Saudi America

The Truth About Fracking and How It's Changing the World

Bethany McLean

• Publisher: Columbia Global Reports
• Year: 2018
• ISBN:
  9780999745458
• Topic: Business
• Subtopic: Energy Industry
• Index: Business

"A sharp portrait of the US shale revolution." -- Financial Times Bestselling author Bethany McLean reveals the true story of fracking's impact -- on Wall Street, the economy and geopolitics. The technology of fracking in shale rock -- particularly in the Permian Basin in Texas -- has transformed America into the world's top producer of both oil and natural gas. The U.S. is expected to be "energy independent" and a "net exporter" in less than a decade, a move that will upend global politics, destabilize Saudi Arabia, crush Russia's chokehold over Europe, and finally bolster American power again.Or will it?Investigative journalist Bethany McLean digs deep into the cycles of boom and bust that have plagued the American oil industry for the past decade, from the financial wizardry and mysterious death of fracking pioneer Aubrey McClendon, to the investors who are questioning the very economics of shale itself. McLean finds that fracking is a business built on attracting ever-more gigantic amounts of capital investment, while promises of huge returns have yet to bear out. Saudi America tells a remarkable story that will persuade you to think about the power of oil in a new way.

Shale Revolution

Part One

America’s Most Reckless Billionaire

His death, like his legacy, was a hotly contested subject. On March 2, 2016, just after 9:00 a.m., Aubrey McClendon slammed his Chevrolet Tahoe SUV into a concrete viaduct under a bridge on Midwest Boulevard in Oklahoma City, dying instantly. He was speeding, wasn’t wearing a seatbelt, and didn’t appear to make any effort to avoid the collision.

Just one day earlier, a federal grand jury had indicted McClendon for violating antitrust laws during his time as the CEO of Chesapeake Energy. Investigators ultimately ruled it an accident, but rumors of suicide persist to this day. As Captain Paco Balderrama of the Oklahoma City Police told the press, “We may never know one-hundred percent what happened.”

In the fall of 2008, Forbes had ranked McClendon number 134 on its list of the 400 richest Americans, with an estimated net worth of over $3 billion. But because he borrowed so much money, and secured business loans with personal guarantees, two years after his death, lawyers were still wrangling over the remains of his estate, trying to figure out which debts would be paid—from the $500,000 he owed the Boy Scouts of America to the $465 million he owed a group of Wall Street creditors, including Goldman Sachs. Wall Street’s vultures—hedge funds that invest in distressed debt—had descended, buying the debt for less than 50 cents on the dollar, essentially rendering a judgment that the claims wouldn’t be paid in full.

If McClendon did die broke, it wouldn’t have been out of character. During his years as an oil and gas tycoon, he fed on risk, and was as fearless as he was reckless. He built an empire that at one point produced more gas than any American company except ExxonMobil. Once, when an investor asked on a conference call, “When is enough?” McClendon answered bluntly: “I can’t get enough.”

Many think that without McClendon’s salesmanship and his astonishing ability to woo investors, the world would be a far different place today. Stories abound about how at industry conferences, executives from oil majors like Exxon would find themselves speaking to mostly empty seats, while people literally fought for space in the room where McClendon was holding forth.

“In retrospect, it was kind of like Camelot,” says Henry Hood, Chesapeake’s former general counsel, who worked at Chesapeake initially as a consultant from 1993 until the spring of 2013. “There was a period of time that will never be duplicated with a company that will never be duplicated.”

“Aubrey was a very curious person, and that single trait led him to succeed,” says Marc Rowland, who got to know McClendon in the early 1980s and served as Cheseapeake’s CFO from 1992 to 2010. “A lot of people are driven and smart, but they lack curiosity. Aubrey had that in spades.”

Many people have a far less favorable opinion of McClendon. “Aubrey is irrelevant,” one oil executive tells me. “If you want to tell the American success story, you’ll ignore him. If you want to tell the sad story, write about him.”

Some of his peers, along with some on Wall Street, considered him a buffoon, a con man of sorts, and maybe even a fraud. “He was a catalyst and a visionary, sure, but he tried to kiss all the girls,” says one old-time oil man. “He was a whirling dervish.” “America’s Most Reckless Billionaire,” Forbes once called McClendon, and for many in the industry, that headline defined the man.

But if it was a con, he was conning himself, too. Because he believed.

He was, in many ways, the embodiment of a transformation that has changed the face of not just the oil and gas industries but of geopolitics as well. The contradictions and questions in McClendon’s story continue to reverberate across the industry he did so much to create. You might think of McClendon as a bit of J. R. Ewing, the fictional character in the television series Dallas, mixed with Michael Milken, the junk bond king who pioneered an industry and arguably changed the world, but spent several years in prison after pleading guilty to securities fraud. Over and over, I heard the same refrain: “Aubrey epitomizes everything we’re talking about.”

