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
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
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
"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
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
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
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
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
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
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
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
Chesapeake and McClendon are the victims of technology and a
strategic blunder rather than governance -- Joseph Schumpeter's
process of "creative destruction" in action.