The Frackers: The Outrageous Inside Story of the New Billionaire Wildcatters (34 page)

They’d find something else in the Marcellus: scrutiny and criticism as they never before had experienced.

Excitement over the Marcellus Shale can largely be attributed to two people, Bill Zagorski and Terry Engelder, who focused on the formation when no one else cared about it.

Zagorski was a middle-aged geologist at a subsidiary of a small gas company called Range Resources. In 2003, he was charged with finding “the next Barnett,” but Zagorski and his team met disappointment drilling a deep layer of rock in the Appalachian Basin. Frustrated and eager for a diversion, he took a trip to meet a friend who was meeting some success with a shale formation in Alabama and wanted Zagorski’s advice. Zagorski quickly realized that his crew had been drilling through a similar layer of Appalachian shale called the Marcellus.

“Holy cow, we have same thing!” Zagorski said.

Back in Pennsylvania, Range began drilling test wells in the Marcellus.

Holy shit, this is big stuff,
Zagorski thought.

In 2004, he convinced his bosses to spend several million dollars to frack the rock in the Marcellus, using the same techniques Mitchell Energy had used in the Barnett. The early results were even better than Zagorski and Range could have hoped for, so the company began leasing additional land in Pennsylvania. It took them another three years to crack the code and coax huge amounts of gas from the Marcellus layer by combining fracking with horizontal drilling.

Some others followed Range into the Marcellus, but activity was still limited. Land in the town of Dimock, in the lush green mountains of Susquehanna County, in the northeastern corner of the state, didn’t go for much more than twenty-five dollars an acre in late 2005 and 2006. It wasn’t much money, but the area was struggling, many farms were on their last legs, and the cash came in handy.

The wild roar of the diesel generators was deafening as the first wells were drilled; most used fracking techniques that had not yet been refined. The process involved pumping over a million gallons of water into the shale a mile below, along with some chemicals and sand. Between 10 percent and 30 percent of it usually came back up, carrying a range of chemicals used to create the fractures in the rock, as well as natural components including iron, radium, and oil-laced drilling mud. The flowback in Dimock and elsewhere usually collected in large, lined ponds.

Just before Christmas 2007, Engelder, a sixty-one-year-old professor of geosciences at Penn State University and one of the few focusing on this rock layer—together with a colleague named Gary Lash from the State University of New York—calculated how much gas was buried in the Marcellus by examining the production of Range’s wells. Their figure was staggering: fifty trillion cubic feet of recoverable gas, enough to put the Marcellus among the largest gas fields in the world and roughly twenty-five times the government’s previous estimate. It turned out that Zagorski had discovered one of the largest energy fields in modern history, one that was ten times the size of the Barnett.

In 2008, Chesapeake and others raced to lease land—paying as much as $5,000 an acre—and Engelder was an instant celebrity. Later, he’d boost his estimate to 489 trillion cubic feet, or the equivalent of twenty years of gas consumption for the entire nation

Alta Resources—the company launched by Joe Greenberg and Todd Mitchell with backing from eighty-eight-year-old George Mitchell—was among the most convinced the Marcellus area was packed with enough natural gas to change the country.

Alta sold its holdings in Arkansas’s Fayetteville formation for $580 million, giving George Mitchell a new, $100 million windfall. The company immediately began searching for acreage in the Marcellus region. They called Nick Steinsberger to help develop a strategy to fracture the rock and let the gas flow. Soon, Mitchell’s new company had leased thousands of acres in Northeast Pennsylvania, not far from the town of Dimock.

Until 2008, drilling and fracking around the country hadn’t attracted much controversy. There were few reported examples of harm and much of the production was in less populated areas in the country, or in states like Texas with a long history of supporting the energy business.

Pennsylvania wasn’t nearly as welcoming to the high-volume hydraulic fracturing cropping up around the state. Although Pennsylvania has a rich history of oil and gas drilling and was the site of the nation’s first oil well, in the city of Titusville, the Dimock area and many other parts of the state atop the Marcellus Shale hadn’t seen a great deal of recent drilling. In early 2008, some locals became wary of the activity, especially those who had moved to the area to get away from noise and pollution. Drillers rushing to the Marcellus to tap the gas, such as a company called Cabot Oil and Gas, were honing their techniques and working to make them safer. But many were still figuring out how to drill the challenging rock in the region.

