The Frackers: The Outrageous Inside Story of the New Billionaire Wildcatters (45 page)

During a speech to investors and analysts in the first week of October 2012, Hamm described the new find. It didn’t seem right to call it Andy’s Neck, so it was renamed the South Central Oklahoma Oil Province, or the SCOOP formation. Hamm said it could add 1.8 billion barrels to Continental’s reserves. Andy’s neck was safe, it seemed.

The news sent Continental’s shares climbing more than 5 percent and set off a search by rivals for nearby land. At sixty-six, Hamm had come full circle. He was back in Oklahoma, out to uncover one of the last meaningful shale plays in the country.

Hamm already owned more oil in the ground than any American. It didn’t seem life could get any better.

•   •   •

O
n April 8, 2013, Hamm met his old friend Mickey Thompson at an Oklahoma City bar to watch the NCAA basketball championship. It was a much-anticipated game between Louisville and the University of Michigan, and Hamm should have been in good spirits. Continental shares were on their way to $100, an all-time high, and Hamm soon would be worth more than $12 billion.

Hamm seemed subdued and preoccupied, though. Thompson had an idea why. For the previous several years, word had circulated around Oklahoma City that Hamm and his wife had a strained marriage. A few weeks earlier, Continental had announced that Sue Ann had quietly filed for divorce a year earlier, just ten days after the couple hosted the event for Romney in their home.

By the night of the game, friends had noticed a change in Hamm. He had become more serious and reserved. The public airing of the marital dispute in various media outlets, including allegations that his wife had discovered Hamm was having an affair three years earlier and a suggestion that she had been videotaping him at home, had embarrassed him, the friends said.

Thompson, who was close to both Hamm and his wife, tried to cheer his friend up. He joked that he was the last person who should give Hamm marriage advice, since Thompson already had been married and divorced four times. There’s no one “more matrimonially challenged,” Thompson told Hamm, making him smile.

Because Hamm and his wife didn’t have a prenuptial agreement, and because Sue Ann had spent time as a senior Continental executive, experts said she likely had claim to as much as half of Hamm’s wealth. When members of the media did the math, it made some heads spin. Sue Ann seemed in line for at least $3 billion, making her wealthier than Oprah Winfrey. The divorce likely will be the costliest in history, with a bigger payout than those of Rupert Murdoch, Stephen Wynn, and Michael Jordan.

Even British tabloids began to cover the story, weighing in with details on the four homes the couple owned and the debutante ball their daughter had attended. Investors began to speculate that the divorce might hurt the value of Continental shares if Sue Ann were to receive half of Hamm’s shares and sell some of them. On Hamm’s victory lap, the divorce had tripped him up in a humiliating way.

When a reporter caught up to Hamm outside an Oklahoma City courtroom and asked how he was doing, he replied simply, “Not very good.”
⁸

•   •   •

B
y January 2013, it was clear to most everyone that Aubrey McClendon had to go. Clear to most everyone but McClendon, that is.

Chesapeake Energy ended 2012 below seventeen dollars a share, down from above twenty in the fall that year. More important, big investors, including O. Mason Hawkins of Southeastern Asset Management and billionaire Carl Icahn, had become convinced Chesapeake had an “Aubrey discount.” Wall Street was being extra skeptical of the company because it had lost faith in McClendon’s leadership, Hawkins and Icahn believed.

Newly installed board members had disagreed with McClendon over capital spending and expenses, with McClendon pushing for a larger budget than the board was comfortable with. During the last week of January, board members told the company’s new chairman, Archie Dunham, to give McClendon the bad news. They had the votes to oust McClendon from the company he had cofounded twenty-three years earlier, and they wanted him gone.
⁹
It was a coup d’état, and there was nothing McClendon could do about it, Dunham told him.

McClendon, fifty-three years old, was stunned by the news. Ever the optimist, he still believed in Chesapeake and was sure he could improve the company’s performance and please his new board members.

After Dunham told McClendon he was out, he started to pout, telling Dunham the board had mistreated him, according to someone close to Chesapeake’s board. At one point, McClendon wanted to examine details the company had about its wells but the board wouldn’t let him, the person said.

When the company announced McClendon’s departure, investors immediately pushed Chesapeake shares up 9 percent, a final slap in the face for him.

