The End of Country

by Seamus McGraw

  Six months earlier, none of this would have mattered to either of us. Our mother wasn’t starving—that was certain—but she wasn’t rich, either, and if one of the lederhosened woodcutter figurines in one of her clocks were to turn ax-murderer, her estate would have fallen safely below the estate tax threshold. But now, things were entirely different. If anything was to happen to our mother now, or in the near future, the Internal Revenue Service would value her land, the farm, at a rate based on its market value as a gas-producing entity and would demand taxes on 45 percent of its estimated worth. Considering the value of the lease she had signed, and the rising estimates of the amount of gas beneath it, and considering the fact that if and when it started producing, the IRS would demand payment based on the amount of money that it might produce over its thirty-or-more-year lifetime, that could mean that my sister and I would have to come up with a million or more dollars before we ever saw a red cent from the drilling.

  There were ways around it, of course. All of them were over my mother’s head, which naturally meant that it would be up to my sister and me to come up with the right strategy. There was no doubt that we would. This kind of finance was my sister’s forte, and as a reporter, I had the skills to do whatever research would be necessary. I assured my sister of that. “I know,” she said. “We’ll be fine.” But I also knew that a lot of those people I’d been thinking about when I wrote that line about “hitting the lottery” would not. There was a damned good chance, and there still is, that a generation from now, they’ll lose everything as a direct result of their good fortune.

  What’s more, other forces were working on those fortunes as well.

  GEOLOGISTS WILL TELL YOU that the vast, shallow, and long-buried sea that gave birth to the Marcellus Shale so many millions of years ago was big enough to create its own weather. Economists will tell you that it still is.

  It proved that in the fall of 2008.

  It was around that time, of course, that the whole precarious house of cards that was the U.S. economy was teetering on the brink of collapse, about to be brought down by the weight of its own avarice. Banks and insurance firms, manufacturers and consumers, had all been leveraging themselves with debt beyond reason, debt secured by nothing more substantial than the largely unquestioned belief that housing prices—the shaky foundation supporting it all—would continue to rise. At the top of the financial food chain, a cabal of clever money men had found a way to hedge their bets, developing convoluted financial instruments to pass along the risk, secure in the knowledge that other people would always be willing to beggar themselves to bet on the American dream, and that it would be those people’s ass on the line if the whole scheme blew up. It was a sucker’s bet, of course. Beginning in the spring of 2008, the bet started to unravel, and by the fall, everyone in the country, it seemed, had simultaneously begun to realize that it had all been an elaborate and largely unregulated game of three card monte. The black queen had been a joker all along.

  But by that point, it was too late. Many of the most prestigious names seemed headed for extinction. Bank of America, Citigroup, even AIG, companies that were deemed too big to fail, were failing, and the federal government pumped more than a trillion dollars into the banking industry in a frantic effort to keep it from going under and taking everything else with it as it sank. And as the country’s unemployment rate soared, as its factories scaled back, and consumers of everything started learning for the first time in their lives how to do without, demand for oil and natural gas, commodities that only weeks earlier had been trading at record highs, plummeted.

  By September, both oil and natural gas were trading at half their July averages. I assumed this would at least delay Chesapeake’s efforts to drill on my mother’s land. But what I didn’t know was that the very economic collapse that threatened virtually every other industry in the nation, together with tightening credit and dwindling returns that in fact had even forced the oil and gas industry to dramatically cut back operations elsewhere in the country, actually made the Marcellus Play, particularly in Pennsylvania, hotter than it had ever been.

  To understand why, it’s critical to understand the way drillers think. In a way, they’re like heroin addicts: the only way they know how to deal with good times is to drill another well, the only way they know how to deal with bad times is to drill another well, and as soon as the warm glow of a new gas well hits a driller’s bloodstream, he’s off looking for another hit. They tie off chunks of land with leases, and like a junkie tapping his forearm with two fingers to raise a vein, they send out their thumper trucks to bang the ground or place seismic charges on fields so they can measure the sound waves and see where the thickest, richest shale might lie. And when they find it, they jab a 120-foot needle in the ground and get another taste.

