The Frackers: The Outrageous Inside Story of the New Billionaire Wildcatters (36 page)

“It was painful,” Souki says. “I wanted to reduce debt but this added to it.”

The August financing deal gave Cheniere enough cash to keep its operations going for about three more years, providing the company with time as it searched for someone to buy the extra capacity in its gas import terminal. But Cheniere was burning through about $50 million a year and had to repay its lenders about $1 billion in 2012. It was difficult to imagine how the company was going to pay that money back.

Souki had kept his engineers and development people around, despite the deep layoffs at the company, so its operations continued. His hope was that natural gas supplies might shrink enough by 2012 to let his idea of importing gas to the United States become popular once again.

By the end of 2008, though, the whole idea of importing natural gas seemed preposterous, much like it did at the beginning of Souki’s long journey. So much gas was pouring out of shale wells that the notion of getting even more gas from foreign countries was absurd. In December, the U.S. government’s Energy Information Administration estimated that LNG imports eventually would reach 1.2 trillion cubic feet a year, down from a forecast of 6.4 trillion cubic feet a year just two years earlier. Imported gas was expected to drop to 3 percent of U.S. natural gas consumption by 2030 from 16 percent in 2007.
⁹

By the end of 2008, Souki had his own doubts about the country’s need for foreign gas. “I started getting suspicious” that producers would be able to get so much gas from U.S. shale deposits that his company’s services wouldn’t be needed after all, he says.

Natural gas prices finished 2008 at about $5.60 per thousand cubic feet, close to their lows for the year, while oil closed at $44.60 a barrel. At those levels, gas was cheaper in the United States than it was abroad. It made absolutely no sense for anyone to even consider paying the cost of freezing gas, shipping it in huge ships similar to giant thermoses, and then having it converted at Cheniere’s plant for sale in the United States. Global gas producers were gearing up to send their product anywhere but America. Souki wasn’t the only one with a project to import LNG who now looked foolish, but that didn’t make him feel any better.

Shares of Cheniere Energy finished 2008 at less than three dollars. It was such a dramatic comedown for Souki and his company that his friends became concerned about him.

“A lot of friends took me out and made sure I wasn’t left alone,” Souki remembers.

Charif Souki seemed down for the count, much like his fellow dreamers and wildcatters with grand visions of a new era for energy in America.

Technology is the real enemy.

—Saudi sheik Ahmed Saki Yamani

A
ubrey McClendon and the Chesapeake Energy brain trust tried to reassure nervous investors that the company would be fine, despite lower energy prices and inhospitable capital markets. After they announced plans to sell as much as $3 billion of assets and reduce spending, the stock stabilized around sixteen dollars a share at the beginning of 2009, as the overall market bottomed out.

McClendon seemed in good spirits around Chesapeake’s campus, perhaps because he had a new plan to score a huge windfall for himself. A bit later, an attorney working for McClendon approached the three members of the compensation committee of Chesapeake’s board of directors. McClendon’s lawyer had an unusual suggestion for board members.

McClendon had been stunned by 2008’s margin calls and how he had been forced to sell almost all of his Chesapeake shares. Now he couldn’t afford the cost of the 2.5 percent stake he was getting in his company’s wells. Chesapeake gave McClendon ownership in the wells under what it called its Founder Well Participation Program, but only if he paid the wells’ proportional drilling costs.

McClendon’s lawyer told the three board members that the Chesapeake chairman and chief executive needed a cool $75 million so he could afford his bill for the wells. Since McClendon no longer had that kind of money, the lawyer asked that the board grant him that sum as a special, one-time bonus.

McClendon didn’t have an obvious reason to claim a bonus, let alone one so outsized. In the corporate world, those kinds of payouts are usually for doing something special, or at least a job well done. But Chesapeake shares had dropped nearly 60 percent in 2008. Headlines about his margin calls, and how flat-footed McClendon had been before the market’s meltdown, didn’t suggest someone deserving of a huge reward, or even a pat on the back. The guy should have felt lucky just to keep his job, some said.

The three board members on the committee—longtime analyst Charles Maxwell, investment banker Frederick Whittemore, and former Oklahoma governor Frank Keating—were well aware of the criticisms leveled at McClendon. Some of them, such as Maxwell, had even tried to warn McClendon that his spending was over the top, though it wasn’t like they challenged him very much.

The committee members were also quite cognizant of how much the stock had tumbled. The value of Maxwell’s own Chesapeake shares had dropped from $2.5 million to $600,000 since the 2008 crisis.

Nonetheless, the three board members agreed to meet to consider the request from McClendon. As they began discussing the matter, the board members quickly adopted a very different perspective on the bonus idea than the outside critics.

