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By John Kemp
LONDON, Jan 31 (Reuters) - Shareholders must be hoping theremoval of Aubrey McClendon as Chesapeake's chief executive willend the corporate governance discount attached to the company'sshare price and unlock superior returns. They are likely to bedisappointed.
Removing McClendon does not the resolve the company's basicproblem: it is the second-largest producer in a market (U.S.natural gas) which has been transformed by the advent of a newtechnology (hydraulic fracturing) and now faces years ofoversupply as well as a radical change in the cost of productionwhich has left many old assets stranded and devalued.
Shareholder activists like Carl Icahn have focused ongovernance issues. But even a quick look at the performance ofChesapeake's share price compared with the price of themain product it produces shows the company has been felled bythe drop in natural gas prices rather than governanceproblems.
TRACKING GAS PRICES DOWN
Chesapeake's shares have broadly tracked changes in gasprices and peers like Devon Energy where no governanceproblems have been alleged ().
Chesapeake's shares rose sharply following the announcementof McClendon's departure. Chesapeake is up by about 20 percentsince the recent low on Jan 10, more than the 7 percent increasein Devon's share price over the same period.
But it hardly qualifies as a "surge". Chesapeake's shareprice is still down 7 percent compared with the same time lastyear, about the same as Devon's 11 percent loss. Both companieshave seen their share prices fall by 30-35 percent over the lasttwo years. Natural gas prices have dropped around a quarter overthe same period.
Icahn has been generous in his praise following McClendon'sdecision to quit the company, but like other activists he nowneeds to accentuate the positive: he owns a large number of thecompany's shares.
"Aubrey has every right to be proud of the company he hasbuilt, the world class team of people at Chesapeake and thecollection of assets he has assembled, which in my opinion arethe best portfolio of energy assets in the country," Icahn saidin a statement released on Tuesday.
"While it is known that some of these assets will be sold bythe company in due course, I do not believe that this will inany way effect the ultimate realisation of Chesapeake'spotential. I am confident that history will prove Aubrey hasbeen correct about the value of natural gas in general and thevalue of Chesapeake in particular."
History is unlikely to prove any such thing. Chesapeake doesindeed have fantastic assets. But their value has beendrastically changed by the shale revolution. Chesapeake's newchief executive will confront the same problem as hispredecessor.
STRANDED ASSET PORTFOLIO
Like Exxon, which bought XTO in 2010, and Shell, whichbought East Resources in 2010, Chesapeake's strategy wasdesigned for a world where gas prices averaged $6 or $8 permillion British thermal units in the long-term.
Under McClendon, Chesapeake failed to fully understand theimplications of all its competitors investing in the same newtechnology, leading to a dramatic reduction in the industry'scost of production and a massive amount of oversupply. It thenassumed it had the balance-sheet strength and guts to ridethrough the slump while low prices forced others to shutproduction and abandon their own expansion plans.
In the end, shareholders ran out of patience.
Turfing out the chief executive is satisfying, probably anecessary act of expiation. Perhaps it will allow for a changeof narrative. But it does not alter the fundamental value of thecompany.
Chesapeake's great assets (in terms of their potential forgas production) are not necessarily worth much in a market setto remain oversupplied for at least the next couple of years andpossibly longer. The way the market values gas resources hasprofoundly changed.
The company will try to sell some of its acreage, but no onewill pay much, especially since many of Chesapeake's leases arefor gas-rich and liquids-rich plays rather than oil ones. Thecompany will need to offer discounts if it wants to offload asubstantial number.
Chesapeake (for the acreage it retains) or a buyer (for theacreage it sells) will then be left with the same strategyMcClendon had: waiting for an eventual upturn in demand or theconstruction of a string of LNG export terminals to relieveoversupply and force prices higher.
The first LNG export terminals will take at least 3-4 yearsto build even if they are approved by the Department of Energy.A big boost in domestic demand is even further away.
FELLED BY TECHNOLOGY
Chesapeake can conserve cash by cutting its drillingprogramme further. But then its output will quickly decline andthere is no guarantee others will cut back enough to boostprices.
Slashing the drilling programme and conserving cash does notchange the fact the company has a portfolio of assets it boughton the assumption gas prices would be much higher than they aretoday and are likely to remain for the foreseeable future.
The world has changed, permanently vaporising a large amountof Chesapeake's value, which the company is unlikely ever torecapture.
Chesapeake is not alone. Similar value-destruction hasoccurred at Exxon and Shell, but has gone unnoticed because theyare large diversified companies with much greater exposureoutside the United States and to oil rather than gas.
In July 2012, BP took a two-part writedown of $2.1billion on U.S. shale gas assets, which had been hit by theslump in prices.
A few days later, BHP Billiton took a $2.8 billion writedownon some of its U.S. shale gas acreage -- ironically assets ithad bought from Chesapeake 18 months previously for $4.75billion.
Removing McClendon does not change the basic problems withthe company's operating environment or the value of its assetportfolio.
Chesapeake and McClendon are the victims of technology and astrategic blunder rather than governance -- Joseph Schumpeter'sprocess of "creative destruction" in action.
