand emerged for imported gas, he figured he might as well build more than one terminal, to try to reap bigger gains. So Cheniere also leased acreage in Sabine Pass, Louisiana, also on the Gulf Coast. This spot held little more than a hunting trailer and an assortment of animals, including bobcats, alligators, and free-range cattle. Souki even found a site for a third LNG conversion facility; it was in Corpus Christi, but the site was far from that troublesome bridge. Cheniere purchased options to lease hundreds of acres of land in the three locations and began designing gas import terminals, going full speed ahead.

Souki’s company couldn’t really afford all its heavy spending, though. Cheniere was selling for less than fifty cents a share, or a puny $25 million. Most investors were sure the company would go under. Cheniere’s own landlord in Sabine Pass figured he’d pocket a few hundred thousand dollars to lease the land for a couple of years, and when Souki’s company inevitably collapsed the landlord would get his land back.

Souki hadn’t even begun raising money to pay for his first plant and pipeline, something Reimer estimated could cost more than a billion dollars. It’s one thing to be ambitious; at that point Souki seemed downright delusional.

By early 2002, Cheniere had run out of money, just as the skeptics had anticipated. Souki couldn’t afford a few million dollars to obtain permits with various government agencies, such as the Federal Energy Regulatory Commission, to build his first plant. He was even forced to borrow $30,000 from Reimer just to make payroll.

He reached out to Wall Street investors to try to raise $30 million to pay for the application process and obtain government approval for his three gas importing terminals. By then, natural gas and oil prices were edging higher again and the country was rebounding from the September 11 terror attacks, buoying Souki.

If I can just convince 3 percent of the people I meet with, that will be enough,
he thought.

He traveled up and down the streets of Manhattan, sharing his vision with big-name investors like Kohlberg Kravis Roberts & Co., the Blackstone Group, and Apollo Advisors. Souki was confident they could score big profits by investing a few billion dollars in his import facilities, or simply by helping him flip his prime real estate to a party with deeper pockets who could afford the billions necessary to actually build the terminals.

Everyone wanted to hear Souki’s story. They all liked the idea and wanted more details. He still couldn’t raise enough money to make his plan happen, however. “When you’re talking about two billion dollars you don’t have a lot of friends,” he recalls.

Souki wasn’t deterred. He always had been good at raising big bucks in the Middle East, and he still had prime contacts in the area. He began flying to the region, and to other foreign locales, pitching his radical idea and trying to sign customers looking to sell gas to America. Souki and his wife would first fly to Paris or London, where Rita would stay and spend time with friends, while Souki went on to Algeria, Saudi Arabia, Nigeria, Equatorial Guinea, and elsewhere.

In Doha, the capital city of Qatar, Souki managed to get a dinner meeting with Abdullah bin Hamad Al-Attiyah, the minister of energy and industry. “You’re going to have a new market in America,” Souki told Attiyah, trying to entice him to direct a big investment Cheniere’s way so Qatar could sell gas in the United States.

The prospect of targeting the huge American market held instant appeal. Qatar had built enormous production facilities and needed to find demand. Attiyah and other local executives and officials even seemed to root for Souki, who shared a Middle Eastern descent, spoke Arabic, and was a David up against the Goliaths of the energy world. Local technocrats did their research and received promising reports about Souki’s sites on the Texas and Louisiana coasts.

Souki couldn’t get Attiyah or anyone else to sign on the dotted line, however. Cheniere just seemed too tiny and risky. Souki had made a career out of raising cash, but he couldn’t raise a measly $20 or $30 million. There already were four LNG terminals in the United States that had been built in the 1970s, some potential investors noted. Two had been mothballed, and the other two hardly were in use. Who needed another costly LNG conversion facility?

Souki, still pitching his crazy idea, flew to a breakfast meeting with Michael Smith at Denver’s Brown Palace Hotel. The two men seemed a perfect match. A native of the New York borough of Queens, Smith had become wealthy in real estate, recently sold his energy company for $400 million, and was looking for investment projects. Smith’s company had drilled in the Gulf Coast. Like Souki, Smith had become convinced that energy prices were heading higher as gas discoveries became more infrequent and existing wells were depleted. Smith even had taken a year off at one point to ski in Colorado, just like Souki.

