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New Chesapeake Chairman to Be Named This Week

June 18, 2012
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Chesapeake Energy Corp.'s Aubrey McClendon, who has served as chairman and CEO since he co-founded the company in 1989, will no longer be running the board of directors after Friday (June 22). Questions remain about how the incoming nonexecutive chairman may change the company's direction -- and how McClendon conforms in his more tightly defined role.

Many shareholders see McClendon's demotion as a plus. In a historic shareholder revolt earlier this month the stockholders garnered enough support at the annual meeting to oust two board members up for reelection, reincorporate in Delaware from Oklahoma, implement a supermajority voting standard and implement proxy access (see NGI, June 11).

Southeastern Asset Management Inc. CEO O. Mason Hawkins, who oversees the largest Chesapeake shareholder block (13.6%), voted against the board members up for reelection, V. Burns Hargis, president of Oklahoma State University, and former Union Pacific CEO Richard K. Davidson. Both men tendered their resignations from the board following the meeting on June 8. Southeastern, which took an active role in the company as the personal loans by McClendon were disclosed beginning in April, will be appointing three of Chesapeake's new independent directors while investor Carl Icahn (7.8%) is to become -- or to appoint -- a fourth director.

With board member Louis Simpson, a former Berkshire Hathaway executive who was appointed last year at Southeastern's request, it means that with the new chairman -- one Hawkins and Icahn are likely to approve -- the two shareholders would control the board and therefore, McClendon.

Selling the midstream businesses for $4 billion to Global Infrastructure Partners on the same day as the annual meeting was applauded by Hawkins. In early May "we urged the move not just to strengthen the balance sheet but also to reduce future capital spending...We believe that management and the soon-to-be reconstituted board will vigilantly prioritize and pursue these and other value-creating opportunities."

Some energy analysts think that business-wise, things are looking more positive for Chesapeake. Based on the midstream sale, Canaccord Genuity's John Gerdes raised his price target to $28 on the company; it closed at $18.10 on Friday. To comply with Chesapeake's four-times net debt/trailing 12-month earnings before interest, taxes, depreciation and amortization, the company still "needs to monetize an additional $2.5 billion of assets" in 2012, Gerdes said. The company "should exhibit 14% production growth in '12."

Based on other asset sales planned, "we view these targets as achievable given asset sales should net $6.5-9.5 billion," said Gerdes. Proceeds from the Permian Basin sale could net $4-6 billion; the Mississippian Lime joint venture (JV), $1-1.5 billion; Utica JV, $500 million to $1 billion; northern Denver-Julesburg Basin, $500 million; and miscellaneous sales another $500 million.

However, using the midpoint of Chesapeake's guidance it still may need another $8 billion-plus of sales this year to bridge a projected funding gap, according to the oil and gas analysts with ISI Group.

"The latest disposals cover roughly half that before accounting for impacts on free cash flow. These are hard to judge, but the foregone annual cash flow amounts to $195 million. Against that, Chesapeake says its capital-expenditure budget will also drop by $1 billion a year on average. It is questionable as to why so much was budgeted given that Chesapeake's pipelines serve natural gas wells where output growth looks unlikely in the near-term. Either way, though, the capital expenditure part of the equation should fall."

On paper, the free cash flow impact relative to the budget "looks like a positive $800 million a year," said ISI analysts. "On that basis, the company needs another $3.3 billion of asset sales to balance its 2012 math at the midpoint. With a package of assets including its Permian Basin interests already up for sale and worth perhaps north of $8 billion, Chesapeake's sums look easier to solve. But its work is still far from done. It will have to pay someone else now to use those pipelines. And these sales fly completely in the face of the company's previous vertical integration strategy.

Meanwhile, in a landmark agreement reached on Thursday a drilling unit of Chesapeake agreed to allow more than 4,400 New York landowners locked into natural gas leases the opportunity to renegotiate their contracts, said New York Attorney General Eric T. Schneiderman. Chesapeake Appalachia LLC also agreed to reimburse the state $250,000 for the costs of the investigation.

Chesapeake came to agreement with New York law enforcement officials that landowners with leases that were extended as a result of the New York Department of Environmental Conservation's (DEC) environmental review into high-volume hydraulic fracturing (fracking) had the right to negotiate leases with other natural gas operators for more favorable environmental or financial terms. The agreement follows a lawsuit that Chesapeake Appalachia lost last year when the U.S. District Court for the Northern District of New York found that even if producers were prevented from fracking wells in the state because of the environmental review they were required to pay property owners to hold the leases (see NGI, April 11, 2011).

Chesapeake agreed under the terms of the state settlement to either match other operators' terms or release the landowners' original leases, including leases that have expired or would expire before Dec. 31, 2013. Under terms of the settlement with Schneiderman's office Chesapeake may not use the DEC's fracking review to extend any leases expiring after Dec. 31, 2013, and is to release leases that have been extended using only the term extension where a blank has been left for the negotiated factor. Some of the contracts had blanks in them where a monetary amount should have been.

All other landowners, except those extended by a term extension provision, with leases having expired, or expiring by Dec. 31, 2013, have the right to negotiate bona fide offers from other companies. Chesapeake then would either match the new offer or release the lien. Chesapeake still may extend leases that have a term extension provision if it does not contain any blanks and the leases have not yet expired.

Chesapeake also is required to make quarterly reports to New York Attorney General's office on the number of leases it has renewed, matched and released including the 50 leases to be released outright (8,604 acres); 4,365 leases subject to being matched (255,579 acres); and 1,865 leases with an option to be extended (96,524 acres).

Three years ago Chesapeake officials sent letters notifying New York lease owners whose terms were set to expire that the company was electing to extend those leases. "In these letters Chesapeake adopted the position that it could not perform any exploration and development operations for shale wells until the DEC completed preparing a supplemental generic environmental impact statement (SGEIS) for high-volume hydraulic fracturing," Schneiderman said, referring to the SGEIS that the state is preparing (see NGI, Dec. 20, 2010; July 28, 2008).

At that time Chesapeake officials "informed landowners that their leases contained provisions that allowed the company to extend the terms under force majeure, purported force majeure and 'covenants' clauses and/or other common law rights based on the principles of force majeure." The force majeure clause exempted the contracting parties from fulfilling their obligations for causes that could not be anticipated. Agreements that were made under Chesapeake's force majeure contract claims were released under the settlement.

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