Capital Cycles, Booms and Busts

On 28 June 2020 Chesapeake Energy filed for Chapter 11 in the US Bankruptcy Court for the Southern District of Texas. It had skipped interest payments earlier in the month, and shortly before filing it had paid about $25 million of retention bonuses to its executives (reported). Its restructuring agreement with lenders and noteholders would exchange debt for equity and eliminate about $7 billion of it; its shareholders, who had owned one of the two largest gas producers in the United States, were wiped out. Two months earlier, on 20 April, the May contract for West Texas Intermediate crude had settled at −$37.63 a barrel (Chapter 5), and Henry Hub gas was below about $2/MMBtu. Chesapeake emerged on 9 February 2021, owned by its former creditors, with little debt and a plan to do almost the opposite of what had made it famous.

What had made it famous was land. Aubrey McClendon and Tom Ward were Oklahoma landmen, the people who negotiate drilling leases with mineral owners, when they founded Chesapeake in Oklahoma City in 1989 with about $50,000 (reported). Their approach was to acquire acreage first and fast, drill aggressively and use whatever financing markets would provide. When the horizontal drilling and multi-stage fracturing techniques that George Mitchell's company had proved in the Barnett Shale spread in the early 2000s, McClendon concluded that the winner would be whoever controlled the land first. From about 2005 to 2011 Chesapeake led the largest land grab in US oil and gas history, leasing in the Barnett, Fayetteville, Haynesville, Marcellus, Eagle Ford, Utica and elsewhere, and claimed about 15 million net acres at its peak (company claim). Its capital spending, including leases, often exceeded $10 billion a year (reported).

The money came from four places. Chesapeake issued high-yield bonds and shares. It sold minority stakes in its plays to companies that wanted a way into US shale, Plains, BP, StatoilHydro, Total and China's CNOOC among them, for cash plus "carries" in which the partner paid part of Chesapeake's future drilling costs: about $3.3 billion from Plains for the Haynesville in July 2008 and about $3.4 billion from StatoilHydro for the Marcellus in November 2008, for example (reported). And it sold volumetric production payments, future gas from specific wells, for cash up front. The model produced rapid growth in reported output and large gains on asset sales. It did not produce free cash flow.