By John Kemp
LONDON Jan 31 Shareholders must be hoping the removal of Aubrey McClendon as Chesapeake's chief executive will end the corporate governance discount attached to the company's share price and unlock superior returns. They are likely to be disappointed.
Removing McClendon does not the resolve the company's basic problem: it is the second-largest producer in a market (U.S. natural gas) which has been transformed by the advent of a new technology (hydraulic fracturing) and now faces years of oversupply as well as a radical change in the cost of production which has left many old assets stranded and devalued.
Shareholder activists like Carl Icahn have focused on governance issues. But even a quick look at the performance of Chesapeake's share price compared with the price of the main product it produces shows the company has been felled by the drop in natural gas prices rather than governance problems.
TRACKING GAS PRICES DOWN
Chesapeake's shares have broadly tracked changes in gas prices and peers like Devon Energy where no governance problems have been alleged ().
Chesapeake's shares rose sharply following the announcement of McClendon's departure. Chesapeake is up by about 20 percent since the recent low on Jan 10, more than the 7 percent increase in Devon's share price over the same period.
But it hardly qualifies as a "surge". Chesapeake's share price is still down 7 percent compared with the same time last year, about the same as Devon's 11 percent loss. Both companies have seen their share prices fall by 30-35 percent over the last two years. Natural gas prices have dropped around a quarter over the same period.
Icahn has been generous in his praise following McClendon's decision to quit the company, but like other activists he now needs to accentuate the positive: he owns a large number of the company's shares.
"Aubrey has every right to be proud of the company he has built, the world class team of people at Chesapeake and the collection of assets he has assembled, which in my opinion are the best portfolio of energy assets in the country," Icahn said in a statement released on Tuesday.
"While it is known that some of these assets will be sold by the company in due course, I do not believe that this will in any way effect the ultimate realisation of Chesapeake's potential. I am confident that history will prove Aubrey has been correct about the value of natural gas in general and the value of Chesapeake in particular."
History is unlikely to prove any such thing. Chesapeake does indeed have fantastic assets. But their value has been drastically changed by the shale revolution. Chesapeake's new chief executive will confront the same problem as his predecessor.
STRANDED ASSET PORTFOLIO
Like Exxon, which bought XTO in 2010, and Shell, which bought East Resources in 2010, Chesapeake's strategy was designed for a world where gas prices averaged $6 or $8 per million British thermal units in the long-term.
Under McClendon, Chesapeake failed to fully understand the implications of all its competitors investing in the same new technology, leading to a dramatic reduction in the industry's cost of production and a massive amount of oversupply. It then assumed it had the balance-sheet strength and guts to ride through the slump while low prices forced others to shut production and abandon their own expansion plans.
In the end, shareholders ran out of patience.
Turfing out the chief executive is satisfying, probably a necessary act of expiation. Perhaps it will allow for a change of narrative. But it does not alter the fundamental value of the company.
Chesapeake's great assets (in terms of their potential for gas production) are not necessarily worth much in a market set to remain oversupplied for at least the next couple of years and possibly longer. The way the market values gas resources has profoundly changed.
The company will try to sell some of its acreage, but no one will pay much, especially since many of Chesapeake's leases are for gas-rich and liquids-rich plays rather than oil ones. The company will need to offer discounts if it wants to offload a substantial number.
Chesapeake (for the acreage it retains) or a buyer (for the acreage it sells) will then be left with the same strategy McClendon had: waiting for an eventual upturn in demand or the construction of a string of LNG export terminals to relieve oversupply and force prices higher.
The first LNG export terminals will take at least 3-4 years to build even if they are approved by the Department of Energy. A big boost in domestic demand is even further away.
FELLED BY TECHNOLOGY
Chesapeake can conserve cash by cutting its drilling programme further. But then its output will quickly decline and there is no guarantee others will cut back enough to boost prices.
Slashing the drilling programme and conserving cash does not change the fact the company has a portfolio of assets it bought on the assumption gas prices would be much higher than they are today and are likely to remain for the foreseeable future.
The world has changed, permanently vaporising a large amount of Chesapeake's value, which the company is unlikely ever to recapture.
Chesapeake is not alone. Similar value-destruction has occurred at Exxon and Shell, but has gone unnoticed because they are large diversified companies with much greater exposure outside the United States and to oil rather than gas.
In July 2012, BP took a two-part writedown of $2.1 billion on U.S. shale gas assets, which had been hit by the slump in prices.
A few days later, BHP Billiton took a $2.8 billion writedown on some of its U.S. shale gas acreage -- ironically assets it had bought from Chesapeake 18 months previously for $4.75 billion.
Occidental Petroleum announced on Thursday it was taking a $1.1 billion charge mostly related to the impairment of natural gas assets in the midcontinent.
Removing McClendon does not change the basic problems with the company's operating environment or the value of its asset portfolio.
Chesapeake and McClendon are the victims of technology and a strategic blunder rather than governance -- Joseph Schumpeter's process of "creative destruction" in action.