In a natural gas glut, big winners and losers

Gas companies are committed to spending far more to produce gas than they can earn selling it.

The crew of workers fought off the blistering Louisiana sun, jerking their wrenches to tighten the fat hoses that would connect their cement trucks to the Chesapeake Energy drill rig – one of the last two rigs the company is still using to drill for natural gas here in the Haynesville Shale.

At its peak, Chesapeake ran 38 rigs in the region. All told, it has sunk more than 1,200 wells into the Haynesville, a gas-rich vein of dense rock that straddles Louisiana and Texas.

Fed by a gold-rush mentality and easy money from Wall Street, Chesapeake and its competitors have done the same in other shale fields from Oklahoma to Pennsylvania.

For most of the country, the result has been cheaper energy. The nation is awash in so much natural gas that electric utilities, which burn the fuel in many generating plants, have curbed rate increases and switched more capacity to gas from coal, a dirtier fossil fuel.

Companies and municipalities are deploying thousands of new gas-powered trucks and buses, curbing noxious diesel fumes and reducing the nation’s reliance on imported oil.
And companies like fertiliser and chemical-makers, which use gas as a raw material, are suddenly finding that the United States is an attractive place to put new factories, compared with, say, Asia, where gas is four times the price.

Dow Chemical, which uses natural gas as a material for producing plastics, has assembled a list of 91 new manufacturing projects, representing $70 billion in potential investment and up to 3 million jobs, that various companies have proposed or begun because of cheap gas.

“The country has stumbled into a windfall on the backs of these entrepreneurs,” said Edward Hirs, a finance professor at the University of Houston who contributed to a report that estimated that the nation’s economy benefited by more than $100 billion last year alone from the lower gas prices.

But while the gas rush has benefited most Americans, it’s been a money loser so far for many of the gas exploration companies and their tens of thousands of investors.
The drillers punched so many holes and extracted so much gas through hydraulic fracturing that they have driven the price of natural gas to near-record lows.

And because of the intricate financial deals and leasing arrangements that many of them struck during the boom, they were unable to pull their foot off the accelerator fast enough to avoid a crash in the price of natural gas, which is down more than 60 per cent since the summer of 2008.

Although the bankers made a lot of money from the dealmaking and a handful of energy companies made fortunes by exiting at the market’s peak, most of the industry has been bloodied – forced to sell assets, take huge write-offs and shift as many drill rigs as possible from gas exploration to oil, whose price has held up much better.

Rex W Tillerson, the chief executive of Exxon Mobil, which spent $41 billion to buy XTO Energy, a giant natural gas company, in 2010, when gas prices were almost double what they are today, minced no words about the industry’s plight during an appearance in New York this summer. “We are all losing our shirts today,” Tillerson said. “We’re making no money. It’s all in the red.”

Boom and bust

Like the recent credit bubble, the boom and bust in gas were driven in large part by tens of billions of dollars in creative financing engineered by investment banks like Goldman Sachs, Barclays and Jefferies & Co.

After the financial crisis, the natural gas rush was one of the few major profit centers for Wall Street dealmakers, who found willing takers among energy companies and foreign financial investors.

Big companies like Chesapeake and lesser-known outfits like Quicksilver Resources and Exco Resources were able to supercharge their growth with the global financing, transforming the face of energy in this country.

In all, the top 50 oil and gas companies raised and spent an annual average of $126 billion over the last six years on drilling, land acquisition and other capital costs within the United States, double their capital spending as of 2005, according to an analysis by Ernst & Young. Now the gas companies are committed to spending far more to produce gas than they can earn selling it. Their stock prices and debt ratings have been hammered.

“We just killed more meat than we could drag back to the cave and eat,” said Maynard Holt, co-president of Tudor Pickering Holt & Co., a Houston investment bank that has handled dozens of shale deals in the last four years. “Now we have a problem.”
Aubrey K McClendon, chief executive of Chesapeake Energy, had a secret, and he was anxious to share it.

He called Ralph Eads III, a fraternity buddy from Duke who had become his go-to banker. McClendon explained that he had quietly acquired leases on hundreds of thousands of acres somewhere in the southern United States – he would not say exactly where – that could become one of the world’s biggest natural gas fields. But to develop the wells, he needed billions of dollars.

Chesapeake’s stock price sank this year after it was revealed that McClendon had taken a personal stake in Chesapeake wells and then used those investments as collateral for up to $1.1 billion in loans used mostly to pay for his share of the cost of drilling those wells. The company is trying to raise $14 billion this year by shedding assets, a goal it has almost reached with huge recent sales of West Texas oil and gas fields and pipelines to Royal Dutch Shell and Chevron.

To help the company through this difficult patch, McClendon turned to his old friend, Eads. Jefferies & Co., joined by Goldman Sachs, offered Chesapeake an emergency $4 billion unsecured bridge loan, at 8.5 per cent interest, to give the company a lifeline until it could sell enough assets to keep afloat. (The company says it intends to pay back the entire loan this year from recent sales.)

In hindsight, it should have been clear to everyone that a bust was likely to occur, with so many new wells being drilled and so much money financing them.
But everyone was too busy working out new deals to pay much heed.

The bust has certainly hit Haynesville hard. Some local landowners, having spent their initial lease bonuses, are now deeply in debt. Local restaurants and other businesses are suffering steep losses now that so many drillers have left town.

“At this point we’re struggling,” said Shelby Spurlock, co-owner of Cafe 171 in the town of Mansfield. The restaurant is decorated with wall collages of drill worker uniforms from companies that are leaving the area. Once open from 4 am to 10 pm and employing four servers, the restaurant has cut its hours and is down to two servers.

“Our very existence is in danger,” she sighed. Eads, ever the dealmaker, is unfazed. He tells anyone who will listen that the price of natural gas will eventually recover. He is making money, meanwhile, helping struggling companies and opportunistic investors strike deals at the new, lower prices.

“These shale assets are forever,” he said. “They are going to produce for a hundred years.”