Decision Making at Chesapeake Energy Corporation

Founding and Early Growth

Chesapeake Energy Corporation was founded by Aubrey K. McClendon and Tom L. Ward with an initial $50,000 investment. The company completed its IPO at a split-adjusted price of $1.33 per share, valuing the company at $70 million and reducing McClendon's and Ward's combined common stock ownership from 100% to just under 60%.

Chesapeake drilled a major deep gas discovery at Navasota River in the deep portion of the Giddings Field in Texas. During the period 1994–1996, Chesapeake and its industry partners located almost two trillion cubic feet of new gas reserves using state-of-the-art horizontal drilling technology in the deep and highly pressured Austin Chalk formation in Giddings. As the company's production and reserves grew dramatically, so did its common stock price. During this three-year period, the stock price increased from $0.47 per share to $34.44 per share, making Chesapeake the number one performing stock in the United States during that period.

In 1995, the company moved from the NASDAQ to the NYSE, joining the majority of its energy-producing peers.

Austin Chalk Expansion and Strategic Pivot

Unfortunately, the company's — and the industry's — significant investment to extend the successful Austin Chalk trend from Texas into central Louisiana proved disappointing. Higher drilling costs, unanticipated geological and engineering challenges, and dramatic declines in oil and gas prices led to substantial write-downs of the company's assets.

Faced with the need to overhaul its strategy and asset base, McClendon and Ward decided it was time to return to their roots in Oklahoma as Mid-Continent natural gas producers. They believed that U.S. natural gas prices would significantly increase in the years ahead, and that the Mid-Continent was a region ripe for consolidation and for the application of leading-edge deep-drilling and natural gas exploration techniques.

In 1997, the company started drilling for natural gas in the Mid-Continent using a strategy of employing significant operating scale in a limited number of operating areas. By achieving this scale, Chesapeake was able to attain higher per-unit revenues, lower per-unit operating costs, improved rates of drilling success, and generally higher returns from drilling investments. As a result of disappointing drilling results in areas of Louisiana outside of Masters Creek, it refocused its Louisiana Austin Chalk Trend drilling program into the Masters Creek area.

That same year, Chesapeake also acquired two Oklahoma City-based independent oil and gas producers that owned total proved reserves of approximately 160 billion cubic feet equivalent (Bcfe) of natural gas for $193 million. These reserves were approximately 70% proved developed and increased the company's proved reserves by approximately 40%. Excluding $17 million of pipeline and marketing assets, Chesapeake's acquisition price was approximately $1.10 per million cubic feet equivalent (Mcfe). These acquisitions established a new core area of operations in the Anadarko Basin of western Oklahoma and significantly increased the company's inventory of drilling opportunities. Chesapeake also purchased Hugoton Energy Corporation, which held approximately 300 Bcfe of proved gas reserves; combined with Chesapeake's existing proved reserves of 580 Bcfe, this gave the company total reserves of approximately 880 Bcfe.

Mid-Continent Acquisition Strategy

In 1998, the company began a strategy of consolidating onshore U.S. natural gas assets. The success of Chesapeake's repositioning from 1998 onward resulted in the company becoming the nation's fourth-largest independent natural gas producer. The company also began building shareholder equity through a combination of earnings and the issuance of common and preferred equity.

Chesapeake entered into an alliance with Calgary-based Ranger Oil Company to jointly develop a 3.2 million-acre area of mutual interest in the Helmet, Midwinter, and Peggo areas, and purchased the Mid-Continent properties of privately owned Enervest Management Company, L.C. for $38 million. Those properties included approximately 40 Bcfe of proved reserves and were expected to produce approximately 4.5 Bcfe in 1998.

The strategy of targeting the Mid-Continent region was prompted by several factors. Multi-pay geological targets resulted in decreased drilling risk, with an overall average success rate of 92% during the preceding fifteen years. The region also had almost no federal land, which facilitated exploration by reducing environmental restrictions. The decline curves of properties in the area were also very predictable. Because the gas reserves in this region are located in accessible areas, drilling costs are lower than in more remote locations.

Chesapeake's acquisition strategy focused on seeking out small companies with valuable assets in need of capital infusion to solve liquidity problems, as well as larger companies seeking to divest non-core assets. By the end of 2004, the company had achieved a 96% success rate for both operated and non-operated wells — an extraordinary result reflecting years of prudent asset acquisition.