Soon, Dimock’s residents—and their growing concerns—would be heard around the world.

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C
harif Souki was working hard to join McClendon and Ward atop the energy world. Souki had bet it all on a Louisiana terminal that would transform imported liquefied natural gas and pipe it around the country.

He was beginning to have a harder time of it, though. Shares of his company, Cheniere Energy, began to weaken in the latter part of 2007 amid concerns about all the debt it had piled up to build its plant.

Things got worse as 2008 began. The stock dropped from nearly thirty-three dollars a share to just over eleven dollars in mid-April as doubts grew about whether the expensive facility would ever be built. Souki began to hear chatter that short sellers, or investors who profit by wagering against a stock’s price, were zeroing in on his company, eager to push it lower.

The loss of confidence came just as Souki was trying to raise the last few hundreds of million dollars of financing to build the terminal. With the stock weak, Souki knew it now would be almost impossible to raise the money, especially with financial markets turning wobbly. He’d have to figure out another way to come up with the cash.

“I started to get really nervous,” he says.

Cheniere executives at least had one event that might bring them good fortune. On Monday, April 21, 2008, senior government officials, local politicians, and energy regulators were scheduled to fly to Cameron Parish, Louisiana, for a grand opening of the terminal. The ceremony had the potential to remind investors that Cheniere was on its way and would actually be importing LNG soon enough. It also figured to improve lagging morale among employees, many of whom were coming from the company’s headquarters in Houston.

The morning of the ceremony, Meg Gentle, Cheniere’s head of strategic planning, got into her car with a colleague to make the nearly three-hour drive to the Gulf Coast. Along the way, she got a call on her cell phone from an unfamiliar New York number. It was an analyst from Moody’s Investors Service, the debt rating company, with some bad news.

“We’re putting you guys under review” for a possible ratings downgrade of debt sold by the regasification terminal, the analyst told Gentle.

The news startled Gentle and her colleague. Cheniere had contracts with Total and Chevron that seemed sufficient to meet the interest payments on the debt.

Gentle was told she and her colleagues had an hour to dispute anything factual in a memo that Moody’s was about to distribute to investors.

“We’re in a car,” she told the analyst. “Can you just do this tomorrow when we’re in the office to deal with this?”

Sorry, that won’t be possible, the analyst said. The news went out, signaling to investors that the debt was riskier than it had appeared, the latest blow to the company.

When visitors arrived at the site, just over the border from Texas and adjacent to the Gulf of Mexico, they witnessed an industrial facility that had been transformed by Cheniere workers. A couple of years earlier, the spot had been little more than marshland, so thick and deep it seemed like quicksand. Once, a civil engineer working on the grounds had even lost a tractor in dense marsh.

Then there were the animals that usually made the site their home, the variety of which might have made a zoo jealous. There were bobcats, coyotes, hogs, raccoons, rattlesnakes, huge rats, and free-range cattle, all walking around doing their thing, unconcerned with Charif Souki’s big plans. Migratory ducks, geese, and almost every other kind of bird made regular appearances. Most of the animals had been shooed away by Cheniere employees, except for a newborn alligator in a ditch of standing water just outside the terminal’s entrance.

Souki’s team seemed to think of everything to try to make the event a success. Each guest was handed insect repellent to deal with the mosquitoes on the warm, humid day. Carpeted trailers filled with a Louisiana-style lunch were brought in, as if it was the Super Bowl. There was a Cajun band and luxurious Porta Pottys that gave the Louisiana locals who worked on the facility a good laugh.

Samuel Bodman, the U.S. energy secretary, got the festivities off to an upbeat start, saying the day was “an important moment for southwestern Louisiana and for the entire country.” He noted that the Cheniere facility was “the first domestic onshore regasification terminal built in more than twenty-five years,” predicting that it would “help us diversify our energy supplies, suppliers, and supply routes.”

