SPECIAL REPORT: Chesapeake, McClendon endure rocky year; more uncertainty ahead
Aubrey McClendon, 53, endured a trying year running the second-largest natural gas producer in the United States, Chesapeake Energy Corp. But as corporate, state and federal probes into McClendon and the company continue, 2013 isn't looking much easier.
Facing a cash crunch, the natural-gas giant that McClendon founded had been counting on profits from land that was leased in Colorado, North Dakota and Wyoming. The deals, however, have soured - at a cost to Chesapeake of more than a billion dollars, the company told investors in November.
Like property owners in Michigan and Texas, land owners in North Dakota have sued Chesapeake over allegations that the company reneged on leasing agreements. And now, one of its leading regional contractors is suing Chesapeake for allegedly failing to pay a $15 million bill, court documents show.
McClendon's personal finances also remain strained: This autumn, according to a document filed in Oklahoma County, Oklahoma court, he put up at least part of his renowned wine collection as collateral for a loan from a fellow Oklahoma tycoon.
In building Chesapeake to the size and stature it holds today, McClendon oversaw $43 billion in spending over 15 years to snap up drilling rights across the country, holdings equal in area to West Virginia. But that empire, and the personal fortune he intertwined with it, is now under severe financial and legal strain across much of America.
In April and May, Reuters reported that McClendon had arranged more than $1.5 billion in undisclosed personal loans and that his largest personal lender was also a major investor in Chesapeake. The company removed McClendon as chairman and cut short a perk that enables him to invest in Chesapeake wells. The Securities and Exchange Commission and Chesapeake's board of directors continue to examine the financial relationship between McClendon and the company.
Reuters subsequently found that Chesapeake and rival Encana Corp had discussed taking measures to avoid bidding against the other for land they hoped to acquire in Michigan. The Department of Justice and the Michigan Attorney General are investigating whether Chesapeake, at McClendon's behest, violated anti-trust laws. New emails reviewed by Reuters suggest the talks between the companies may have been more extensive and detailed than previously reported.
The latest revelations add to the struggles of a company that was already beleaguered by slumping natural-gas prices and a $16 billion pile of debt.
"It wouldn't surprise me if McClendon lost his board seat and was terminated," said Mark Hanson, an oil analyst for Morningstar. "If I were a shareholder of the firm, you could make a case that he's probably done more harm than good."
McClendon declined an interview request. The company declined to discuss its ongoing internal investigation of McClendon's business deals or the investigations by the SEC, the Justice Department and Michigan authorities.
But interviews and a review of public records show that McClendon's deals with individuals who also did business with Chesapeake continue today.
One lender with prominent ties to Chesapeake has required that McClendon put up even more of his property to secure a 3-year-old personal loan.
In October, McClendon signed over at least part of his wine collection as collateral on a personal loan from George Kaiser, an Oklahoma financier, according to a document filed in Oklahoma County.
The loan was originally backed only by McClendon's interest in two of his own companies, McClendon Ventures and Chesapeake Investments. In June, McClendon added to the collateral by pledging his collection of oil and gas memorabilia, according to a document filed in Oklahoma County.
The October filing calls the latest collateral pledge the "Wine Security Agreement." The amount financed was not disclosed.
The call for additional collateral raises questions about how his financial situation is perceived by an important creditor of both McClendon and Chesapeake.
Kaiser is chairman of BOK Financial Corp., parent company of the Bank of Oklahoma. The bank is among a number of financial institutions that have extended credit to Chesapeake, according to the company's filings with the SEC.
In addition, Goldman Sachs and the private equity unit of the George Kaiser Family Foundation invested $421 million in Chesapeake through a complex deal known as a volumetric production payment, according to court records and SEC filings. The deal, signed in December 2008, provided cash to Chesapeake in exchange for future oil and gas production from the company's wells in Oklahoma and Arkansas.
A McClendon spokesman declined to discuss the loans. Kaiser did not respond to requests for comment.
"Because of the potential conflicts of interest that have existed prior and still exist at Chesapeake, any dealings that the company has with firms that are also dealing with Aubrey, I think investors have the right to know that," said JPMorgan oil and gas analyst Joseph Allman.