Souki described his three-step strategy: Once Cheniere received a permit to build its first plant, Souki planned to find customers willing to give Cheniere lucrative contracts to convert their LNG to natural gas. After Cheniere signed a client or two, Souki figured it would be easy to find backers willing to finance the billion-dollar construction of an expensive terminal and connecting pipeline. After he built one terminal, he’d build a few more. By then, his plan included building four LNG terminals.

When he heard Souki’s idea, Smith gave an immediate and blunt reaction. “You’re out of your mind,” he said. “No one’s built an LNG facility in this country in over twenty years. . . . One terminal is a massive undertaking, four at the same time makes no sense.”

Just read our plan over, Souki insisted. I really think you’ll like it.

Over the next few weeks, Smith digested the materials, did his own research, and became intrigued despite himself. Additional conversations with Souki piqued Smith’s interest.

“He’s such a charismatic, interesting guy,” Smith says.

But Smith soon learned of several lawsuits in Cheniere’s past that raised some concern for him. “This is an interesting idea but I’m going to pass,” he finally told Souki.

Souki spent another six months trying to raise his money, with no luck. The company was spending about $200,000 a month and time was running out. When an investment banker working with Souki invited Smith to hear a speech Souki was giving at an energy exploration-and-production conference, Smith agreed to join the audience.

Souki usually was a smooth speaker, but he was unusually awkward that day, perhaps a sign that even he was tiring of the never-ending sales process. Halfway through his speech, he stopped to apologize to the audience of analysts and investors. He was discussing importing natural gas, but it was a subject most had little interest in, he realized. There were only about twenty-five people in a room that held over one hundred, a further sign of how few wanted to hear from him.

After the speech, Souki joined Smith in a private room. Souki told Smith that Cheniere was going to focus on just one project, the prospective facility in Freeport, Texas, not on trying to build three others. The two men began an intense, three-month negotiation, settling on a deal for Smith to invest several million dollars with Souki.

A few days later, however, Souki’s banker called Smith with news that Souki had inked a deal with Dow Chemical to both finance the terminal and become its first customer, Smith recalls. (Souki says he never told Smith he had a deal with Dow. At most, he was “posturing,” he says.)

Smith became upset, believing Souki had used him to get Dow to agree to its investment. “When your deal falls apart, call me,” Smith says he told Souki’s banker. “But our deal will be on new terms.”

“I was fucking angry,” Smith remembers.

Smith was sure Dow would walk away from Souki and Cheniere. “They were a fly-by-night company with just an idea . . . it wasn’t hard to see they had no money” and that Dow would have second thoughts.

Sure enough, Dow never completed a deal with Cheniere. Souki’s banker got in touch with Smith to ask if he remained interested in putting up the money. Souki and the banker hadn’t made it a secret that they were talking with other parties, including Dow, Souki says, so they never understood why Smith would be upset by what Souki calls a simple “break in the negotiation.”

Late on a Friday afternoon in early August 2002, Souki flew to New York’s Palace hotel to meet Smith, who drove in from a summer resort in the Hamptons.

This time I’m not going to get fucked,
Smith thought as he approached the hotel.

In September 2002, they agreed to a new deal. Smith would pay Cheniere $5 million—$1 million up front and the rest down the road. In return, Smith would get full control over Souki’s most advanced project in Freeport, Texas, with Cheniere reduced to a 40 percent minority investment. Smith wanted ownership of any company he was going to invest a lot of money in.

Smith also insisted that Souki agree not to move forward on his other LNG projects for about a year, to give Smith’s Freeport facility a big head start. Oh, and one other thing: Smith demanded that Charles Reimer, Souki’s in-house LNG expert, leave Cheniere and join Smith’s new company.

“I liked Charif but Cheniere was technically insolvent,” says Smith. “I just wanted my new company to be fully protected and isolated from any problems Cheniere could have.”

Souki didn’t care about Smith’s concerns. He was actually thrilled someone else agreed with his argument about the value of importing gas. “Now there were two maniacs, not just one,” he quips.