As Bodman spoke, Cheniere employees on the side of the room began whispering about the debt downgrade and how the stock had begun the day’s trading with a troublesome dive.

Souki didn’t seem aware of the chatter as he walked to the podium to begin his own address before the array of senators, congressmen, and businessmen. He began his speech, stressing how America needed to import natural gas. But he soon became distracted. Souki noticed a few audience members focused on their BlackBerry phones and other devices. Some glanced down, shaking their heads, as if something bad was happening.

A buzz grew, even as Souki continued. He tried to stick with his upbeat remarks, but he could sense what was happening. Shares of his company were plunging, on the very day of his long-awaited triumph.

Later, Souki checked the stock for himself. Cheniere had opened for trading at just over eleven dollars a share. By the end of the celebratory event, the stock was well under ten. By the close of trading, Cheniere shares were barely above seven dollars, a remarkable collapse of 36 percent in a single day.

Just months earlier, Souki had been worth $150 million. His plan to import gas seemed foolproof. Even Goldman Sachs and Warren Buffett seemed to agree with his approach. Now Souki’s company was on life support and his wealth was evaporating. A few weeks later, Standard & Poor’s cut its own rating on Cheniere to junk levels that suggested the company might not make it.

Every day, Souki heard a new rumor in the market that he had to refute. One day it was that Total and Chevron would stop making payments, something Souki was sure wouldn’t happen. Another day it was that Cheniere was defaulting on its debt, though by Souki’s calculation he had a cushion of more than two years.

“It was a vicious rumor campaign, but it panicked investors,” he says. “Things looked completely desperate.”

Friends called to see how Souki was holding up amid all the bad news. “How does it feel?” one well-wisher asked.

Souki tried to make light of the dramatic turn of events. “Well, I’ve never lost $150 million before.”

Inside, though, Souki was confused and angry. He was disgusted with the fickle stock market and furious at short sellers who he believed were ganging up on Cheniere even though its terminal remained on track and nothing much had changed for its business. He called a lawyer to see if there was anything he could do about the short sellers, but realized he didn’t have many options. He also blamed himself for not anticipating the troubles and securing the crucial financing.

Suddenly, he was in a personal bind. Souki had been unwilling to sell any of his nearly three million Cheniere shares, worried about the message it might send investors and confident that bigger gains were ahead. So he had borrowed money to pay for his expensive lifestyle, pay his taxes, and pay other expenses, using the shares as collateral.

As the stock plummeted, Souki received a margin call from his lenders, forcing him to sell over two million of his shares to pay back the debt. By the end of June 2008, he was left with just 600,000 shares of his company, worth nearly $3 million. A few weeks later, the stock was below three dollars a share. Souki was worth a few million dollars, but it mostly was in real estate, which wasn’t liquid and was tumbling in value. He sold his private jet and a boat to raise some cash.

Adding to Souki’s frustration was that friends and employees were investors in his company. The stock tumble meant that they too were suffering.

Almost everything Souki had touched in his career had turned golden. He didn’t know how to react to this setback, and it sapped his confidence. “I felt shitty and seriously doubted myself,” he says. “You question your intelligence . . . it was shocking.”

An old friend called to comfort Souki. “Charif, you did something spectacular,” he said. “You did your best, you never lied to anyone.”

Souki felt horrible, though, and his self-doubt grew. Shares of other energy companies were soaring, but Cheniere dropped below three dollars in July 2008.

Souki had to take drastic measures to keep the company afloat. He laid off more than half of his 360 employees, in an attempt to preserve cash.

“I felt terrible,” he says. “I still thought it would work, but I wasn’t sure anymore.”

Souki had been pummeled by the market and his energy dreams were in tatters.

It was a prelude of what was to come.

O
il and gas prices slipped in July 2008, after soaring for much of the year. By month’s end, Chesapeake Energy was trading for fifty dollars a share, down from seventy earlier in July. It was becoming clear that the crumbling of the housing market was going to impact the overall economy, a worrisome sign for the energy market. The broader stock market had also begun to weaken, dropping over 10 percent in just six weeks.