In their view, McClendon had directed $18 billion of spending over the previous several years on shale acreage around the country. The joint ventures completed in 2008, including those with Plains and Statoil, placed a value of about $28 billion on that acreage, while generating over $5 billion of up-front cash for the company. So McClendon had created $10 billion in value, in the view of these board members.

Some of the committee members were especially impressed with the Statoil deal. They were amazed McClendon managed to pull it off, since the agreement was inked in the teeth of the financial meltdown and Statoil could have found a way to back out of it. The transaction clearly was a herculean feat by McClendon, in the eyes of these board members.

The more they debated it, the more board members were convinced that a $75 million bonus meant getting McClendon for a bargain. They began to feel outrage that anyone would question such a sizable payout.

“God damn it, if we can’t give him one percent of what he’s made the company, what balance is there?” Maxwell asked at one meeting. “This man has performed brilliantly.”

Sure, the deals McClendon made were part of his role as the company’s chief executive officer, rather than any kind of special additional chore. And the $28 billion value for the properties was just on paper. If Chesapeake actually tried to sell the acreage, there was no way it was going to get any sum close to that valuation in early 2009, given that financial markets had cratered and the economy was still crumbling.

That didn’t seem to matter to the committee members. They agreed to cut the $75 million check. Aubrey McClendon’s personal comeback was well under way.

Not only that, but McClendon, who agreed to keep his cash compensation flat for five years, also received nearly $33 million in Chesapeake shares as part of his 2008 compensation. Including some extras, it added up to a $112 million package that made him one of the nation’s highest-paid executive that year.

It probably didn’t hurt that members of the compensation committee had long-standing personal ties to McClendon. Several years earlier, for example, McClendon had donated thousands of dollars to the congressional campaign of Catherine Keating, Frank Keating’s wife. Whittemore in the late 1990s had lent money to McClendon.

Each member of the compensation committee had made over $600,000 annually for their services on Chesapeake’s board, with Keating netting over $760,000. By contrast, most directors at other companies made about $200,000 annually for their service on corporate boards.

Like all of the company’s board members, the three also had access to Chesapeake jets. In addition, Keating’s son and daughter-in-law both worked at Chesapeake, making over $130,000 a year each, according to securities filings.

The $75 million bonus wasn’t enough for McClendon, though. He also worked out a deal to sell his personal collection of five hundred antique maps of the American Southwest to Chesapeake for just over $12 million, the amount he had paid for them.

It made a bit of sense for the company to purchase the maps, since they were being displayed in conference rooms and elsewhere on Chesapeake’s campus, and the company was already insuring them. Chesapeake told shareholders that the dealer who had worked with McClendon to amass the collection judged their value to be $8 million more than the company was paying.

“The maps complement the interior design of our campus buildings and contribute to our workplace culture,” Henry Hood, Chesapeake’s general counsel wrote to investors in late April 2009, most likely with a straight face. “The company was interested in continuing to have use of the map collection permanently and believed it was not appropriate to continue to rely on cost-free loans of artwork from Aubrey.”

That argument was something of a stretch. Natural gas prices were under pressure and Chesapeake was cutting spending and selling assets to raise cash. Yet it somehow had enough spare coin to buy McClendon’s nineteenth-century maps.

Even McClendon’s fans on the board blanched at the map purchase, though they didn’t put up much of a fight to stop it. “Those things would have dropped like lead in an auction” at the time, Maxwell says, because the economic downturn was impacting art and collectibles. “Paintings at Sotheby’s already were dropping. . . . It was too much to pay.

“I didn’t like it, but what was I going to do about it?” Maxwell says.

In the past, McClendon had received some criticism centering on Chesapeake’s outsized spending and use of debt, among other things. But the compensation package and map deal set off a wave of invective the likes of which McClendon hadn’t experienced. Wall Street analysts, investors, and members of the media, many of whom had been deferential to the executive, began digging up a range of potential conflicts of interest involving McClendon and Chesapeake, forcing the company to respond, even when the perceived infractions were small potatoes.

In late April, for example, the company revealed that it had paid approximately $177,000 to an affiliate of the Deep Fork Grill, the restaurant in which McClendon was a 49.7 percent owner, for food and beverage catering services during 2008. The company said McClendon hadn’t been involved in the decision to hire Deep Fork and that he had requested the company limit its use of the restaurant in the future.
¹

It wasn’t the money that got people so upset, really. The purchase of the maps, which led to lawsuits from shareholders, was a drop in the bucket compared to Chesapeake’s operating budget; the catering expense was even more insignificant. But to many investors, the deals were a sign that McClendon had too much leeway at the company, even when it wasn’t yet clear that his costly shale push would pan out.