His company had a million-dollar lifeline and a commitment of $4 million to help pay for preliminary work on an import facility at Sabine Pass, Louisiana, the terminal Souki would now focus on. It wasn’t much, and he’d still have to raise a billion dollars somehow to build the thing. Cheniere was moving ahead, though, even if its stock still traded for about a buck a share. Souki’s dream was alive, if only just barely.

H
enry Harmon had a hunch why Aubrey McClendon was calling.

It was the summer of 2005 and McClendon was on the phone asking if he could fly to Charleston, West Virginia, to meet Harmon.

Harmon, who ran a natural gas company in the Appalachian Basin called Columbia Natural Resources, was intrigued by the call. McClendon was the industry’s rising star, and Harmon was thrilled that he wanted to visit.

Days later, McClendon took a private jet to Charleston to take Harmon to dinner. Aware that McClendon was a big steak fan, Harmon took his guest to the Chop House, one of the city’s most upscale restaurants, eager to hear why McClendon had come all the way to see him.

McClendon and Harmon sat in a private dining room featuring rich oak floors and comfortable leather chairs. McClendon had a juicy cowboy steak on his plate, but he couldn’t focus on his food. He fired question after question at Harmon: What was it like operating on the East Coast? Are there environmental concerns that Chesapeake didn’t have to worry about in Texas, Oklahoma, and elsewhere? What about the company’s unions?

Harmon quickly realized why McClendon had flown to see him—McClendon was coming after his company. For three years, McClendon had privately lusted after Columbia’s natural gas wells, which stretched from the Finger Lakes region in upstate New York all the way south to central Alabama, with the heart of its operations in West Virginia. By then, McClendon and Ward had made a decision that it was time for Chesapeake to head to the East Coast, after the company had gobbled up so much land elsewhere in the country. Now it was time to act.

Columbia, the second largest producer on the East Coast, hadn’t given any indication that it wanted to sell itself. But McClendon knew the company was owned by a number of parties—including investment bank Morgan Stanley—that likely would pursue a sale someday. He wanted to be ready to pounce if they did.

Harmon cautioned McClendon about an acquisition. The East Coast is a more densely populated region, he noted, making it harder to drill new wells near people’s backyards without sparking a backlash from some landowners and environmentalists. It’s very different here, Harmon told McClendon.

McClendon shrugged off the warning, exuding optimism and self-confidence. He told Harmon that natural gas prices were heading still higher and his company would be a natural fit within Chesapeake’s growing empire. “We’re the best buyer” of Columbia if it’s going to be sold, he said.

A few months later, Columbia’s owners put the company up for sale, just as McClendon had hoped. Some of the largest oil and gas companies in the country showed immediate interest. McClendon insisted to Ward that Chesapeake needed to beat their rivals in the quest for Columbia.

One day, McClendon showed up, unannounced, in the New York City lobby of Morgan Stanley’s headquarters. Chief executives of major companies normally don’t fly anywhere without a handler or two, and they usually don’t show up anywhere unannounced. Aubrey McClendon wasn’t a typical CEO, though. He was alone in the lobby, carrying a small bag, and he wanted to speak with the banker working on the sale of Columbia.

“Can I come up and tell you why we’re the best buyer?” McClendon asked a stunned Morgan Stanley banker. “Can we get a deal done?”

In October, McClendon got his way. Chesapeake announced a deal to pay $2.2 billion in cash for Columbia, while also assuming $800 million of the company’s debt. It was more than Chesapeake had ever paid for an acquisition and a sign that the company’s land acquisition machine was now in overdrive.

Aubrey McClendon and Tom Ward had truly arrived. Their company now controlled eight million acres, almost the size of New Jersey and Connecticut, throughout seven states. Chesapeake sat on nearly seven trillion feet of gas, making it the sixth largest natural gas producer in the nation.

Adoration and accolades quickly followed. That year,
Forbes
magazine named McClendon one of America’s top-performing executives. The company is “the closest thing you’re going to find to a Bill Gates story in the energy industry,” an energy industry analyst, Stephen Smith, told a reporter.
¹

Those who challenged McClendon and Ward’s strategy usually were dismissed as naïve or excessively cautious. On a quarterly conference call with investors and others, Duane Grubert, a stock analyst at Fulcrum Global Partners LLC, asked when Chesapeake was going to stop borrowing and buying companies at expensive prices. “When is enough enough?” Grubert asked.