Chesapeake’s stock remained 25 percent higher on the year, but reasons for concern were mounting. In late August, natural gas prices, which are more directly tied to the health of the U.S. economy than oil, fell below eight dollars per thousand cubic feet, and oil dropped to about $115 a barrel.

Aubrey McClendon had resisted taking steps to prepare for any bad times, seemingly oblivious to the tempest building around him. Now he felt compelled to do something, just in case things got worse.

McClendon got in touch with a group of banks that had underwritten the sale of new Chesapeake shares a few weeks earlier. He asked the banks for permission to hedge his huge holdings of Chesapeake stock. McClendon hadn’t soured on his company and he didn’t want to sell his shares, he told the banks. He just wanted to buy some protection, an umbrella in case of rain.

“At that point, he recognized the potential for failure,” says a colleague of McClendon.

The banks, which had the right to approve such a move according to the terms of the offering, refused. McClendon wasn’t allowed to reduce his exposure to Chesapeake. If things turned stormy, he would have to deal with the consequences.

By then, McClendon had personally borrowed a total of more than $500 million from banks, including Goldman Sachs, J.P. Morgan, and Wells Fargo, using Chesapeake stock as collateral. He had used the borrowed money to buy additional Chesapeake shares, finance gas wells he jointly owned with the company, and pay for all his real estate purchases and commodity trading. He had borrowed millions more from other parties, including Centaurus Advisors, the personal investment fund of John Arnold, a billionaire Houston hedge fund trader.

McClendon had become accustomed to borrowing one dollar for every three dollars of stock he held in his company, a ratio that he thought was quite conservative. But as Chesapeake fell to forty-five dollars a share in early September, the value of McClendon’s collateral—which amounted to about half of his borrowing at each of the three banks—shrank, raising some concerns among McClendon’s lenders.

Financial markets quickly spun out of control. Investors fled from almost every financial- and housing-related company, and the U.S. government was forced to bail out mortgage giants Fannie Mae and Freddie Mac.

On Sunday, September 14, the American financial system was shaken to its core when venerable investment bank Lehman Brothers Holdings filed for bankruptcy protection and brokerage giant Merrill Lynch & Co., in its own weakened position, agreed to be sold to rival Bank of America. In a tailspin, the Dow Jones Industrial Average dropped to around 11,000 from just over 13,000 in early May. Investors, suddenly scared about the nation’s economic outlook, pushed natural gas prices to about seven dollars per thousand cubic feet, down by almost half in just over two months.

It wasn’t just the financial meltdown that was weighing on gas prices. Some investors also were starting to suspect that the nation might have an oversupply of natural gas, thanks to the accelerated drilling by Chesapeake and others in shale formations around the country.

Marc Rowland, Chesapeake’s chief financial officer, wanted to do something to put the company on a firmer footing. He called Chesapeake’s lenders and converted the company’s $4 billion credit line into cash. He figured the money might serve as a cushion if the economy took a turn for the worse. The move caused some nervousness among Chesapeake shareholders, but so many companies were considering similar moves at the time that investors didn’t dwell on what Chesapeake was doing. The company also announced plans to reduce spending and sell assets, trying to assuage shareholder worries.

Despite the carnage on Wall Street and the hand-wringing in corporate suites around the country, McClendon seemed remarkably buoyant around the office. He worked on cutting new energy transactions, as if he were sure the downturn in prices would prove fleeting.

In early October, Chesapeake finalized a deal to buy gas fields and an eighty-mile pipeline in the Barnett Shale owned by ExxonMobil. Chesapeake also closed in on an agreement to raise $3.4 billion by selling a 32.5 percent interest in its Marcellus Shale wells to Norway’s Statoil ASA, a transaction similar to Chesapeake’s earlier, successful joint venture with Plains Exploration.