Once amounting to about $3 billion, McClendon’s wealth had plummeted due to the forced selling of his shares in 2008 and the reduced value of his stakes in the company’s wells. By March 2013, he fell off
Forbes
magazine’s billionaire list, even though he had received a severance package of about $47 million. Even his friends were unsure how much cash and assets McClendon had after subtracting mountains of debt he owed related to his ownership stake in Chesapeake’s wells.

As he made plans to leave the company in April, colleagues sensed McClendon was looking forward to the next chapter of his career. He sent an upbeat letter to his employees, saying his departure was due to “philosophical differences” with the board, while promising that the “separation will be amicable and smooth.”

He added, “In many respects, our accomplishments are unique and I will always remain immensely grateful for the time I have spent with you.”

In the end, McClendon couldn’t slow his pursuit of new drilling opportunities in America. He also had a remarkable affinity for debt and lavish pay, irking a nation still digging out of a historic downturn caused by leverage and greed.

McClendon had helped build Chesapeake into the second largest natural gas producer in the country. Though Chesapeake shares ran into difficulties during the last few years of McClendon’s tenure, they remained up over 200 percent since 1993, beating almost every rival’s performance.

More important, McClendon’s single-minded focus on producing natural gas from once dismissed U.S. shale formations was a big reason the nation managed to produce so much oil and gas so suddenly. It also helps explain the steep drop in American energy costs, even as prices rose around the world.

At a company farewell picnic in March, McClendon walked through the crowd and chatted with employees, wearing a rumpled white dress shirt, sleeves rolled up as usual, and khaki pants. Choking back tears during a goodbye speech, he said his “greatest joy was knowing that this company played such a leading role” in changing the nation’s energy outlook. He left the stage to a standing ovation.
¹⁰

•   •   •

B
y early 2013, the dissident investors in Tom Ward’s company, SandRidge Energy, weren’t going anywhere. If anything, their anger was intensifying. Dinakar Singh, who ran hedge fund TPG-Axon, insisted to friends that his effort to oust Ward was about more than pushing SandRidge shares higher. Singh told them that Ward had fleeced shareholders and shouldn’t be allowed to get away with it.

“It’s just wrong,” he told one friend.

Singh’s firm had proposed a vote to remove Ward and the rest of SandRidge’s board of directors. It was the kind of proposal usually brushed off by companies. Shareholders generally ignore these votes or simply cast their votes with incumbent managers.

Singh’s proposal tapped a vein of unhappiness that Ward hadn’t fully appreciated, however. When a respected proxy advisory firm called ISS recommended that shareholders vote to replace a majority of the board, writing that “the apparent failures of stewardship on this board are legion,” it was clear that the odds of Ward remaining at his company were slim.

In early March, SandRidge executives hosted an annual day for investors and analysts, hoping to spark enthusiasm for the company. Ward was well aware that almost everyone was focused on the upcoming vote and whether he would be ousted. It was the elephant in the room.

As Ward started his opening speech, he tried for a little levity. “Sorry we’re running a little bit late,” he said. “I was back to talking to Aubrey about a board seat . . . just kidding, just kidding.”

Ward did little to win over investors or analysts that day. By then, he was resigned to stepping down at his company. Negotiations over terms of his departure became so ugly, though, that a team of bankers from Morgan Stanley was brought in to find a solution. The bankers failed miserably, however, resulting in a showdown between Ward, SandRidge’s directors, and the dissident investors.

With results of the vote just two days away, Ward realized he was boxed in. He knew it was only a matter of time before he also would be kicked out.

On Wednesday, March 13, a press release announced a deal that seemed likely to lead to Ward’s departure. In the release, Ward was only allowed to give a perfunctory goodbye to his president, who was resigning immediately. It was never clearer how powerless Ward had become at the company he had founded. Six weeks earlier, Aubrey McClendon had been forced out at Chesapeake. Now it was happening to Ward as well.

McClendon and Ward had helped change the country in just a few short years. Along with their fellow frackers, they helped alter the course of American economic and geopolitical history with a remarkable drive to discover new energy deposits. Businesses and consumers were enjoying falling energy costs, the oil and gas industry was thriving, and energy independence was in sight.

In the end, however, both men met condemnation and denigration. Instead of riding off into the sunset, they’d both lose their jobs.

When the press release was issued, SandRidge shares rose 6 percent; investors cheered Ward’s likely departure, just as they had celebrated McClendon’s.

A few months later, Ward was out at SandRidge, a precipitous fall that was cushioned by a $90 million severance package and the $150 million in shares he retained.

