BROOKE COUNTY, W.Va. -- Most of the clusters of land that Chesapeake Energy has leased for natural gas drilling in this rural West Virginia county are pooled into rectangular shapes that lean northwest, the better to allow the rock below to fracture properly and the better to make room for a massive drill.
Yet the only two Brooke County properties that the Oklahoma company's CEO Aubrey McClendon has chosen to mortgage his personal drilling stakes in do not fit that mold.
Marred by gaps of land out of the company's control, neither cluster appears likely to see the level of drilling needed to pay back Mr. McClendon's loans.
That may be strategic.
By mortgaging properties that appear to be some of his company's least desirable assets, Mr. McClendon can raise money off holdings that might not otherwise be profitable. And should he default on the loans, he would lose a stake in property that wasn't his company's best bet anyway.
The arrangement protects Mr. McClendon from bigger personal losses while exposing the company's shareholders to the kind of risky financial deals that have drawn scrutiny and caused the stock price to plummet in recent weeks.
Meanwhile, the private equity firms lending the money for the mortgages haven't specified what research went into the properties, and shareholders have been told little about the specific pieces of farmland that are being used by Mr. McClendon to raise money on the promise of future drilling.
The issue of the CEO's mortgages has been in the spotlight lately, although the program that allows Mr. McClendon to purchase a 2.5 percent stake in every well drilled by Chesapeake Energy has been in place for years. Mr. McClendon has been borrowing against the stakes he acquired through the Founders Well Participation Program, allowing him to raise cash at a time when competitors are pulling back and waiting for natural gas prices to rise.
The undisclosed mortgages, taken out by Mr. McClendon's Jamestown Resources company, are said to top $1 billion -- an amount of money that critics say indicates an unsustainable practice of constant leveraging.
Critics see a parallel strategy in Mr. McClendon's high-risk personal portfolio and the company's ongoing debt problems, with more than $10 billion in debt reported last quarter. For his part, Mr. McClendon has said he's aligning his personal portfolio with his company's success, assuring shareholders that's the recipe for an incentivized executive.
But in Brooke County, the CEO's personal portfolio is aligned with some of his company's least promising assets.
One cluster of land that he has borrowed against has a sizable chunk of necessary property missing in the middle -- courtesy of a neighbor who refuses to sign a lease. Another is a jagged assembling of properties that looks nothing like the other pooled units in Brooke County.
Even in the case of the most promising land units, the risk of using these oil and gas interests as collateral seems high.
Industry activity underground has slowed because natural gas prices have dipped to levels that not even the private equity firms granting the mortgages anticipated when underwriting them. And up on the surface, the promise of lucrative future drilling is compromised by the politics and drilling delays of the Marcellus region, whether it's because of neighbors who refuse to allow drilling on their land or firms that lease land right next door.
Brooke County's example raises the question: How valuable are the properties being used to raise this controversial capital?
In 2005, Chesapeake shareholders approved Mr. McClendon's participation in the Founders Well Participation Program, an arrangement that allowed the CEO to take a working 2.5 percent interest in each well his company drills. Mr. McClendon's quiet mortgaging of those stakes has prompted shareholder lawsuits, forced Mr. McClendon to give up his chairmanship position and raised questions about Chesapeake's aggressive expansion into natural gas-rich shale regions in Appalachia.
The mortgages -- first reported by the Post-Gazette on March 25 -- borrow against whole drilling units and is financing his share of the well costs.
Chesapeake has assembled its West Virginia properties into "units" that treat multiple plots of land as one giant holding, often with several wells on each.
Units in Brooke County tend to follow a similar shape: they are relatively clean, tilted rectangles that slant toward the northwest. The units are laid out that way because drillers fracture shale rock in a northwest direction, running perpendicular to the east-facing formation. That creates the maximum amount of fissures and allows shale gas to escape more freely.
Only two units in Brooke County don't have the layout conducive to northwest-facing drilling. Those are the two properties that Mr. McClendon has mortgaged.
