THE crew of workers fought off the blistering Louisiana sun, jerking
their wrenches to tighten the fat hoses that would connect their cement
trucks to the
Chesapeake Energy drill rig — one of the last two rigs the company is still using to drill for
natural gas here in the Haynesville Shale.
At its peak, Chesapeake ran 38 rigs in the region. All told, it has sunk
more than 1,200 wells into the Haynesville, a gas-rich vein of dense
rock that straddles Louisiana and Texas. Fed by a gold-rush mentality
and easy money from Wall Street, Chesapeake and its competitors have
done the same in other shale fields from Oklahoma to Pennsylvania.
For most of the country, the result has been cheaper energy. The nation
is awash in so much natural gas that electric utilities, which burn the
fuel in many generating plants, have curbed rate increases and switched
more capacity to gas from coal, a dirtier fossil fuel.
Companies and municipalities are deploying thousands of new gas-powered
trucks and buses, curbing noxious diesel fumes and reducing the nation’s
reliance on imported
oil.
And companies like fertilizer and chemical makers, which use gas as a
raw material, are suddenly finding that the United States is an
attractive place to put new factories, compared with, say, Asia, where
gas is four times the price. Dow Chemical, which uses natural gas as a
material for producing plastics, has assembled a list of 91 new
manufacturing projects, representing $70 billion in potential investment
and up to three million jobs, that various companies have proposed or
begun because of cheap gas.
“The country has stumbled into a windfall on the backs of these
entrepreneurs,” said Edward Hirs, a finance professor at the University
of Houston who contributed
to a report that estimated that the nation’s economy benefited by more than $100 billion last year alone from the lower gas prices.
But while the gas rush has benefited most Americans, it’s been a money
loser so far for many of the gas exploration companies and their tens of
thousands of investors.
The drillers punched so many holes and extracted so much gas through
hydraulic fracturing that they have driven the price of natural gas to
near-record lows. And because of the intricate financial deals and
leasing arrangements that many of them struck during the boom, they were
unable to pull their foot off the accelerator fast enough to avoid a
crash in the
price of natural gas, which is down more than 60 percent since the summer of 2008.
Although the bankers made a lot of money from the deal making and a
handful of energy companies made fortunes by exiting at the market’s
peak, most of the industry has been bloodied — forced to sell assets,
take huge write-offs and shift as many drill rigs as possible from gas
exploration to oil, whose price has held up much better.
Rex W. Tillerson, the chief executive of Exxon Mobil, which spent $41
billion to buy XTO Energy, a giant natural gas company, in 2010, when
gas prices were almost double what they are today, minced no words about
the industry’s plight during an appearance in New York this summer.
“We are all losing our shirts today,” Mr. Tillerson said. “We’re making no money. It’s all in the red.”
Like the recent credit bubble, the boom and bust in gas were driven in
large part by tens of billions of dollars in creative financing
engineered by investment banks like Goldman Sachs, Barclays and
Jefferies & Company.
After the financial crisis, the natural gas rush was one of the few
major profit centers for Wall Street deal makers, who found willing
takers among energy companies and foreign financial investors.
Big companies like Chesapeake and lesser-known outfits like Quicksilver Resources and
Exco Resources
were able to supercharge their growth with the global financing,
transforming the face of energy in this country. In all, the top 50 oil
and gas companies raised and spent an annual average of $126 billion
over the last six years on drilling, land acquisition and other capital
costs within the United States, double their capital spending as of
2005, according to an analysis by Ernst & Young.
Now the gas companies are committed to spending far more to produce gas
than they can earn selling it. Their stock prices and debt ratings have
been hammered.
“We just killed more meat than we could drag back to the cave and eat,” said
Maynard Holt,
co-president of Tudor Pickering Holt & Company, a Houston
investment bank that has handled dozens of shale deals in the last four
years. “Now we have a problem.”
A Master Salesman
Aubrey K. McClendon, chief executive of Chesapeake Energy, had a secret, and he was anxious to share it.
He called
Ralph Eads III,
a fraternity buddy from Duke who had become his go-to banker. Mr.
McClendon explained that he had quietly acquired leases on hundreds of
thousands of acres somewhere in the southern United States — he would
not say exactly where — that could become one of the world’s biggest
natural gas fields.
But to develop the wells, he needed billions of dollars.
“I can get the assets,” Mr. McClendon told Mr. Eads, a vice chairman
of Jefferies, according to three people who participated in that call, nearly five years ago. “You have to get the money.”
Get it he did. Mr. Eads, a pitch artist who projects the unrestrained
enthusiasm of a college football coach, traveled the world, ultimately
raising an extraordinary $28 billion for Mr. McClendon’s “secret”
venture in the Haynesville Shale, as well as other Chesapeake drilling
projects.