Unlike many others who come from nothing and make their fortunes in the oil patch, McClendon, who was born on July 14, 1959 in Oklahoma City, was oil industry royalty. His great uncle was the Oklahoma governor and senator who in 1929 co-founded Kerr-McGee, which was the ExxonMobil of its time. McClendon, who was always immensely popular, was the president and co-valedictorian of his senior class. He headed to Duke, where he was the rush chairman of his fraternity. “Athletes and non-athletes, party boys and geniuses,” is how he described those years to a Duke University publication. “It was a collection of good guys from across the nation. We studied hard, we played hard.” “He was super competitive and aggressive,” recalls someone who knew him at Duke. “If he had a few drinks, he’d want to wrestle. He was big and strong and a little bit out of control.”

At Duke, McClendon met the woman who would become his wife, Whirlpool heiress Kathleen Upton Byrns. Her cousin, Fred Upton, has served as a Republican congressman from Michigan since 1987. As chairman of the Committee on Energy and Commerce, Upton was a key defender of fracking.

In college, he also met Hood, who recalls a driven if rambunctious young man. “Aubrey was thoughtful, tall, and handsome, but incredibly clumsy,” Hood recalls. “He always had an ink stain on his shirt from the pen in his front pocket. We called him ‘Aubspill,’ because he was always spilling. In basketball, he was always throwing elbows like a bull in a china shop.” Another variation of the nickname, Hood recalls, was “‘Aubkill,’ because McClendon’s outsized competitive instinct made him dangerous in physical activities.”

McClendon thought about being an accountant until, during his senior year, he came across an article in the Wall Street Journal. “It was about two guys who had drilled a big well in the Anadarko Basin that had blown out, and it was alleged to be the biggest blowout in the history of the country,” McClendon told Rolling Stone. “They sold their stake to Washington Gas and Light and got a $100 million check. I thought, ‘These are two dudes who just drilled a well and it happened to hit.’ So that really piqued my interest.”

Three years before McClendon was born, the iconoclast geologist M. King Hubbert first outlined his ideas on peak oil. Essentially, the idea was that since the amount of oil is finite, production will follow a bell curve, and after peaking, it will inevitably decrease. Time seemed to prove Hubbert right. American oil production peaked in 1970 at 9.6 million barrels a day and began a steady, seemingly inexorable decline.

For the U.S., it was a profound role reversal. Until the 1970s, American oil and swaggering Texas oil barons ruled the world. The Texas Railroad Commission controlled the international price of oil by allowing a certain amount of production, and maintaining spare capacity. But in 1972, as U.S. production slowed, Texas had to start producing flat out. “This is a damn historic occasion and a sad occasion,” the Texas Railroad Commission’s chairman declared. The following year OPEC, which had been created by Iran, Iraq, Saudi Arabia, and Venezuela in 1960, began to flex its new muscles. OPEC declared an oil embargo during the Yom Kippur war against all of Israel’s allies, including the United States. Oil prices quadrupled.

The disruption of oil sent Americans in search of other energy sources. Yet oil, which is primarily used for transportation (passenger cars today account for about half our daily consumption), has the benefit of being relatively easy to ship around the world. Natural gas, on the other hand, is used primarily for heating and in power plants and manufacturing. It cannot easily be shipped. One must construct liquefaction plants in order to freeze the gas into liquid form, and then build “regasification” plants to turn the LNG back into gas, all of which costs billions of dollars. And in the 1970s, the scarcity of gas was a major concern too. Congress effectively kept the U.S. from building gas-fired power plants in favor of coal in 1978. The government also launched a partnership between the Energy Department and dozens of companies and universities called Eastern Gas Shales Project, which aimed to figure out how to recover natural gas from shale deposits. And in 1980, Congress passed the Crude Oil Windfall Tax Credit Act, which provided tax credits to “qualified unconventional gas wells.” By “unconventional,” they meant drilling in areas, like the shale rock, that had not been drilled before.

When McClendon graduated from Duke in 1981, everyone said oil prices would only go higher. But prices defied the prognosticators and began to crater, thanks to a global economic recession and a tidal wave of new supply from United Kingdom’s North Sea, Alaska’s North Slope, and Mexico. OPEC cut its production in an effort to boost the price, but with the onslaught of new supplies, all that happened was that Saudi Arabia lost market share. In 1985, Saudi Arabia gave up and unleashed production, and the price tumbled further.

Not incidentally, that was also the last gasp of truly spectacular American oil riches. In the early 1980s, drilling in Texas, in particular, had rebounded as prices shot higher. It was the era of J. R. Ewing-style conspicuous consumption. Midland, Texas even boasted its own Rolls Royce dealership. But as the price of a barrel of crude slid, real estate cratered and banks went under. Occidental Petroleum bought Iowa Beef Processors, and Gulf Oil considered buying the Barnum and Bailey Circus. Oil had become a grungy, dreary business. It was desperate days.

But McClendon was never one to be deterred. He thought there was opportunity in assembling packages of drilling rights—for gas, not oil—either to be sold to bigger companies or to be drilled. In the mere existence of that opportunity, America is almost unique, because it is one of the few countries where private citizens, rather than governments, own the mineral rights under their properties. In order to drill, you just have to persuade someone to give you a lease. McClendon became what’s known in the oil and gas business as a land man, the person who negotiates the leases that allow for drilling.