Each already has one well on the property, but any future development needed to fully drain the acreage is going to face several impediments.
Drillers typically space wells about 1,000 feet apart, and will usually drill horizontally underground at least 3,000 feet, said Tim Carr, a professor of geology and geography at West Virginia University.
Using maps that Chesapeake submitted to Brooke County officials, it becomes clear that the John Hupp North and Mildred Mani units are unlikely to see the same scale of drilling activity as the unmortgaged properties.
One unit, the 461-acre John Hupp, has a sizable piece of acreage missing from the middle that would stop any additional drilling rig from traveling the optimal 5,000 feet underground.
That missing acreage is property owned by Marion Stone, a Brooke County woman who refuses to sign a lease with Chesapeake over what she sees as unfair lease terms and company practices.
Chesapeake has drilled one well on the John Hupp unit, along its far west portion. Any well that might run parallel to that first drill would be cut short by Ms. Stone's unleased property.
Another land cluster, called the Mildred Mani unit, is a jumbled, 254-acre shape with angular cuts and one current well. Buying up the surrounding property to make the unit more symmetrical would be difficult, as well. Most of it is owned by BP and Somerset Minerals LP.
Still, Mr. McClendon has been able to generate cash flow from these two less-than-desirable holdings through mortgages with EIG Global Energy Partners, a Washington, D.C.-based energy investment company.
The two properties represent a small portion of Chesapeake's holdings in Brooke County.
The company owns more than 11,000 acres there, most of it acquired through a land swap with driller Range Resources in 2010. Pooling several properties into giant "units" allows the company to minimize surface impact and extract gas from multiple leaseholds using a single rig, the company says.
Work on the Hupp and Mani units is further complicated because companies often save money by planning sequential wells on the same unit. That helps avoid the need to move rigs and equipment far distances.
"Shale gas is like McDonald's," said Mr. Carr. "You're making your money on your ability to do it efficiently."
Chesapeake referred questions to Ron Hutcheson, a crisis management specialist responding to inquiries about Mr. McClendon's personal assets. Mr. Hutcheson declined comment for this story.
While the Hupp and Mani units illustrate the physical challenges in treating oil and gas interests as a traded commodity, both units point also to the built-in market risks that come with trading natural gas mortgages like the home mortgages that soured the economy in 2008.
Natural gas prices have plummeted to their lowest levels in years, dipping below $2 per Mcf and forcing companies across the industry to temper Marcellus Shale operations and reduce projections.
When EIG agreed to take on Mr. McClendon's loans, the company underwrote the mortgages at a time when natural gas was selling at around $6 per Mcf, said a source with knowledge of the firms' agreement.
Now that gas prices have fallen sharply, any return for EIG on these mortgages could take up to six years, the source said -- perhaps triple the amount of time the company initially hoped.
Proponents of the mortgage arrangement say the energy sector is not a get-rich-quick business, and that EIG and Chesapeake see this as a long-term strategy.
Yet EIG is protecting itself, too, with interest rates on Chesapeake's loans as high as 13 percent.
"It's the equivalent of a payday loan," said Mark Hanson, a Chicago-based analyst at Morningstar Inc. "It only speaks to the corner that Mr. McClendon has put himself into. You only go to a loan shark when you have nowhere else to go."
EIG and the other firms that issued Mr. McClendon's mortgages don't stand to lose if the company or its CEO file for bankruptcy.
That's because the company is required to continue paying so-called working interest partners off a well's revenue, even in the event of a bankruptcy brought on by the recent trouble, meaning royalty checks would still go to landowners and EIG would still receive payments on its loans.
Should either bankruptcy occur, however, it might jeopardize EIG's mortgaging of any future wells that Chesapeake drills.
Mr. McClendon's personal 2.5 percent program isn't due to expire until June 2014.
Erich Schwartzel: email@example.com or 412-263-1455. First Published May 10, 2012 4:00 AM