Other bankers working in the glass office towers of downtown Houston
were equally busy. While the skyscrapers are home to global giants like
Chevron and lesser-known companies like
Plains Exploration and Production,
they also house storefronts for Wall Street deal makers who play a
vital, though less visible, role in the nation’s surging energy
production.
Mr. Eads, 53, a Texas native, is a prince of this world. His financial
innovations helped feed the gas drilling boom, and he has participated
in $159 billion worth of oil and gas deals since 2007.
A Sigma Alpha Epsilon fraternity brother of Mr. McClendon, he headed to
Wall Street directly after Duke. He first earned a national profile in
2001, while working for the El Paso Corporation, a natural gas pipeline
operator.
Regulators accused El Paso
of creating an artificial gas shortage in California in the previous
year, contributing to a power crisis in the state. Although El Paso
eventually
settled
the complaints for $1.7 billion, Mr. Eads said El Paso was guilty of
nothing more than coming up with creative financial transactions.
“I wake up every day thinking about how to finance big things,” he said.
His tall, lanky frame and bellowing voice make him hard to miss, even in
a large crowd. And his deal radar is never off, as he works the room at
dinner parties and charity events.
That is how he met Jim Flores, the chief executive of Plains Exploration, who eventually invited him on a duck hunt.
After Mr. McClendon’s urgent request for money, Mr. Eads put in a call
to Mr. Flores to see if he might be willing to finance part of
Chesapeake’s Haynesville project.
“Aubrey and I have calculated it, and it might be the largest gas field
in the world,” Mr. Eads said he told Mr. Flores, noting early results
from a single well that showed unprecedented gas flows.
The type of deal he pitched, nicknamed “cash and carry,” was certainly
aggressive and innovative. Plains would pay Chesapeake $1.7 billion to
gain ownership of about one-third of the drilling rights that Chesapeake
had leased in the Haynesville. Plains would also commit to paying out
another $1.7 billion to cover half of Chesapeake’s drilling costs, in
return for part of the future profits.
“It’s going to be a great investment,” Mr. Flores said on the day the deal was announced in July 2008.
But the deal, like others later struck by Chesapeake, benefited Mr. Eads
and Mr. McClendon and their companies far more than the people writing
the big checks.
Chesapeake spent an average of $7,100 an acre on the drilling sites it
had leased in the Haynesville. Plains paid Chesapeake the equivalent of
$30,000 an acre.
Jefferies and the other firms involved in arranging the deal made an estimated $23 million on this transaction.
Much of the money that Mr. Eads raised for American gas drillers came
from overseas oil and gas companies, like Total of France and Cnooc, the
China National Offshore Oil Corporation. He told them the American
shale revolution was an opportunity they simply could not afford to pass
by.
“This is like owning the Empire State Building,” Mr. Eads said,
recalling one of his favorite lines. “It’s not going to be repeated. You
miss the boat, you miss the boat.”
In China, he was in awe at just how much money was available to invest.
One senior executive at a major Chinese oil company that Mr. Eads
declined to identify, citing the confidential nature of the
negotiations, explained that the country wanted to move as much as $750
billion from United States Treasury bonds into the North American energy
business.
Mr. Eads was only happy to oblige, helping to secure
$3.4 billion from
the Chinese for Chesapeake through two deals.
Not everyone believed the story line of endless profits and opportunity.
Mr. Eads said one oil company executive whom he would not identify had
rejected his pitch, complaining, “The reason for the glut is you guys.”
The executive said he expected natural gas prices to plummet.
In private, Mr. Eads acknowledged that his pitches involved a bit of bluster.
“Typically, we represent sellers, so I want to persuade buyers that gas
prices are going to be as high as possible,” Mr. Eads said. “The buyers
are big boys — they are giant companies with thousands of gas economists
who know way more than I know. Caveat emptor.”
Investment banking revenue at Jefferies reached $1.1 billion in 2011, a
record for the firm, up from $750 million in 2007. Energy deals were
cited among the biggest drivers of that surge, which came despite major
problems at the firm because of its exposure to European sovereign debt.
Mr. Eads would not say how much he had been compensated for this
bonanza. But Dealogic, a firm that tracks Wall Street transactions,
estimated that Jefferies collected at least $124 million in fees from
Chesapeake since 2007, a large share of its overall revenue on oil and
gas deals, which ranged between $390 million and $700 million during the
same period, according to two different industry estimates.
Even before the recent round of deals, Mr. Eads was a wealthy man. He
lives in a sprawling, 11,000-square-foot lakefront mansion in Houston
and has a wine cellar with 6,500 bottles. In 2010, he bought an $8.2
million home in the exclusive West End of Aspen, Colo., whose other
homeowners have included Jack Nicholson and Mariah Carey.