“It’s been a hard few years,” says Ward, who predicts that his moves at SandRidge will be proven wise over time. “It’s easy to throw stones.”

•   •   •

A
lmost immediately after the press release went out, Ward walked out of the office into a brisk Oklahoma evening. He got into his black BMW X6 and drove a few blocks to the Chesapeake Energy Arena, where the Oklahoma City Thunder were getting ready for a key matchup. There, he joined James, his younger son, and Frank Alberson, who had grown up in the Ward home, in front-row seats behind the basket.

From the opening tip-off, the Thunder began to pummel the Utah Jazz in a nationally televised game. Ward loosened his blue tie and seemed to enjoy himself. After a dunk by the Thunder, he gave his son a wide smile. By halftime, Ward was beaming, as if a load was off his back.

At the other side of the court, in his own prime spot under the opposing basket, Aubrey McClendon sat with his wife. McClendon wore a smart dark suit and a red tie, as if he were interviewing for a new career. Weeks earlier, McClendon had quietly inked a deal to rent office space in a six-story glass-and-concrete building about a mile from Chesapeake’s headquarters. He had already begun courting investors to raise money for his next venture, a company that would explore for oil and gas. They would do it in the United States, of course.

During a break in the action, McClendon met an old friend near midcourt. McClendon was ebullient as he spoke of his plans for a comeback.

“Are you almost ready to go?” the friend asked.

McClendon flashed a big smile. “I’m almost there.”

Perfect is the enemy of good.

—Voltaire

ENVIRONMENTAL TENSIONS

T
he wildcatters, entrepreneurs, and hopeless dreamers who took a chance on drilling in shale and other challenging U.S. rock formations have brought clear benefits to the country and possibly the world. U.S. natural gas prices, as of the summer of 2013, were about a third of those in Asia and less than half of those in Europe, thanks to surging American shale-gas production. As a result, U.S. consumers and companies are paying less to heat and cool their homes and businesses. Chemical, plastic, fertilizer, and other companies relying on natural gas to manufacture their products also are benefitting, a key reason some foreign companies are moving to the United States or building factories in the country.

Expanding energy production and related activities could lead to more than two million jobs by 2020. They also could add more than one percentage point to annual economic growth over the next ten to fifteen years, while the nation’s trade deficit is expected to drop by 85 percent by 2015, helping the value of the U.S. dollar.

But how much damage have the pioneers created in their pursuit of oil and gas? Is fracking as bad as activists say, and what will its impact be as drillers continue to pursue energy from shale and other rock formations?

The short answer: Fracking has created less harm than the most vociferous critics claim, but more damage than the energy industry contends. And it may be years before the full consequences of the drilling and fracking are clear.

One of the most dramatic accusations leveled by those campaigning against fracking is that methane—the main component of natural gas—has invaded various water systems as a result of nearby drilling, jeopardizing the health of local residents. One of the most frightening moments in Josh Fox’s 2010 documentary,
Gasland,
is when a Colorado homeowner opens a kitchen faucet, strikes a match to his tap water, and sees it explode in a fireball.

The scene seems like clear-cut evidence that methane has leaked from nearby gas wells.

•   •   •

T
his accusation likely is overstated, however.

Methane—a colorless gas that’s generally considered nontoxic unless it’s in superhigh quantities—occurs in shallow bedrock. It’s been known to naturally seep into water wells and springs and has done so throughout history in various regions, whether or not there’s been any nearby gas production. In fact, three states—New York, Kentucky, and West Virginia—have towns with the name Burning Springs, a testament to this age-old phenomenon.

Joyce Siracuse, the sixty-year-old owner of Joycie’s café in Montrose, Pennsylvania—six miles from the epicenter of the fracking controversy in Dimock—says she and her friends regularly lit water afire in their grade school bathroom in the late 1960s, long before fracking came to her part of the state. “We all lit the faucets growing up,” she says. “It wasn’t a big deal.”

There are times when poorly sealed wells, rather than hydraulic fracturing, can lead to methane-filled drinking water. But that has occurred in a minority of wells, according to a 2013 study by Duke University examining drilling in the Marcellus Shale region in Pennsylvania.

