The Oil and the Glory

When you are betting on shale gas, watch the dealer’s eyes

When you are betting on shale gas, watch the dealer’s eyes

When someone invites you to a party but leaves before dessert, it might be time to locate your own coat and hat. Such are the suspicions generated by Chesapeake Energy, which after selling numerous billion-dollar pieces of its vast shale gas holdings to the world’s largest energy companies has abruptly announced that it is drawing down.

A Chesapeake-led rage in shale gas has gone on for some four years, ignited by advances in a drilling method called hydraulic fracturing. In the beginning, Oklahoma-based Chesapeake, run by a wildcatter named Aubrey McClendon, was among the most aggressive acquirers of shale gas leases in the United States. A Forbes writer described McClendon as perhaps "reckless," but also "charming" and "erudite," not to mention youthful, ingenious and even heroic. (At O&G, we have found McClendon temperamental and ideologically self-destructive to a degree that risked the entire shale-gas bonanza, but that’s just us.)

Altogether, drilling by Chesapeake and other companies has since then transformed the U.S. from a natural gas importer into a country so awash in gas that it may spend decades as an exporter. Russia has been rendered less secure in Europe, and China may shake things up further by opening up an even larger shale-gas frontier.

Along the way, Chesapeake has generously let later-comers into the game. Among McClendon’s deals, he got $3.6 billion from BP for a 25 percent stake of Chesapeake’s Fayetteville shale in Arkansas, and all of its Woodford Shale of Oklahoma’s Arkoma Basin. A year ago, McClendon got $4.75 billion for Chesapeake’s Fayetteville Shale holdings from Australian mining giant BHP Billiton. That was just after he did a $1.3 billion deal with China’s CNOOC for a piece of his company’s Niobrara Shale, straddling Colorado and Wyoming.

Four weeks ago, Chesapeake disclosed another blockbuster deal — a $2. 3 billion partnership with France’s Total for part of the company’s Utica Shale holdings in Ohio.

But last week, Chesapeake announced that the risk is too high. The shale-gas rush had resulted in the historical boom-bust bane of the oil patch — massive over-production, and a price collapse — and McClendon was moving on; oil, for example, was looking pretty good, the company said. In an amusing piece at the Financial Times, John Dizard, a long-time shale gas skeptic, quotes from Catch-22, and goes on to describe Chesapeake’s announcement:

The Wall Street maxim is that they never ring a bell at the top. However, on Jan. 23, Chesapeake Energy did ring a bell at the bottom. The undoubted leader of the shale gas revolution announced that it would reduce drilling expenditures this year by more than 70 per cent, curtail its gas production by 8 per cent, cut land buying by $2 billion, and allow uneconomic gas leases to expire.

ConocoPhillips followed quickly with its own gas-patch pullback.

These moves are valid. The history of John D. Rockefeller informs us that, when faced with fire-sale prices and no sign of an uptick, you either have to drive your competitors out of business, or reduce your own supply by closing down some operations. In a note to clients this morning, Bernstein Energy’s Bob Brackett suggests that low prices and the rush to get out of the market may ultimately present an excellent buying opportunity for cash-rich bargain-hunters.   

One only notes that McClendon was not signaling his new religion as recently as a month ago, when he was helping himself to Total’s billions. According to calculations by Bloomberg’s Joe Carroll and Jim Polson (who relied on numbers provided by the consultants IHS Inc.), Total paid $15,000 an acre for the Chesapeake property, or "more than four times the average per-acre price from seven Utica shale transactions tracked by IHS from March 2011 to September 2011." This seemed like a bubble. The Jan. 18 Bloomberg piece quotes IHS analyst Sven Del Pozzo: "I don’t feel confident that the prices being paid now are justified. I’m wary."

Conoco CEO Jim Mulva has since gone on a promotional tour to get Americans to use more of the fuel. He is urging the Obama Administration to  regulate lightly to encourage shale oil drilling. The rest of the industry is saying the same. This is late: Two years ago, the shale drilling industry declined an Obama Administration effort to make Big Gas part of its climate-change agenda, boosting the consumption of gas in order to lower the emissions of heat-trapping gases; industry players suggested that they wouldn’t cooperate with the White House because global warming doesn’t exist.

The White House effort collapsed. But not Aubrey McClendon’s shale swagger.