Mr. Eads’s success has produced no shortage of jealousy in Houston.
“A lot of people don’t like him because he got ahead of everyone else,” said Chip Johnson, chief executive of
Carrizo Oil and Gas,
who made two big deals in which Mr. Eads was involved. “He got the
reputation for overselling, but I have a hard time believing you can
fool the big companies.”
“Without him,” Mr. Johnson added, “the country would not have had the huge gas supply as quickly as we did.”
Others have been more critical.
“He is like the bartender serving drinks for people who can’t handle it,” said
Fadel Gheit, a
managing director at Oppenheimer & Company, about Mr. Eads. “And
the whole gas industry has gotten a rude awakening, a hangover, with gas
prices plummeting. The investment bankers were happy to help with a
smile and get their cut.”
A Train Without Brakes
“Quit drilling,” T. Boone Pickens, the Texas oilman, barked to his
fellow board members at Exco Resources, a small, independent drilling
company based in Dallas that, like Chesapeake, had made a big bet in the
Haynesville. “Shut her down.”
Mr. Pickens, 84, made billions of dollars as a hedge fund manager and
wildcatter drilling for oil and gas. He borrowed heavily to build up the
oil and gas reserves of Mesa Inc. in the late 1980s before losing the
company during its financial difficulties a decade later, when drooping
gas prices hurt its ability to repay debts and pay dividends. He wanted
Exco to avoid a similar fate.
There was only one problem: under the contracts that Exco signed, it couldn’t stop drilling.
The company followed Chesapeake’s lead and struck its own $1.3 billion
cash-and-carry deal with the BG Group, a British gas company. BG paid
Exco $655 million in cash upfront and agreed to foot 75 percent of the
bill for future drilling in the Haynesville in return for a share in
future profits on the gas produced.
When the arrangement was made, it seemed like a winner all around. Exco
had more than 53,000 acres of leases in the Haynesville, but like
Chesapeake, it lacked the money it needed to drill on all the land. BG’s
financing helped Exco to increase the number of rigs it had working in
the Haynesville to 22 from four.
Nevertheless, the agreement, negotiated by Goldman Sachs, came with some
important strings attached: Exco had to keep all 22 rigs drilling for
gas, even as the price was dropping. BG wanted to reach certain targets
for drilling wells and producing gas in the United States, and it was
intent on sticking with the plan, even if its partner now insisted that
it made no economic sense.
“They are great partners, but they have their pedal down around the
world, and we are part of that,” Douglas H. Miller, Exco’s chief
executive, explained to Wall Street analysts last year.
Mr. Pickens was furious. “We are stupid to drill these wells,” he said in a recent interview.
But Exco was not alone. Many of its fellow gas companies — including
Chesapeake and Petrohawk — had little choice through last year but to
keep drilling, no matter how low the price fell or how big a glut was
forming.
It wasn’t just the cash-and-carry deals that were forcing them to drill.
The land that the natural gas companies had leased, in most cases, came
with “use it or lose it” clauses that required them to start drilling
within three years and begin paying royalties to the landowners or lose
the leases.
Exco, Chesapeake and others initially boasted about how many acres they
had managed to lock up. But after paying bonuses of up to $20,000 an
acre to the landowners, the companies could not afford to lose the
leases, even if the low price of natural gas meant that drilling more
wells was a losing proposition.
The industry was also driven to keep drilling because of the perverse
way that Wall Street values oil and gas companies. Analysts rate
drillers on their so-called proven reserves, an estimate of how much oil
and gas they have in the ground. Simply by drilling a single well, they
could then count as part of their reserves nearby future well sites. In
this case, higher reserves generally led to a higher stock price, even
though some of the companies were losing money each quarter and piling
up billions of dollars in debt.
Just as in the earlier real estate bubble, the main players publicly
predicted success even as, privately, their doubts were growing, court
documents show.
Mr. McClendon suggested in August 2008 to Wall Street analysts that he
had fundamentally transformed the once-risky, century-old oil and gas
business into something with the reliability of an assembly line.
“We consider ourselves to be in the gas manufacturing business, and that
requires four inputs in our opinion — those inputs are land, people,
science and, of course, capital,” Mr. McClendon told the analysts. “We
think that’s pretty impressive and hope you do as well.”
But soon after, he told some Chesapeake employees that the company might
have made some big mistakes. “What was a fair price 90 days ago for a
lease is now overpriced by a factor of at least 2x given the dramatic
worsening of the natural gas and financial markets,” Mr. McClendon wrote
in an October 2008 e-mail that has since become public in a lawsuit
against Chesapeake.
And as with so many other shale gas players, Chesapeake struck so many
complicated financial deals that it couldn’t stop ramping up the gas
factory.
“At least half and probably two-thirds or three-quarters of our gas
drilling is what I would call involuntary,” Mr. McClendon acknowledged
at one point.