Critics also contend that the toxic chemicals used for fracking can enter nearby water systems, making people and animals sick and putting public health at risk. But there have been virtually no proven cases of any fracking chemicals traveling up and into water tables, and there are reasons to doubt it will happen. Aquifers in the Barnett, Marcellus, and Haynesville regions are between four hundred and twelve hundred feet below the surface, according to a 2012 report by the U.S. Government Accountability Office, while the shale in those regions is between 4,000 and 13,500 feet from the surface. Most scientists say it will be nearly impossible for chemicals to migrate the distance between these shale formations and the aquifers, though they can’t say for sure it won’t happen.

“I’ll take my chances on winning the lottery over the chances of frack fluid in the groundwater,” environmental engineer Radisav Vidic of the University of Pittsburgh told
Scientific American
magazine in May 2013.

That’s not to say water quality is great in the drilling areas. It’s just hard to determine how it got that way. A 2011 Penn State study found that about 40 percent of water wells tested before drilling began failed at least one federal drinking water standard, usually for coliform bacteria, turbidity, or manganese.
¹

Hand-wringing about earthquakes caused by fracking also seems overblown. For one thing, it isn’t the fracking process itself that may be lubricating preexisting fault lines; rather, it seems to be the disposal of wastewater by those reinjecting it into adjacent rock. To date, only small, locally produced tremors have been detected—much like with other mining activities—rather than huge quakes. And seismic events likely can be avoided by conducting seismic surveys or adjusting injection pressures.

Still, industry members are too quick to gloss over concerns about their activities, an insouciance that has created a public relations nightmare for their business. Leaks and surface spills of dangerous chemicals used in fracking fluids have been documented, and wells that aren’t properly sealed have allowed gas and chemicals to migrate through the wellbore.

Professor Vidic has found evidence of contamination in Pennsylvania streams receiving wastewater from centralized treatment facilities in the Marcellus, and blowouts have caused fracking fluids to enter local streams. State environmental regulators have demonstrated that oil and gas development damaged water supplies for at least 161 Pennsylvania homes, farms, churches, and businesses between 2008 and the fall of 2012, though the majority of the complaints were deemed unfounded and the industry says it has improved its standards since then.
²

Bad casing and cementing can cause problems in any drilling activity, of course, but wells that are hydraulically fractured usually are exposed to higher pressures than those that aren’t fracked, raising additional concerns.

Another lingering concern: Operators aren’t always required to disclose every component of the frack fluid they use, because they say such disclosure would reveal trade secrets. Since 2011, more than twenty states have begun to require the disclosure of the bulk of the components of the fluid, but the rules provide exceptions. Since the fracking cocktail can include acids, detergents, and poisonous chemicals, along with more innocuous materials, there’s ample reason for unease.

Drilling is an industrial activity that brings intense noise, traffic, and disturbance to towns near active wells. Because so much water is used for fracking, this drilling requires even more truck trips than usual. And shale production impacts air quality, just as any oil-and-gas drilling does. Dust and engine exhaust from truck traffic is a health hazard, as are emissions from diesel-powered pumps. Silica sand, which is used in the fracking mixture to prop open fractures in rock, can lodge in lungs, potentially causing silicosis.

Sometimes the impact of the drilling is startling. In 2011, residents of Pinedale, Wyoming, a bucolic town of two thousand that’s near gas fields, began complaining of watery eyes, shortness of breath, and bloody noses because of ozone levels exceeding those in Los Angeles and other major cities on their worst days.

“I never would have guessed in a million years you would have that kind of danger here,” said Debbee Miller, a manager of a Pinedale snowmobile dealership.
³

Despite these ills, and the awful image many have of the frackers, there’s actually reason to think their activity has in some ways been good for the environment. The glut of gas has sent prices falling. This has encouraged the United States to shift much of its energy consumption from coal to gas. That’s likely healthy for the environment because burning natural gas releases about half as much carbon dioxide—a greenhouse gas believed to contribute to global warming—as coal when producing the same amount of energy. And natural gas emits far less nitrogen oxide, which causes smog; it also spews no mercury or particulate pollution, unlike coal.

In fact, U.S. energy-related emissions of carbon dioxide fell 12 percent between 2005 and 2012 and now stand at the lowest levels since 1994, according to the U.S. Energy Department’s Energy Information Administration. That unexpected improvement is due to more electricity coming from gas instead of coal, as well as the lingering effects of the economic downturn, which has slowed energy demand.

Before toasting the frackers, however, there’s one big caveat: Natural gas wells and pipelines frequently leak methane. And methane is a more potent contributor to climate change than carbon dioxide. If too much methane is being leaked into the environment by the gas wells and pipelines, it could be more than offsetting the reductions in carbon dioxide coming from the shift from coal to gas. Some states require natural gas producers to use technology to capture gas during the construction and drilling of wells, but many have resisted the requirements.

