Chesapeake Energy CEO capitalizing today on tomorrow's profits in West Virginia's farmland
March 25, 2012 8:00 AM
Mortgaging the future of natural gas
By Erich Schwartzel and Elisabeth Ponsot Pittsburgh Post-Gazette
An affiliate company owned by Chesapeake Energy CEO Aubrey McClendon is mortgaging its stake in West Virginia oil and gas leases, making Brooke County farmland part of a billionaire's portfolio built to profit on the promise of future drilling.
The affiliate company -- Jamestown Resources -- has entered into mortgages with a global investment group to raise funds against untold portions of its holdings in West Virginia. Jamestown Resources is owned by Mr. McClendon, who also owns a personal stake in every well that Chesapeake drills.
The mortgaging gives Mr. McClendon the opportunity to raise cash now on the promise of drilling at a time when the industry is scaling back production and waiting for natural gas prices to rebound. Meanwhile, the practice is never disclosed to the landowners whose property it concerns, although it is filed in the Brooke County Courthouse alongside their leases.
It's a win-win situation for Mr. McClendon: Drill a profitable well, and the loan is easily paid off and well profits go to Oklahoma City-based Chesapeake. If the well doesn't produce or isn't drilled, the only collateral jeopardized is oil and gas interests in Brooke County.
"What Aubrey does with his own investments is separate from what the company does," said Bob Brackett, a senior analyst at New York-based Sanford C. Bernstein & Co. LLC. "But Aubrey as the CEO is willing to take big bets, and he's consistent with his own money."
The mortgages can be bundled and traded, not unlike how home mortgages have been on Wall Street.
Since landowners do not have to be informed about the mortgaging practice, it's hard to gauge just how common it is. Chesapeake says this is standard procedure for such transactions. P. Nathan Bowles Jr., an oil and gas attorney in Charleston, W.Va., who served as trustee on some Jamestown mortgages, agrees it's a standard strategy.
"It's not uncommon at all. It is used whenever somebody wants to leverage their investments," Mr. Bowles said. "When it comes to oil and gas, somebody might go to a lender and say, 'I have these leases, I'm experienced in the business ... so I'd like to borrow money to finance the drilling and I'll pay you back as this oil or gas is produced.' "
Chesapeake calls this everyday business, saying it's taken mortgages out on holdings for the 23 years it's been operating.
While the recent mortgages are taken out against stakes held in each individual oil and gas lease, the borrower -- in this case Mr. McClendon -- presents the entire package of interests to EIG Global Energy Partners, a Washington, D.C.-based energy investment company, in order to secure the total loan.
"In the end, the package is put together and it is like a person saying 'I will mortgage my house and my farm and my summer home to secure the same loan,' " Mr. Bowles said.
Jamestown is able to secure this loan on the promise that Chesapeake will continue to drill as it has for years. In 2010, Chesapeake's daily production rate averaged approximately 2.8 billions of cubic feet equivalent (bcfe), an increase of 14 percent from 2009.
But what if the wells leveraged for cash up front don't produce?
"The debt's still there. The borrower is still required to pay off the debt," Mr. Bowles said. "So how else can the borrower do that if they didn't have the money to drill in the first place?"
The money raised from mortgaging Jamestown stakes does not finance Chesapeake operations, said Henry J. Hood, senior vice president land and legal and general counsel. Mr. Hood said Chesapeake "has no involvement in the negotiation or documentation" of the mortgages.
"It's doubtful that it would be a significantly sufficient amount of money" for Chesapeake's massive operations anyway, Mr. Brackett said. A horizontal drilling rig can cost as much as $7 million.
Chesapeake and Jamestown share more in common than a CEO and names that harken to Virginia's colonial days.
Jamestown has listed a business address that is the same as Chesapeake headquarters, and other times lists the same Oklahoma post office box number used by the McClendon Family Foundation nonprofit and used by Mr. McClendon's wife when she donated $2,400 to New York Republican Congressional candidate George Phillips' unsuccessful 2010 campaign.
In February, Jamestown also was one of several of Mr. McClendon's affiliates named on Chesapeake's selling of 487,000 acres to BHP Billiton Petroleum in Arkansas' Fayetteville Shale.
The Jamestown mortgages are part of Mr. McClendon's expansive personal portfolio, which includes partial ownership in the NBA Oklahoma City Thunder and the Deep Fork restaurant in Oklahoma City.
Mr. McClendon's personal penchant for several sources of funding also has been seen through Chesapeake's recent transactions.
Chesapeake Energy has not been shy about partnering in billion-dollar deals to help pay for operations. Like other drillers, Chesapeake Energy has found itself needing cash to finance the competitive land rush and drilling boom that have emerged atop the Marcellus and Utica natural gas formations.
Statoil of Norway, for example, owns a one-third stake in Chesapeake's Marcellus acreage, and Chesapeake has signed other joint ventures with foreign firms in nearly every major American shale play.
As Chesapeake's acreage expands, Mr. McClendon is afforded a 2.5 percent stake in every well drilled through a unique corporate program.
The program, called the Founders Well Participation Program and reported on by Reuters last year, has helped Mr. McClendon's compensation skyrocket to one of the highest salaries of any chief executive in any sector. In 2010, he earned more than $21 million.
Jamestown holds the same stakes associated with Mr. McClendon's 2.5 percent. The affiliate holds undisclosed oil and gas interests in Brooke County properties -- leases that include 184 acres in Buffalo, W.Va., owned by a couple who lives in Cuba, N.Y., and 280 acres owned by an elderly woman in Wellsburg, according to documents reviewed by the Post-Gazette.
In late January, Jamestown mortgaged its stake in these and other holdings to EIG. Mr. McClendon's signature is on the mortgages or deeds of trust on file at the Brooke County Courthouse.
The mortgaging puts these deeds in EIG's global investment portfolio, which includes midstream operations in America and wind farms in the United Kingdom. In November, EIG worked with Chesapeake on a joint venture program in Ohio's Utica Shale valued at $3.4 billion.
Mortgaging oil and gas interests provides an immediate loan for Jamestown Resources, and EIG stands to make money from interest on the kind of Marcellus holding that's generated unprecedented financial excitement in the energy sector.
EIG clients can invest in funds that include these Jamestown mortgages, bundling them into holdings that can be sold to equity investors not unlike the home mortgages once sold to Fannie Mae or Freddie Mac.
Unlike with home mortgages, however, it's much harder to collect collateral on defaulting oil and gas mortgages.
A deed of trust taken out on the Brooke County oil and gas interests gives EIG absolute and unconditional control over the assets. If Jamestown defaults on its monthly loan payments -- whether rigs have been drilled -- EIG can foreclose upon the holding.
These Jamestown mortgages are relatively new, and Mr. Bowles hasn't seen a default on similar mortgages since the 1970s, long before the Marcellus Shale boom began. Still, he said, the practice can be considered risky for drilling companies.
"Some operators like to avoid mortgages and so they do everything on a cash basis," he said. "And if they don't have the money saved up, they don't drill."