“I can’t get enough,” McClendon retorted, adding that Chesapeake’s backlog of acreage surely would prove valuable.
²

Grubert remained worried about the risks McClendon and Ward were taking. By the end of 2005, Chesapeake had nearly $5.5 billion of debt, up from less than a billion five years earlier.

Grubert didn’t respond to McClendon’s quip, however. There didn’t seem any point in pushing back.

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hesapeake shares soared, and the company emerged as among the country’s best hopes of staving off a seemingly imminent shortage of natural gas. Investors couldn’t get enough. Chesapeake’s stock doubled in just a year, moving past thirty dollars a share.

Few benefited from the move like McClendon and Ward. By late 2005, McClendon’s nearly eighteen million shares were worth over $500 million. Ward had over fourteen million shares worth over $400 million. Each executive had also purchased between 1 percent and 2.5 percent of every well drilled by Chesapeake, adding to their wealth. The ability to buy a piece of the company’s wells was granted to the executives when the company went public, a perk that executives at a few rival companies enjoyed.

Like adrenaline junkies, McClendon and Ward seemed desperate for new kicks—and ways to expand their already swelling fortunes. By then, they had already become investors in a hedge fund run by veteran oilman T. Boone Pickens, stakes that proved lucrative. They wanted more, though.

McClendon and Ward arranged lines of credit at major Wall Street firms, including Goldman Sachs and Morgan Stanley, which allowed the Chesapeake cofounders to borrow millions of dollars to make trades in personal accounts at the firms. The pair weren’t required to seek approval from Chesapeake’s board of directors for the trading, nor did they ask for it.

Every week or so, McClendon and Ward called trading desks of the Wall Street firms and placed bets on natural gas futures, among other investments. Traders at the firms say McClendon and Ward usually showed prescience in their trading moves, leading to hefty gains. Ward, for one, made tens of millions of dollars most years, and sometimes more than $100 million, he later acknowledged.

It’s very unusual for top corporate executives to actively trade stocks and commodities. It’s hard enough to run a big company, let alone also try to figure out where various markets are headed. Such activity can also raise questions about conflicts of interest and whether an executive has access to information that other investors aren’t privy to. Indeed, Ward led a group that oversaw Chesapeake’s trading in oil and gas that was done to hedge, or protect, the company from big price swings. As such, he and McClendon played an active role in daily trading by Chesapeake.

McClendon and Ward often bought natural gas futures contracts—financial contracts obligating them to buy gas at a future price and day—while Chesapeake tended to sell natural gas futures as part of its hedging program. As a result, there was no conflict of interest in the activity, at least in their minds. Also, McClendon and Ward didn’t trade gas in large enough volumes to easily move markets, nor did Chesapeake itself.

While corporate executives operate under strict guidelines when it comes to buying and selling stocks, and insider trading is heavily scrutinized, commodities markets are different. Buyers and sellers are allowed to use their knowledge to hedge against price swings and trade commodities, as long as their trading doesn’t manipulate prices.

McClendon and Ward never shared details of their trading with shareholders or members of Chesapeake’s board of directors. Technically, they didn’t need to. The public never found out about the lines of credit provided by the Wall Street firms or about the calls both executives were placing to do their trading. McClendon sometimes called hedge fund traders and others to discuss where natural gas prices were headed, but the traders usually didn’t know he was placing trades in his own account.

The Chesapeake cofounders didn’t seem to go out of their way to hide their trading, though, and some senior colleagues were aware of it. Whenever they were asked about the trading, McClendon and Ward downplayed it, a strategy that seemed to head off potential news stories about the activity.

“I just play the stock market, I play the commodity markets,” McClendon told a reporter for the
Wall Street Journal
in 2006. “Sometimes I win, sometimes I lose.”
³

As for Ward, he viewed the trading as an extension of moves he had made in personal accounts for years. Heck, his personal e-mail address was made up of his initials and the word “trading,” as if he were publicizing his hobby.

“I had trading accounts at several banks . . . I’ve always traded, I’m not afraid of markets,” Ward says. “It started out of college.”

