Author: Mark Holder, Stone Fox Capital
Covestor model: Opportunistic Arbitrage
Disclosure: No position in stocks mentioned
Forbes has a fascinating story about Chesapeake Energy CEO Aubrey McClendon. His risk taking has made Chesapeake Energy (NYSE: CHK) into the second biggest producer of natural gas in the US and the largest land owner in the prolific shale plays in the US.
His level of risk taking has, however, made investors shy away from the stock. Reading the detailed Forbes article makes a normal investor’s head spin. All the joint ventures, hedging, VPPs, and oil services make it very complex for an investor to understand the risks involved in an investment which could depress the stock in the future.
As skeptics point out, this all sounds eerily close to Enron – though that’s probably not fair. CHK is just the opposite from Enron, in fact, as it is actually hedging and selling production it owns. Building up land positions in shale areas and selling a portion for a profit is very smart. It sure beats the majors sitting around and missing the opportunity completely.
What actually scares me is that McClendon appears a lot more like WorldCom’s Bernie Ebbers. Always wheeling and dealing, whether within the business or outside via farmland, wine, or art. As a WorldCom employee who lived through the rise and fall of Bernie, the similarities are stark. The ultimate similarity was the willingness to take a huge risk on buying the company’s stock with borrowed money. Both seemed to think the business can grow forever – so much so that they don’t know when to stop. Why any billionaire would take such risks is beyond me.
McClendon has become so successful that he is forcing natural gas prices too depressed levels in the US. Sure that can spur demand, but at what price and when? CHK has all these leases to drill now and demand might be years away. Has CHK just pushed up acreage prices while pushing down natural gas prices? If it finds another natural gas shale play should it pounce on the opportunity or just keep it quiet hoping to buy cheaper later. After all, it isn’t likely that gas pries rise until 2013 or 2014.
What’s so great about the Marcellus Shale at $3.5 natural gas? It can’t be shipped to foreign markets to collect much higher prices and nat gas apparently is abundant now. The liquid plays like the Eagle Ford shale and potentially the Utica shale hold immense value now. In my opinion, CHK should’ve kept all the Eagle Ford assets and avoid a partner in the Utica shale as oil prices are likely to stay high for a long time as the global demand for oil increases.
Read the article for now. The stock, on the other hand, needs more research. CHK is a fascinating story on value creation, but the riskiness of the assets are concerning. Ultimately the success of McClendon might be his undoing as demand might never grow with the supply creation. This is a potentially bad situation for a risk taker being ahead of the market.