Wall Street was in its death throes at the time, so few paid much attention to the Statoil deal, but it was one more sign that global energy companies were becoming convinced the shale revolution was for real. For McClendon, the Statoil agreement was reassurance that all was well with his company. “Everything except macro events” was “really going our way,” according to McClendon.
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But Chesapeake shares kept falling, setting off alarm bells at the banks that had lent McClendon hundreds of millions of dollars. During the first week of October, as an intensifying housing crisis seemed likely to lead to a U.S. recession and pressure energy prices, Chesapeake tumbled to just twenty-two dollars a share.

The lenders decided they needed to act. Late in the afternoon of October 8, a Goldman Sachs executive in the firm’s private wealth group called McClendon, reaching him in his Oklahoma City office. The Goldman manager relayed disturbing news: The Chesapeake shares that McClendon had used as collateral had dropped so dramatically that they no longer held enough value to back the approximately $300 million that McClendon had borrowed from the investment bank.

Come up with more collateral fast or we’re going to have to sell your shares to help satisfy your debts, the Goldman executive told McClendon. The Chesapeake cofounder was getting a “margin call” from Goldman, as if he were a gambler under pressure to repay debts to his bookie after a bad losing streak. Only in this case, the bookie was facing his own strains caused by the plummeting market.

McClendon had to do something to stop Goldman. If they sold his shares, Chesapeake likely would sink even further and he’d suffer the kind of embarrassment few chief executives had ever endured. But McClendon was in a corner. He didn’t have enough cash or investments to boost his collateral. He had another idea, though. He picked up the phone to call a Goldman executive to ask for help.

Bill Montgomery, a senior investment banker in Goldman Sachs’s Houston office, was the usual intermediary between the bank and Chesapeake. Over time, McClendon and Montgomery had become close, so he might have been expected to help McClendon out of his jam. But Montgomery was on a retreat with energy executives in a remote part of Wyoming where there was no cell phone service.

McClendon didn’t have time to wait for Montgomery’s return. Instead, he called someone even more senior at the bank, Jon Winkelried, Goldman Sachs’s copresident. A few months earlier, McClendon had hosted Winkelried at the Deep Fork Grill, a restaurant in Oklahoma City co-owned by McClendon. They had forged a relationship and there was good reason to think Winkelried might be sympathetic to McClendon’s plight.

Only a few weeks earlier, Winkelried had been in a state of panic about his own finances. Born in suburban New Jersey, Winkelried had become a gentleman rancher, spending millions to build a facility to raise and train horses and to buy ranches around the country. He paid nearly half a million dollars to purchase a mare aptly named “I Sho Spensive.” Like McClendon, Winkelried had most of his net worth tied up in his company’s shares, so he had borrowed money to live out his cowboy fantasies.

As Goldman Sachs stock plunged in September, pressure grew on Winkelried. He became so desperate for cash that he turned to his bosses for help. Winkelried had been a loyal and accomplished executive, so Goldman agreed to buy his stake in investment funds run by the firm, handing Winkelried a check for nearly $20 million.
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Goldman had come to Winkelried’s rescue in a situation that shared similarities with McClendon’s. It made sense to think Winkelried now might save McClendon, a longtime customer of the investment bank.

Winkelried took McClendon’s call. The Chesapeake executive, aware he didn’t have much time left, made an urgent case as to why Goldman shouldn’t close his trades out. He told Winkelried that hedge funds were teaming up to short Chesapeake shares, hoping to profit as the stock tumbled.

“Hedge funds are killing the stock,” McClendon insisted.

Chesapeake was still doing great and its outlook was bright, McClendon argued. The stock was bound to rebound. Just allow a few more days before closing out the account, he asked Winkelried. It wasn’t fair that Goldman was cutting him off.

“Y’all are just killing me,” McClendon pleaded.

Winkelried listened patiently. He even sounded sympathetic. He told McClendon that he’d speak to others at Goldman about granting him a reprieve of a few days. Maybe the stock would rebound enough to prevent the need for them to act.

“We have to do what’s right for the firm but if I can get you some more time I will,” Winkelried said. It wasn’t clear if he was going to advocate for McClendon or if he was just being polite. But now McClendon had a chance at staving off disaster.