For him, the drilling binge had some significant financial consequences.
During the good times, Chesapeake paid him handsomely in cash and
perks. He achieved a net worth of over $1 billion, and he made it to the
Forbes list of the 400 wealthiest Americans. He bought homes in
Bermuda, Colorado and Hawaii, as well as a stake in the Oklahoma City
Thunder basketball team.
An unusual company program also allowed Mr. McClendon to buy a small
personal stake in Chesapeake’s wells. That is expected to reap more than
$400 million for him over the 15- to 20-year life of the wells,
although it has strained his personal finances for now. An
investigation
by Reuters detailed how Mr. McClendon had borrowed heavily from
Chesapeake business partners to help finance his share of the wells’
costs. That and other issues drew the scrutiny of the Securities and
Exchange Commission, shook investor confidence in him and prompted a
shake-up of Chesapeake’s board that included the removal of Mr.
McClendon as chairman.
(Mr. McClendon refused requests to be interviewed for this article, and he did not respond to a list of questions.)
Mr. Eads appears to have fared better. He had seen the coming crash,
and, as any master salesman would, found a way to play both sides. He
continued to persuade new investors of the great potential in shale
while telling his longtime clients to cash out.
“It is a great time to sell,” Mr. Eads recalled telling Terry Pegula,
the founder of East Resources, who had built up his own operation in the
Marcellus region of Pennsylvania from one well to 75 over the course of
one year. “With all these new plays popping up, I had a real concern
gas prices would weaken.”
Mr. Eads then helped arrange what will go down as one of the great early paydays of the shale revolution: the 2010
sale of East Resources, which Mr. Pegula had started with
$7,500 borrowed from family and friends, to Royal Dutch Shell for $4.7 billion.
There were a handful of other such profit takers, including the Houston
businessman Floyd Wilson, who created a company in 2003 called Petrohawk
Energy with the intention from the start of selling it. Petrohawk
drilled its first Haynesville well in 2008. Last year, it sold itself to
an Australian energy conglomerate, BHP Billiton, in a $15 billion deal
that brought Mr. Wilson and other executives a payout worth at least
$304 million.
But for many gas drillers, there has been only pain.
Exco, whose production of natural gas was still rising in the
Haynesville as of early this year, saw its credit rating downgraded in
May. It reported a loss of nearly $780 million for the first half of the
year, before write-offs and other adjustments, even after it reduced
its work force and rig count. BG, its joint venture partner, reported in
July that it was taking a $1.3 billion write-down on its shale gas
investments in the United States, including the Haynesville deal with
Exco.
Plains Exploration, which celebrated its first deal with Chesapeake back
in 2008, reported a loss for the first quarter this year, but has since
shifted heavily away from gas to oil production and is making money
again. Warm weather last winter exacerbated the glut to historic levels,
reducing prices even further, since so little gas was needed to heat
homes in many parts of the nation.
Chesapeake’s stock price sank this year after it was revealed that Mr.
McClendon had taken a personal stake in Chesapeake wells and then used
those investments as collateral for up to $1.1 billion in loans used
mostly to pay for his share of the cost of drilling those wells. The
company is trying to raise $14 billion this year by shedding assets, a
goal it has almost reached with huge recent sales of West Texas oil and
gas fields and pipelines to Royal Dutch Shell and Chevron.
To help the company through this difficult patch, Mr. McClendon turned
to his old friend, Mr. Eads. Jefferies & Company, joined by Goldman
Sachs, offered Chesapeake an emergency $4 billion unsecured bridge loan,
at 8.5 percent interest, to give the company a lifeline until it could
sell enough assets to keep afloat. (The company says it intends to pay
back the entire loan this year from recent sales.)
In hindsight, it should have been clear to everyone that a bust was
likely to occur, with so many new wells being drilled and so much money
financing them.
But everyone was too busy working out new deals to pay much heed.
The bust has certainly hit the Haynesville hard. Some local landowners,
having spent their initial lease bonuses, are now deeply in debt. Local
restaurants and other businesses are suffering steep losses now that so
many drillers have left town.
“At this point we’re struggling,” said Shelby Spurlock, co-owner of Cafe
171 in the town of Mansfield. The restaurant is decorated with wall
collages of drill worker uniforms from companies that are leaving the
area. Once open from 4 a.m. to 10 p.m. and employing four servers, the
restaurant has cut its hours and is down to two servers. “Our very
existence is in danger,” she sighed.
Mr. Eads, ever the deal maker, is unfazed. He tells anyone who will
listen that the price of natural gas will eventually recover. He is
making money, meanwhile, helping struggling companies and opportunistic
investors strike deals at the new, lower prices.
“These shale assets are forever,” he said. “They are going to produce for a hundred years.”