The busy personal trading still wasn’t enough for McClendon and Ward. In 2004, the executives started a hedge fund called Heritage Management Company to trade coffee, agriculture, livestock, grains, and oil. About 10 percent of the trading in the fund, which was based in a small two-room office in a 1930s skyscraper on Fifth Avenue in Manhattan, was in natural gas, Chesapeake’s key product.
⁴

McClendon and Ward sent daily e-mails to help set the fund’s trading tactics and participated in weekly thirty-minute strategy calls that could be “exhaustive,” according to the fund’s head trader, Peter Cirino.

The fund eventually grew from about $40 million to over $200 million, half of which was the personal money of McClendon and Ward.

“I often marveled at their attention to detail,” Cirino says. “They could multitask with the best of them.”

To McClendon and Ward, the hedge fund’s activities, and all their side trading, were no big deal. Chesapeake was on a roll, providing evidence that they weren’t distracted. Besides, they were just advising the hedge fund, not running it.

It was hard to judge the impact of McClendon and Ward’s trading, however. Chesapeake was responsible for about 10 percent of the activity in the natural gas market, traders estimate. There were times when Chesapeake’s moves, including its hedging and its decisions on natural gas production, influenced markets, traders say. That raised the possibility that the hedge fund could have benefited from the activities of Chesapeake, though no such evidence emerged.

Either way, McClendon and Ward didn’t spend too much time worrying about how the trading by the hedge fund, or their own speculation in the brokerage accounts, might look to outsiders. In their minds, commodity markets were so big that their knowledge of what Chesapeake was up to didn’t give them any kind of trading edge or unfair advantage.

By then, there were few executives around to level much criticism at McClendon and Ward. They were among the most powerful men in American business, and it was hard for staff members to question their decisions, according to a former Chesapeake executive. Later, though, news of the hedge fund would emerge, leading to stinging criticism at an inopportune time for the Chesapeake cofounders.

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hesapeake was discovering new sources of natural gas and McClendon was making money hand over fist. He was determined to spend his newfound wealth like the true energy mogul he had become.

Making a lot of money and accumulating evidence of wealth always seemed to drive McClendon. He was a scion of Oklahoma’s Kerr oil family, but his parents never enjoyed an outsized fortune like others in the clan. Some who knew McClendon said he had a chip on his shoulder and was determined to accumulate wealth that topped anything the Kerrs had. Other friends said he simply developed an appreciation for the finer things in life and tended to be desirous of what others had. Either way, McClendon was driven to have it all.

First there were the homes. McClendon built a 9,000-square-foot stone mansion in Nichols Hills, an exclusive enclave near Chesapeake’s Oklahoma City campus. Then he paid $700,000 for the home behind it.

Aubrey and his wife also bought an $8.6 million home on Bermuda’s so-called billionaire’s row near homes owned by New York City mayor Michael Bloomberg, billionaire Ross Perot, and former Italian prime minister Silvio Berlusconi. The McClendons spent $12 million to give the property a makeover. Later, Katie McClendon paid $11 million for the next-door house overlooking a spectacular cliff on Windsor Beach. McClendon also paid $20.8 million for an eight-acre estate nearby that once was owned by descendants of industrialist Henry Clay Frick, but he later sold it for a small profit. They also owned properties in Minnesota, Maui, and near Vail, Colorado.
⁵

McClendon was always on the lookout for new ways to spend his cash. Riding a Jet Ski on Lake Michigan on vacation, he spotted “the prettiest home along the lake,” he later said.
⁶
He spent $40 million to buy the lakeside home and millions more to purchase 330 acres for a massive resort, including a hotel, nine-hole golf course, marina, and one hundred residences, a development that locals fought to stop.

Then there were his expensive hobbies and interests, including a $12 million collection of antique maps of Oklahoma and nearby states that “would be the envy of the Library of Congress,” his adviser told Reuters. McClendon proudly hung the maps in Chesapeake’s offices, to the cheers of employees and guests of the company. McClendon’s wine collection would total more than 100,000 bottles and be worth millions. A highlight: a six-liter bottle of 1945 Mouton Rothschild valued at about $100,000.

“He went from not knowing anything about wines to having a basement of 1982 Bordeaux,” says a longtime friend.