The payouts to McClendon also came as the country was affixing blame for the deepest economic downturn since the Great Depression. Many viewed the huge bonuses that had been handed out to already wealthy executives as among the reasons the markets and economy had hit the skids. Around that time, a separate furor had erupted over bonuses given to executives of insurance giant American International Group, which had been bailed out by the government.

Others resented the tumble in Chesapeake shares and the selling McClendon had done that placed additional pressure on the stock. Shareholders weren’t getting special bonuses that year; it wasn’t clear to many of them why McClendon was.

“I have never seen a more shameful document than the Chesapeake proxy statement,” investor Jeffrey Bronchick wrote to the company’s board of directors on April 23, 2009, adding that he was disgusted with the board’s leadership. “If I could reduce it to one page, I would frame and hang it on my office wall as a near-perfect illustration of the complete collapse of appropriate corporate governance.”
²

At the company’s annual meeting in Oklahoma City, some investors cheered McClendon. But others berated him and the board. At one point, McClendon appeared to choke up as he responded to criticism.

“You became so enamored with your own success that your greed and your ego took over and you bet the farm,” said Jan Fersing, a Fort Worth, Texas, investor who said he planned to sell his Chesapeake shares.
³

A series of lawsuits were filed by Chesapeake shareholders, including one from the New Orleans Employees’ Retirement System that called McClendon’s payouts “a personal bailout” that was “destructive of company value and opportunity.”

McClendon seemed to shrug off the condemnation. Friends cited a strong marriage that gave him a source of comfort and support. An overriding confidence and positive outlook also likely helped, as did that $75 million bonus.

But those who worked with McClendon said he cared deeply about the insults, even if it sometimes was hard to see their impact. “He doesn’t show it but he’s very sensitive,” says Maxwell, the Chesapeake board member. “He mulls it over in his mind and doesn’t want to give you an advantage, but he talks about it later.”

•   •   •

A
mid the criticism of McClendon in 2009, something else was happening: The nation was finding a bottom. Economic growth remained weak, unemployment high, and natural gas prices dipped below three dollars per thousand cubic feet in August. But the stock market was rallying as investors breathed a sigh of relief that a collapse of the financial system was becoming more unlikely.

The tone of Chesapeake strategy meetings became more hopeful and enthusiastic. Soon, McClendon had announced his company’s third “business model.” He might just as well have called it his “Back to the Future” plan, since it entailed accumulating acreage once again.

It was as if his bad dream was over and McClendon was ready to get back to work. He made plans to expand in the Marcellus Shale, to gobble up land in new and exciting formations like the Utica Shale that was under parts of Ohio, New York, and Pennsylvania, and to catch up to EOG in the Eagle Ford. There also was the Mississippian Lime, a limestone play covering seven thousand acres between south-central Kansas and north-central Oklahoma, not to mention the Niobrara Shale beneath eastern Wyoming.

McClendon had genuine reason for optimism. Geologists were zeroing in on new and exciting shale deposits, while huge amounts of gas appeared to be coming from existing shale formations, including those that Chesapeake had placed expensive bets on. These new wells were producing more gas even while becoming less expensive to drill.

Most of the country was trying to recover from a debilitating housing collapse, but excitement was building within the energy patch. Just as huge amounts of oil were uncovered in East Texas during the Great Depression, setting off “a boom unlike any American had ever seen,” as Bryan Burrough writes in
The Big Rich,
American frackers in 2009 had a chance to help the nation rebound from its economic meltdown.

In August 2009, natural gas prices fell to three dollars per thousand cubic feet, the lowest level in seven years, amid a record amount of gas in storage. Part of the excess supply was due to lower demand amid a still anemic U.S. economy. But there also were fewer than seven hundred drilling rigs operating in the entire country, down from nearly sixteen hundred a year earlier. And yet natural gas output was rising, suggesting that companies were doing a better job getting gas from shale and other rock.

Some of the most promising spots to drill seemed full of oil, not just natural gas. Bedrock with oil was especially attractive because crude prices were on their way to nearly eighty dollars a barrel in early 2010 from just above forty dollars a barrel in early 2009, as oil demand grew in China and other emerging-market nations.

McClendon wasn’t the only one getting reenergized about shale. So were environmentalists like Robert F. Kennedy Jr., who had founded the Waterkeeper Alliance, which was fighting hard against coal mining. “A revolution in natural gas production over the past two years has left America awash with natural gas and has made it possible to eliminate most of our dependence on deadly, destructive coal practically overnight,” Kennedy wrote in an op-ed in the
Financial Times
in July 2009. “America’s cornucopia of renewables and the recent maturation of solar, geothermal, and wind technologies will allow us to meet most of our energy needs with clean, cheap, green power. In the short term, natural gas is an obvious bridge fuel to the ‘new’ energy economy.” (Later, Kennedy became an opponent of fracking to find natural gas.)