Chesapeake's cash crunch, like McClendon's, is rippling through the company's operations. Charles Joyce vows that he'll never do business with Chesapeake again.
Joyce is president of Otis Eastern, a New York-based contractor that laid pipeline for Chesapeake in northern Pennsylvania's Marcellus shale formation from August 2008 until this fall.
In summer 2011, Chesapeake began to fall behind paying its bills, according to documents in a lawsuit filed by Otis on Oct. 9. By this October, the outstanding balance reached more than $15 million. After months of fruitless demands, Otis sued. It is now in the process of filing liens on Pennsylvania land that was leased by Chesapeake.
Otis Eastern's attorney, Kenneth Africano, wrote in a Dec. 5 court filing that Chesapeake is engaging in a "slow payment" strategy to conserve cash and try to force contractors to settle for less than they're owed.
Chesapeake attorneys wrote on Nov. 5 that the company believes Otis submitted duplicate bills worth more than $3 million and failed to complete some projects.
On Dec. 13, an attorney for Chesapeake denied the "slow payment" characterization. The allegation, he said in a filing, was "frivolous."
Chesapeake, the most active driller of new wells in the United States, uses tens of thousands of vendors, from catering companies to drilling firms. Amid complex sales of many of the company's assets, delays in paying some bills might not be unusual.
But Chesapeake also faces a pronounced cash shortage - one that could cause it to conserve cash by delaying payments to vendors. Chesapeake had just $142 million in cash in September, down from $1 billion in June, according to SEC filings.
"The impression you get is that Chesapeake slow-walks payments to its vendors," said Allman, the JPMorgan analyst. "I cover 37 exploration and production companies. I never hear a complaint about other companies slow-walking payments."
Contractor Joyce said that, after laying more than 80 miles of pipeline for Chesapeake in Pennsylvania, his 76-year-old company is severing ties. "I told them that I was not interested to do any more of their work," Joyce said.
On Dec. 21, Otis Eastern did receive what it considers partial payment - a check for $7.9 million from a former unit of Chesapeake's oil and gas infrastructure operation. In June and December, Chesapeake announced that it had sold substantial portions of its oil and gas infrastructure, and the sales could have complicated the bill payments.
The lawsuit by Otis Eastern says contracts with Chesapeake and its affiliates were signed before the sales occurred. Chesapeake remains a defendant in the suit, and Africano, the attorney for Otis Eastern, said Otis intends to continue its litigation until it receives the balance of what it says it is owed.
A spokeswoman for Access Midstream, an Oklahoma City-based company formed in June from Chesapeake's former infrastructure unit, said it is "committed to paying all legitimate invoices from all our contractors upon timely receipt of appropriate supporting documentation as required in our construction contracts."
Otis Eastern isn't the only company upset with Chesapeake and its affiliates. Interviews with attorneys for contractors in Texas, New York and Pennsylvania, and a review of county court records, show Chesapeake fell behind on a variety of bills this year. Those affected extend beyond the contractors, too:
* On Nov. 2, a New Jersey construction and drilling company filed a lien against property leased by Chesapeake in Bradford County, Pa. The company, Carson & Roberts, says Chesapeake owes it $859,000.
* On Dec. 7, two New York contractors also filed liens in Bradford County. They say they are owed $1.8 million for work on a natural gas compression station there.
* And on Dec. 20, a Minnesota drilling contractor filed three liens on properties leased by Chesapeake in Bradford County. The company claims it is owed more than $725,000.
Chesapeake may have transferred the debts owed to contractors, but the company is still listed as the debtor in the non-payment suits. And the liens filed for non-payment show up as claims against land owners with whom Chesapeake cut deals.
Such liens could interfere with an owner's ability to sell the property, said Stanley B. Edelstein, a Philadelphia construction law attorney. "Depending on the language in a mortgage, it could be an act of default," he said.
Bradley Sink and his wife, Beatrice, own the land where construction company Carson & Roberts filed its lien against Chesapeake. Sink, a retired farm equipment dealer, did not know the lien had been filed until he was contacted by a reporter.
"I'm not real thrilled with having a lien on the property," said Sink, who referred the issue to his attorney.
Chesapeake declined to comment on the liens when asked by Reuters.
