Virtually anyone who has followed the onshore drilling bonanza knows the name Aubrey McClendon and the company he co-founded, Chesapeake Energy.
McClendon was the hard-driving CEO and chairman of one of America’s most aggressive drilling companies, but he was brought down earlier this year after a string of financial scandals and potential conflicts of interest came to light. It turned out that at the heart of the natural gas industry’s poster child lay financial practices that drew the ire of investors, the attention of SEC investigators and the fixation of the news media.
But in the past several months there have been a series of largely under-reported events that demonstrate that Mr. McClendon's problems are by no means distinct.
Might the drilling industry have broader financial issues?
First, take a look at what happened earlier this month with SandRidge Energy. The company announced that it will shake up leadership among executives and the board of directors, and may replace CEO Tom Ward. The announcement came after news broke of scandals similar to those at Chesapeake.
Then a few days later, energy reporters shifted attention to Hess which was selling off much of the acreage the company has in the Eagle Ford shale play, located in Texas. Turns out that Hess sold off much of the acreage for $265 million – far less than the $820 million that some prominent Wall Street analysts had predicted.
This may sound like dry, even banal, business news. But it's worth connecting the dots because there is so much more than money at stake where the energy industry is concerned.
“Some of these companies have had performance issues. Some of them have had conflict issues. Some of them have had performance issues combined with some dominating families,” Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, told Reuters, referring to allegations that SandRidge CEO Tom Ward may have allowed a company run by his son to improperly benefit from SandRidge's activities.
Taken together, these disparate events start looking like a pattern. In fact, what was for a long time a fringe perspective, starts looking like a fairly mainstream observation.
For several years now, a brave few financial analysts and reporters have questioned whether there may be something rotten in how many drilling companies report their earnings, how their executives compensate themselves, how they calculate the amount of gas or other fossil fuels they can pull from the ground.
At root, these skeptics have said that there seemed to be a deliberate attempt by some of these companies to mislead investors, lawmakers and the public about the economics of drilling and the financial prospects of their companies. When these skeptics have spoken up, they usually have been shouted down by the energy industry’s massive PR machine.
Let's recount, briefly, a couple highlights from the history of this skepticism.
Back in 2010, John Dizard at the Financial Times labeled shale gas a “fairytale,” explaining that shale extraction was a financial loser. “The basic truth about shale is that it is much harder to extract the gas from those rocks than it is from the sandstones that are the source of most ‘conventional’ gas,” Mr. Dizard wrote.
Oil analyst Arthur Berman has been arguing for years that companies miscalculated the potential of shale gas wells, and then found themselves in a bind, having leased acreage at exorbitant prices.
In June 2011, doubts among industry insiders and federal energy analysts made the front page of The New York Times. The Times also highlighted an obscure SEC rule change that allowed companies to aggressively book shale gas reserves.
Chesapeake Energy has, so far, borne the brunt of the scrutiny, in large part because the company and its founder, Mr. McClendon, have at times seemed larger than life. Their financial woes are well known at this point.
“Chesapeake was a shell game, or maybe I should say a shale game,” Charles Goodyear, former head of mining giant BHP Billiton, told attendees at a recent Yale energy conference.. “I’m not sure it created any economic value at all.”
But recent events strongly suggest Chesapeake is far from alone.
Earlier this month, SandRidge, under pressure from one of its largest investors, announced that they were revamping both their board of directors and the executives who run the company.
CEO Tom Ward, under fire not only for business deals involving family members but also for some of the nearly identical compesation issues to the ones that brought Mr. McClendon down, may be on his way out entirely, and the company’s chief operating officer also announced his resignation.
Mr. Ward co-founded Chesapeake with Mr. McClendon, but departed to run his own company.
Hess Corporation, which is looking to transform itself from a company known for its roadside gas stations into an oil and gas exploration and production company, stunned some investors when it announced the selling price for some of its acreage in one of the hottest shale plays currently, the Eagle Ford. The price was less than a third of what investors expected, sending a signal that the shale may not be as productive as it was hyped up to be.
To frame the problem in its most basic terms, the troubles across the domestic drilling industry largely stem from a lack of transparency. We do not know key information about how the industry operates and makes its predictions. We don't know how they calculate reserves, what chemicals they inject in the ground, or how much in financial liability they have faced from causing environmental harms.
The oil and gas industry is unparalleled in attacking those who want answers. The industry is also distinct in the bevy of loopholes it has enjoyed from federal laws that force other industries to provide the public with this sort of basic information.
Some of this lack of transparency is catching up with the industry. With growing scrutiny of these company's books, executives are having their bluffs called and their poor planning revealed.
Look, for example, at how much shale companies have had to lower the estimates they previously offered for the amount of available gas they can economically pull from the ground. In 2012, company after company was forced to lower these estimates as the price of natural gas plummeted, acknowledging that the gas could not be profitably drilled in current market conditions.
In the fall of 2012 just four companies – Total, BG Group Plc, Encana, and BHP Billiton Ltd. – saw nearly $6 billion in assets disappear from their books due to these write-downs. And Chesapeake Energy’s write-down of 4.6 trillion cubic feet of gas last August was valued at between $4 and $5 billion. BHP Billiton’s admission that $2.84 billion worth of gas in its Fayetteville shale holdings could not be profitably drilled was especially striking, given that the company had purchased that acreage for $4.75 billion only 18 months earlier.
This excellent article from the Fort Worth Weekly describes in plain language exactly how companies got themselves into trouble, pointing out that it’s not just low prices that have wreaked havoc for drillers, but also unjustified expectations about how much oil and gas shale wells can actually produce over the long run.
Currently, SEC rules do not require companies to disclose to their investors many details about precisely how reserves estimates are calculated, leaving investors and energy policymakers alike somewhat in the dark as to what went wrong when reserves are written down.
Some forces are finally pushing the industry to become more transparent.
One of the industry’s most insidious tactics has been to insist on non-disclosure agreements when landowners whose water has been polluted settle contamination lawsuits. These agreements mean that neighbors cannot discuss the cause of their tainted drinking water with anyone – not their neighbors and not the press.
Even EPA researchers looking for proof that fracking has contamined groundwater have repeatedly run into brick walls because of these non-disclosure agreements. Investors also may not be told how much companies have paid to settle lawsuits over contamination.
But these agreements are beginning to draw closer scrutiny. Last week, a Pennsylvania judge ruled in favor of two regional newspapers, finding that the new organizations had the right to information about the case, which had drawn considerable attention before the settlement agreement was inked.
“Whether a right of privacy for businesses exists within the penumbral rights of Pennsylvania's constitution is a matter of first impression,” the judge wrote. “It does not.”
The ruling is a first step towards transparency and access to information about the oil and gas industry.
The question remains how much longer domestic drillers will be allowed to keep other vital information – needed by policymakers, investors, and community members alike – out of the public eye.
Image credit: Shutterstock | Phatic-Photography