An hour or so later, Winkelried called McClendon back with a decision—the investment bank couldn’t do anything to help. Winkelried was polite but firm. In fact, Goldman already had begun selling McClendon’s shares that it held as collateral, as had many of his other lenders. It was too late for the Chesapeake executive.

“Those are the rules,” Winkelried told McClendon. “I’m sorry, Aubrey.”

McClendon hung up the phone, rose from his desk, and opened the door to his office. He slowly made his way down the hall, past the three female executive assistants, and into Marc Rowland’s office.

When Rowland looked up he was surprised by what he saw. McClendon looked pale and shaken. The two executives had spent years working together, but Rowland had never seen his boss like this.

Rowland knew McClendon had borrowed a lot of money to buy Chesapeake shares. But he and others at Chesapeake had no clue how much he had borrowed or what kind of pressure McClendon was under. He was about to find out.

“They just sold my stock,” McClendon confessed to Rowland.

“What the fuck do you mean?”

“The banks,” McClendon responded. “I’m in trouble.”

It dawned on Rowland what was happening. “Do you have anything left?” he asked.

“Yeah, but I still owe” money to lenders, McClendon replied, still looking dazed. He told Rowland that other banks would also have to sell his Chesapeake shares to satisfy his remaining debts.

It was a week of intensifying pain for McClendon and Chesapeake. On Wednesday, October 8, 4.6 million of his shares were sold at $22.68 a share, according to securities filings. The next day, another 11.4 million shares of his stock were sold at between $17.56 and $24. On Friday, October 10, 15.48 million shares were sold at prices ranging between $12.65 and $16.16 a share.

In one horrible week, the forty-nine-year-old had been forced to sell more than thirty-one million shares, or 94 percent of his stake in Chesapeake, the company he helped start and had led to the upper echelon of the energy business. He was left with fewer than two million shares. All the selling put new pressure on Chesapeake. In a single week, the stock fell 43 percent to $16.52, down from nearly $70 in early July.

“What I never dreamed could happen, did happen,” McClendon later said.
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“I honestly did not feel it was risky to have one dollar of margin debt for every three dollars of stock value.”

On Friday, October 10, McClendon tried to explain what had happened to shareholders. The company issued a statement saying that McClendon had “involuntarily” sold “substantially all” of his Chesapeake stock over the previous three days to satisfy margin calls, blaming the “extraordinary circumstances of the worldwide financial crisis.”

“In no way do these sales reflect my view of the company’s financial position or my view of Chesapeake’s future performance potential,” McClendon said in the statement, adding that he was “very disappointed” by the turn of events.

For a few days, McClendon appeared down and discouraged. His face looked so haggard that colleagues wondered if he’d managed any sleep. They were shocked to see the dramatic change in a man so ebullient for so long.

“It was a tsunami,” according to McClendon. “It was a prairie fire.”
⁴

It probably didn’t make McClendon feel any better, but he wasn’t the only energy entrepreneur forced to sell huge stakes in their companies to cover debt collection calls from brokers during that brutal period. On the same Friday that McClendon acknowledged his margin call, XTO Energy, the company vying with Chesapeake for key shale acreage, announced that its chairman and chief executive officer, Bob Simpson, had to sell nearly three million shares, worth more than $100 million. Other energy bigwigs, such as the chief of Tesoro Corp., also had to sell shares to satisfy stock loans that suddenly came due.
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Eighteen minutes after issuing the press release revealing McClendon’s stock sales, and as employees struggled to digest the shocking news, McClendon sent a company-wide e-mail urging his staff “just to ignore” the huge decline in the stock and focus on their work. He attributed the precipitous decline in Chesapeake shares to fallout from the global financial collapse and said the price was “ridiculous.”
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McClendon told employees they had entered a new world. “What was a fair price 90 days ago for a lease is now overpriced by a factor of at least 2x given the dramatic worsening of the natural gas and financial markets,” he wrote in his e-mail.

Days later, Chesapeake tried to back out of various deals to buy oil and gas rights, including an agreement with a company called Peak Energy over land in the Haynesville Shale formation. Chesapeake’s effort would lead to a lawsuit and eventual damage awards to Peak of almost $20 million.
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