So how much leaking is going on? It’s hard to tell, scientists and environmental activists say. The Environmental Protection Agency doesn’t do a good enough job tracking methane leakage, many argue. Some private parties, like the Environmental Defense Fund, are working on studies of the issue, but it’s too early to get a sense of their results. Just as troublesome, the extent of most risks from shale development is unknown because most studies don’t track the long-term, cumulative effect of this drilling.

In some ways, the debate about fracking is a lot of misdirected energy (no pun intended). It’s just not realistic to expect a nation still suffering from the deepest economic downturn since the Great Depression to ignore some of the largest energy fields in the world, forgo the substantial savings that result from drilling in those domestic spots, and keep funneling money to Russia, Iran, Qatar, and other energy powers.

A better tack is to put pressure on oil and gas producers to improve their behavior. There’s been tremendous progress already. Drillers are recycling more frack water, for example. Meanwhile, reports of contamination cases dropped by two-thirds between 2011 and 2012, according to Pennsylvania’s Department of Environmental Protection.

But more regulation of fracking activity is needed, such as rules ensuring that well casings are set at proper depths and have tight seals, to be sure chemicals never leak into aquifers. Ohio and Texas have agreed to extensive rules regulating and testing well casings, but other rules are inadequate, even according to some major drillers. More federal rules to control air pollution from drilling are also needed.

“It’s all totally fixable, but just because the problems are manageable doesn’t mean they will be managed,” says Fred Krupp, president of the Environmental Defense Fund. “It’s going to take action by state regulators, industry, and citizens to make it happen.”

It’s clear that oil and natural gas will be needed for the foreseeable future, another reason to focus on improving the activity of operators rather than try to push them out of the oil and gas business. A world with an eventual population of ten billion people, most of whom are more concerned about putting food on their tables than the impact of fossil fuels on the environment, will need a variety of energy sources.

Few believe renewable energy sources can provide the bulk of the world’s needs anytime soon, but it would be a shame if work on wind, solar, and other cleaner sources slowed amid the burst of oil and gas production. For one thing, it’s not yet clear how long this period of abundant fossil fuels will last. Production from wells from shale and other tight rock is notorious for declining rapidly. The recent growth has been impressive but the output may not last as long as optimists expect.

Hopefully, natural gas will buy time so that renewable energy sources can grab a larger share of the market. In 2012, U.S. usage of solar panels rose 76 percent to the equivalent of enough electricity generation to power 1.2 million homes. Growth is expected to be about as strong in 2013, amid record solar installations.

There are other reasons for optimism, such as a continued drop in energy demand in the United States, a shift that in some ways is as surprising as the nation’s growth in energy production. As recently as 2006, American drivers pledged their allegiance to huge automobiles. Our cars, like our homes, couldn’t be too big. It seemed a bit suspicious—even a tad European—to fret about the environment or gas prices.

By 2007, however, when President George Bush signed legislation reducing gasoline consumption in vehicles, energy demand was on the wane. It’s continued to drop over the past few years as four-dollar-a-gallon gasoline pushed gas guzzlers off the road, as did young people embarrassed at what their parents were driving.

A drop in demand in the United States and around the globe could continue. Companies and homes are becoming more energy efficient. And the average American new car and truck will get nearly fifty-five miles per gallon by 2025, under fuel efficiency standards enacted by President Barack Obama, up from an average of almost twenty-four miles per gallon in 2012. Edward Morse and other analysts at Citigroup also note slowing oil demand in China. Any slowing of global energy demand will bring benefits to the environment and put pressure on prices.

Alternative-fuel vehicles, such as all-electric cars and hybrids, are also gaining popularity. Brokerage firm Raymond James says electric vehicles could claim 1 percent of the market in 2013, a share likely to keep rising. Any widespread embrace of self-driving cars could cripple oil demand.

George Mitchell’s son, Todd, says his father’s work will have had a negative impact on the world if it forestalls progress on renewable energy, instead of giving innovators time to improve wind, solar, and other cleaner energy sources.

“I think that it will be clear in decades or more that extracting hydrocarbons from tight shale formations blew up all previous assumptions about the availability and economics of oil and gas development,” Mitchell says. “What’s harder to understand now is how good a thing that is.”