On March 2 of this year, Aubrey McClendon, Chesapeake Energy founder and former CEO, died suddenly.
As Bloomberg noted in a profile of Mr. McClendon soon after his death, T. Boone Pickens summed up his legacy best by saying,
"No individual is without flaws, but his impact on American energy will be long-lasting.
He was a major player in leading the stunning energy renaissance in America.
He was charismatic and a true American entrepreneur."
— T. Boone Pickens, chairman of BP Capital
Although George Mitchell, the legendary founder of Mitchell Energy, has been called "The Father of Fracking" for his leadership in innovating long reach horizontal drilling and massive hydraulic fracturing technologies, there was no single company that adopted those technologies as part of their business strategy to the degree that Chesapeake Energy did. And, prior to 2013, when referencing the business strategy of Chesapeake, you were ultimately referring to the strategy of Mr. McClendon. For better or worse, there were no large energy companies operating at that time, or today, that so completely reflected the leadership of a single individual.
Chesapeake’s 2011 Annual Report, the last produced under Mr. McClendon’s tenure, was titled "Bold Moves/Big Future" and more than a dozen pages spoke of "bold decisions," "bold plans," "bold acquisitions," "bold strategies," and "bold shifts." The oft repeated adjective would seem to be an apt description for Mr. McClendon and his ambitious vision to grow Chesapeake from just one of many small midcontinent producers into the top player in the US natural gas markets. Under his intense personal direction, Chesapeake expanded from a 3 man operation in 1989 to become the second largest producer of natural gas in the US at the time of his departure in early 2013.
During his time as chairman and CEO, the company added more than 13,000 employees and had stockpiled on the industry’s largest land positions in unconventional fields (with the company’s total leasehold position equivalent to the size of West Virginia). He led the vertical integration of the business into an almost fully self-contained exploration and production company – with subsidiary businesses supplying the company’s drilling rigs, completion units, and fracking fleets. And through a number of controversial personal and corporate investments in real estate, merchants, restaurants, sports teams, and public facilities, he led the redevelopment of much of Oklahoma City, the home of Chesapeake’s headquarters.
Leading the Shale Revolution
As Mr. McClendon notes in his letter to shareholders in Chesapeake's 2011 annual report,
"In late 2004, we developed another keen insight and
recognized the discovery and development of low-cost, low-risk shale gas
could change our industry for decades to come, if not forever."
— from the 2011 Annual Report of Chesapeake Energy, Letter to Shareholders
Extolling the virtues of natural gas to investors, shareholders, employees, and industry partners, in 2005 Mr. McClendon began his relentless push for the company to become a pure-play natural gas producer by aggressively acquiring leases, and competitors, across the major shale plays in the Northeast, North Dakota, and Texas.
From 2005 to 2011, the company’s net share of their gas production (most of it from shale and tight sands) more than doubled from 1.2 to 2.8 bcf per day, positioning the company as the second-largest producer in the US, trailing only XTO, the US gas production division of global giant Exxon-Mobil; and, according to their 2011 annual report, "the largest producer of U.S. natural gas on a gross operated basis with an approximate 9% national market share." By 2012, Chesapeake held more non-conventional gas reserves than any other US producer.
Though Mr. McClendon’s goal for Chesapeake to become one of the largest natural gas producers in the US did come to fruition, his company’s success and that of many others that emulated the company’s strategies in pursuing shale and tight sands resources ultimately unleashed a flood of natural gas into the US market, driving down prices and, in the end, contributing to the bankruptcy of dozens of oil and gas exploration companies.
A Victim of His Own Success
In 2005, when Chesapeake began their aggressive push into shale, total daily US natural gas production was approximately 64 bcf and prices at Henry Hub consistently traded above $5/mmbtu. Even though US production was growing moderately over the subsequent couple of years, winter weather driven demand would occasionally push prices over $10/mmbtu, with spikes as high $13/mmbtu. Though shale development was a high cost proposition (with estimated finding and development costs ranging anywhere from $3 to $6/mmbtu), the promise of growing gas demand and continuing high prices encouraged Chesapeake and others to continue pursuing what at the time looked like a low risk/high reward strategy.
However, by the beginning of 2010, US gas production began to grow rapidly, driven in large part by the Marcellus field in the Northeast, from which production increased from less than 2 bcfd in 2008 to more than 13 bcfd by the end of 2013. With increasing volumes of gas flowing into the US market and little growth in demand due to the lasting effects of the economic crisis of 2007/2008, prices began a steady decline in 2009, with Henry Hub trading consistently below $4/mmbtu and falling as low as $1.82/mmbtu in April of 2012.
Chesapeake’s huge bet, and huge success in developing gas reserves, had ultimately turned against them. The Marcellus was particularly problematic for Chesapeake and the other producers that had invested heavily in the area, as rapidly growing gas production overwhelmed the pipeline takeaway capacity in the region, leading to an increasingly oversupplied market and driving prices even lower in the region. With a limited market and few options for moving production to higher priced regions, Chesapeake and the other producers were forced to sell their gas at the three Marcellus hubs for as much as a $2 discount to the benchmark Henry Hub price.
Faced with persistent low prices, the prospect of an unsustainable debt load due to increasing losses, and concerns about the mingling of his personal interests and finances with those of the company, a shareholder revolt (led in large part by corporate raider Carl Icahn) resulted in Chesapeake’s board firing Mr. McClendon in early 2013.
The Lasting Legacy of Aubrey McClendon
Though Aubrey McClendon didn’t invent the technologies that opened US shale fields for exploitation of oil and gas, nor was his company the only one to "go all-in" in exploring and producing in those areas, it could certainly be said that his vision, ambitions, and bold style catalyzed the shale revolution of the last decade. In the end though, he fell victim to his own strategy (and some might say his personal hubris), as the energy revolution that resulted from Chesapeake and their competitor's drilling successes ultimately unleashed a torrent of natural gas from the shale and tight sands fields across Pennsylvania, Ohio, Louisiana, and Texas, driving down prices and creating a supply bubble that could take years to fully absorb.
Despite the current difficulties facing US producers, there is light at the end of the tunnel. Recent investments in pipeline infrastructure are solving many of the market imbalances that have haunted the Marcellus region. And, with continuing adoption of natural gas for power generation and motor fuels, combined with the promise of increased LNG exports, demand for US natural gas is expected to increase substantially over the next decade and prices will certainly improve. (Learn more in "Supporting the LNG Supply Chain with ETRM Software.")
Mr. McClendon noted in his final letter to Chesapeake shareholders that:
"I am quite confident that when the history of this era of the oil and gas industry is written, the companies that will have performed the best will be those few bold companies that first recognized how unconventional resource development in the U.S.
would end the first 150 years of industry history and set the course for the next era.
I believe this new era will dominate our industry’s future for at least the next 50 years."
— from the 2011 Annual Report of Chesapeake Energy, Letter to Shareholders
Bold innovators will always be missed. There is no doubt that the US natural gas industry has been transformed by the shale revolution and that Mr. McClendon played a pivotal and lasting role.
Learn how Eka's next-generation ETRM software enables energy companies to maximize profitability.