Wednesday, October 1

Aubrey McClendon: Behind the Music, Part II

Tuesday’s improved signs of the health of America’s financial sector were certainly felt in the spacious living room of one Aubrey McClendon.

After seeing his investment in Chesapeake Energy drop more than one hundred million dollars on Monday, the co-owner of the Oklahoma City Thunder recouped his losses on Tuesday as CHK shares went up more than three points, earning McClendon an estimated $110 million within 24 hours.

But, as Lyndon Johnson famously drawled to a colleague more than 40 years ago, chicken salad can turn into chicken shit awful fast.

And it’s that propensity for precariousness that has some investors more than a little concerned about the overall health of Chesapeake.

Within the past month, McClendon’s company has:

- Reported a second-quarter loss of $1.65 billion, down from a profit of $492 million the previous year
- Announced a cut in natural gas production, including cutting rig counts
- Seen a drop in natural gas prices of close to 40%
- Announced that the shale deposits Chesapeake so zealously drilled in Barnett are “ramping down”

For many, it’s no cause for concern, and Chesapeake’s stock is still considered a strong buy for many investors. But for others, it is a little alarming. As a commenter at theoildrum.com noted: “If [Chesapeake] is pulling the plug on [its drilling operations] they better have something in the wings to replace their rapidly declining reserve base. Otherwise they've just announced to the world that their stock is worthless except for its breakup value.”

Many suspect that McClendon’s reasoning for curtailing production comes in the wake of the widespread credit crunch facing North America, but Business Week magazine weighed in with another possibility: that the trading methods practiced by large producers such as Chesapeake undermined the profits those companies made from drilling natural gas.

Essentially, because Chesapeake, and other companies like them, trades oil based on future prices, the constant hedging can often be disastrous, even when gas prices are soaring. As industry analyst Stephen Schork told the magazine after natural gas prices changed this summer, “A lot of people got creamed.”

Further, the magazine noted, there is the anxiety that Chesapeake wasn’t merely trading futures – hedging, if you will – for protection, but for profit. That’s great so long as prices fall in the future, but if that’s not the case, Chesapeake will be forced to pump out more gas to make up the difference, something that isn’t always as possible as it would like.

As the now bankrupt leaders of SemGroup can say with certainty, shorting energy prices isn’t always the wisest move for a company to take.

Simultaneously, a severe drop in natural gas prices can obviously be painful as well. And while natural gas was an attractive alternative fuel when oil was trading at $150 a barrel, it doesn’t look like such a great option when oil drops to less than $100.

With oil falling and natural gas increasing, the natural gas energy would seemingly be in desperate straights. What would be needed to strengthen the price of natural gas then, and, consequently, Chesapeake Energy? Well, how about a plan to get the government to subsidize the wholesale conversion of U.S. automobiles away from petroleum to natural gas? Heard anything about that idea? I thought you may have.

Nonsense ideas about “liberating” America from Middle Eastern oil aside, Chesapeake still faces tough situations stateside. It appears Chesapeake is hoping that its sizable (though dwindling) cash reserves will enable it to withstand any short-term reductions in revenue, unlike the smaller drillers out there who will be unable to hold out for long. Inevitably, the plan goes, the smaller concerns will prostrate themselves at McClendon’s altar, and Chesapeake will buy them up.

All of these financial shenanigans keep Aubrey McClendon a busy man – but not too busy.

When he’s not manipulating the Fort Worth city government into allowing him to put more oil wells within the city limits, hoodwinking the Sierra Club into thinking that his Clean Skies Foundation is anything but a front for drilling for more natural gas, or attempting to pass an “alternative fuels” initiative in California that would cost taxpayers upwards of 10 billion dollars – money that would flow directly to McClendon and Pickens, McClendon is making grandiose promises about future drilling sites, promises intended to buck up his stock’s plummeting value.

“Recent large discoveries using new technologies in natural gas shale basins such as the Barnett, Haynesville, Fayetteville, Woodford and Marcellus have provided new evidence that our country has ample natural gas supplies to power America’s economy for more than a century,” McClendon wrote earlier this year, neglecting to mention that he himself stated that the Barnett reserve has already reached its “high-water” mark.

It’s certainly possible that Chesapeake and McClendon will weather the storm surrounding energy prices and the credit markets, and that the company will snap up enough independent producers of natural gas to maintain an equilibrium. But it is also possible that McClendon’s wheeling and dealing may come back to bite him.

It’s that possibility we’ll look at Friday when we explore why all of this energy mumbo-jumbo matters to readers of a Sonics blog.