Among the legal hurdles facing Chesapeake, one of the most serious is a federal inquiry by the Department of Justice's Antitrust Division. The probe came after Reuters reported that Chesapeake and Canadian rival Encana Corp worked to suppress land prices in Michigan in 2010.
In June, Reuters quoted from internal Chesapeake emails that show top executives of the two companies traded proposals to divide bidding responsibilities for nine private landowners and counties in Michigan.
Other emails reviewed recently indicate that Chesapeake and Encana executives discussed suppressing land prices in Michigan more frequently and in greater detail than previously reported.
One of the emails came from John Schopp, a vice president at Encana. It was sent to Chesapeake's executive vice president of acquisitions and divestitures, Doug Jacobson. Dated June 17, 2010, the email was copied to Jeff Wojahn, president of Encana USA.
Neither Encana nor Chesapeake would comment on the emails.
Schopp noted why he thought teaming with Chesapeake would benefit both firms. "I certainly feel that combining forces will be helpful to prevent further inflation," he wrote. "After a time we might benefit from some deflation as well. Your thoughts?"
Five days later, Schopp followed up in an email: "As we continue our leasing activities, it is increasingly apparent that we need an AMI in place soon versus our alternative to escalate prices." AMI stands for Area of Mutual Interest, a partnership that companies sometimes use to share the costs of developing particular areas. Oil and gas attorneys who examined the email discussions between Encana and Chesapeake say what the two companies were discussing is not how AMIs are supposed to work.
"These agreements are not a way in which companies divide up territory together or avoid sellers playing them off each other," said Bruce Kramer, an expert on oil and gas law.
Such a proposal circulated inside Chesapeake. In late June 2010, one Chesapeake executive inserted comments into the margin of a draft document, according to details of that document shared with Reuters.
One paragraph of that proposal, which addressed future state lease sale auctions, reads: "At any time during the bidding process a party may stop bidding on any designated tract, at which point the other party may commence bidding on such tract."
David Bolton, a senior landman at Chesapeake closely involved in Michigan land leasing, wrote in the margin: "This will be difficult to enforce - I would suggest we keep this simple and coordinate our bidding efforts within the AMI lands prior to the state sale. Then offer each the leases according to this agreement just as we would any other. Your thoughts?"
Another paragraph in the proposal read: "With respect to the tracts that are designated for bidding by only one party, the other party will be free to bid independently bid (sic) on said tracts, including bidding against the designated party."
Next to that paragraph, Bolton wrote: "Why have this if the goal is to keep from running the prices up on each other?"
Darren Bush, a former Justice Department anti-trust attorney, said the emails and proposal comments were likely to be "deeply troubling" to Justice Department investigators already examining Chesapeake and Encana communications.
The emails and comments show "the purpose is to make sure that they are not bidding each other up," said Bush, now a professor of anti-trust law at the University of Houston. "At some point, they think they can stabilize the prices. And then over time, they can have it decrease."
Both Chesapeake and Encana have acknowledged holding talks about forming a joint-venture in Michigan. But the companies say no agreement was ever reached. In September, Encana's board of directors said an internal investigation found no evidence of wrongdoing by the company. It did not say how it came to that conclusion.
The ongoing Justice Department and Michigan Attorney General probes have stymied Chesapeake's plan to sell its Michigan acreage. In June, the company put up for sale 450,000 acres, for which it says it paid $400 million. A sale was expected by Aug. 31. Since then, no prospective buyers have been disclosed.
The investigations could take years to resolve, antitrust experts say. They involve the review of thousands of documents and emails and are likely to include interviews with key executives including McClendon. The investigations could necessitate analyses by economists to determine whether the state of Michigan and private land owners incurred losses.
McClendon most certainly has.
In 2011, Forbes estimated McClendon's net worth at $1.1 billion. After Reuters reported this year that McClendon had taken out more than $1 billion in personal loans, he fell off the magazine's roster of the wealthiest 400 Americans. Forbes now estimates his net worth to be $500 million, less than half of its estimate a year ago. (Reporting by Brian Grow in Atlanta, Anna Driver in Houston, and Joshua Schneyer in New York. Additional reporting by Carrick Mollenkamp; editing by Blake Morrison and Michael Williams)
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