That, it turned out, would make him the perfect person for the new world of fracking, which is not so much about finding the single gusher as it is about assembling the rights to drill multiple wells. “Landmen were always the stepchild of the industry,” he later told Rolling Stone. “Geologists and engineers were the important guys—but it dawned on me pretty early that all their fancy ideas aren’t worth very much if we don’t have a lease. If you’ve got the lease and I don’t, you win.”

In 1983, when McClendon was just twenty-four years old, he partnered with another Oklahoman named Tom Ward, “doing deals for scraps of land in Oklahoma, faxing each other in the middle of the night,” Ward later told Rolling Stone. Six years later, the two thirty-somethings formed Chesapeake Energy, which was named after the beloved bay where McClendon’s family vacationed. They seeded it with a $50,000 investment.

In some ways, they were an odd couple. Bespectacled and balding, Ward came across as more of a typical businessman, whereas McClendon, with his flowing hair and Hollywood good looks, was the dynamo of the duo. They divided the responsibilities, with McClendon happily playing the front man, raising money, and talking to the markets, while Ward stayed in the background running the business. They operated out of separate buildings, with separate staffs. Much later, one observer recalls that when the two would go to Oklahoma City Thunder basketball games, their blocks of seats were on opposite sides of the arena, and they never sat together.

Neither Ward nor McClendon were technological pioneers. That distinction, most people agree, goes to a man named George Mitchell, who drew on research done by the government to experiment on the Barnett Shale, an area of tight rock in the Fort Worth basin of North Texas. Using a combination of horizontal drilling and hydraulic fracturing, Mitchell’s team cracked the code for getting gas out of rock that was thought to be impermeable.

The few people who were paying attention to what Mitchell was doing were far from convinced that it would succeed. Giants like Exxon were selling off their U.S. properties to the small independent companies and going international. “At the time, we dismissed shale because ExxonMobil told us it would cost $125 a barrel to get it out and would never work,” says Jeff Currie, the global head of commodities research at Goldman Sachs.

McClendon, however, was the pioneer in the other essential part of the business: raising money. “As oxygen is to life, capital is to the oil and gas business,” says Andrew Wilmot, a Dallas-based mergers and acquisitions adviser to the oil and gas industry at Purposed Ventures. “This industry needs capital to fire on all cylinders, and the founder and father of raising capital for shale in the U.S. is Aubrey McClendon.” “To be able to borrow money for ten years and ride out boom and bust cycles was almost as important an insight as horizontal drilling,” McClendon, with typical immodesty, later told Rolling Stone. “I never let Aubrey McClendon in the door for a meeting,” says an analyst who works for a big investment firm. “Because we would have bought a ton of stock and it would not have ended well. He was that good.”

In the early 1990s, Bear Stearns helped Chesapeake sell high-yield debt in a first-of-its-kind sort of deal. This was no small achievement. After all, Chesapeake didn’t have much of a track record, and there was less than zero interest in the oil and gas business from the investment community. “I watched him convince people in these meetings,” says a banker who was there. “He was so good, so sharp, with such an ability to draw people in.”

On February 12, 1993—a day McClendon would later describe as the best one of his career—he and Ward took Chesapeake public. They did so despite the fact that their accounting firm, Arthur Andersen, had issued a “going concern” warning, meaning its bean-counters worried that Chesapeake might go out of business. So McClendon and Ward simply switched accounting firms. “Tom and I were thirty-three-year-old land men at the time, and most people didn’t think we had a clue of what we were doing, and probably in hindsight they were at least partially right,” McClendon told one interviewer in 2006. The IPO reduced their ownership stake to 60 percent, but both men kept for themselves an important perk, one that would play a key role in the Chesapeake story: They got the right to take a personal 2.5 percent stake in every well Chesapeake drilled. In the years following its IPO, Chesapeake was one of the best-performing stock on Wall Street, climbing from $0.47 per share to $34.44 per share.

The story that drew in investors was set in a place called the Austin Chalk, which McClendon made sound almost magical—never mind that the Texas Monthly had once called it the “most perverse, contrary, incorrigible oil field known to man.” Its limestone straddles the border between Texas and Louisiana, and while everyone knew that oil was there, the rock wasn’t porous enough to get it out.

Then in 1994, a company called Occidental drilled a hugely successful horizontal well there. Mitchell hadn’t yet done his pioneering work, but Occidental showed that horizontal drilling could allow companies to extract vast quantities of gas economically in a way that hadn’t previously been possible.

McClendon went all in. Chesapeake leased more than a million acres of the Austin Chalk, and McClendon told the Oil & Gas Journal that the location could be “the largest onshore play in the country.” He projected that Chesapeake’s production of gas would grow by 50 percent a year. As the stock soared and Chesapeake issued ever more optimistic press releases, Chesapeake sold approximately $1 billion worth of equity and debt, according to a lawsuit that was later filed. On April 2, 1997, a press relea...