  That’s not to say there weren’t a few desperate weeks for the drillers. In those first critical days in late summer and early fall of 2008, when the markets collapsed, the big gas and oil companies appeared stunned as their stock prices plummeted to levels not seen since the recession of 2001. Billions of dollars of market capitalization vanished overnight. No one felt that more acutely than Aubrey McClendon of the Chesapeake Energy Corporation.

  McClendon, a flamboyant, theatrical former history major and the scion of one of Oklahoma’s oldest oil industry families, had already fought his way back once from the brink of extinction. He had founded the company on a shoestring in the late 1980s, and it was, for a time, one of the most actively traded stocks in the market, but when the market went south in the mid-1990s, so did McClendon’s fortunes. His company was a billion dollars in debt, and you could buy a share of its stock for the price of a pack of gum. Most reasonable people at that point would have thrown in the towel.

  The historian in McClendon recognized the value of the shales in Texas and in Louisiana early on, and the fact that the first natural gas wells ever harnessed in America had been those early wells in Fredonia, New York, appealed to his sense of symmetry. He clearly recognized the chance not only to cut a few deals, but to lead the charge. It took him a couple of years, but by the time the Haynesville Shale play in Louisiana was up and running, Chesapeake was at the front of the pack, controlling more of it than virtually any other player. And when the Marcellus land rush took off, McClendon made it his personal crusade to control more land in the nascent play than anyone else. In fact, if you talk to most of the other drillers who have staked claims in the Marcellus, virtually to a man, they insist that the high-rolling McClendon was almost as responsible as the impecunious geologist Terry Engelder for the stunningly high lease prices that were being paid in places like Susquehanna and Wyoming counties.

  At the time, of course, it made perfect sense. Drilling companies are valued in the stock market not just by their revenues but by their holdings—the amount of reserves, proven, probable, and possible, that they control. As McClendon amassed the largest chunk of land in the four leading shale plays—the Barnett in Texas, the Fayetteville, the Haynesville, and of course the Marcellus—the stock market stood up and applauded. At least, it would have applauded if it hadn’t been throwing cash at Chesapeake with both hands. Shares of the company, which had been trading at about $50.90 in April 2008, had reached the dizzying height of $73.50 on July 2, an increase of nearly 50 percent.

  With his penchant for showmanship, McClendon, already known for his swagger, became even more visible as the face of the new gas industry. He spent lavishly on television commercials that ran on cable networks nationwide touting natural gas as the energy of the future, and he even went so far as to begin building a specialized television network that would promote natural gas. He lobbied Washington for legislation that would expand the market for natural gas, he promoted it as a potential replacement for foreign oil as a motor fuel, and, to the consternation of coal state lawmakers, he pressed for its increased use as a fuel for power plants.

  McClendon was so confident that Chesapeake’s stock, just like those of hi
s nearest competitors, would continue to rise that he personally plunked down $10 million and borrowed from his broker to rack up more than 33 million shares of Chesapeake stock. And then, on October 10, 2008, the bubble burst. McClendon’s broker called in his note—a margin call—when Chesapeake stock hit $16.52, and McClendon had to sell nearly all his shares. It is estimated that in that single day, Aubrey McClendon lost nearly $2 billion.

  If Chesapeake’s CEO was the most visible casualty of the gas industry implosion, he was not the only one. Almost across the board, major gas companies saw their stock prices in free fall—almost 80 percent of their market value had evaporated. Wall Street mavens who just a few weeks earlier had been hawking the shares the way the early residents of Titusville had been selling bottled oil as an elixir now couldn’t get rid of the stuff fast enough.

  It took a while for the smoke to clear. Corporate executives from all the majors spent a few tense days reassuring their boards and their shareholders, and they promised that they’d do all the things corporate executives normally do when there’s a problem. Yes, they would cut expenses, cut them to the bone. They’d stop buying leases, or at least dramatically reduce the number of leases they signed and the price they paid for them. In fact, in those rare places where the occasional lease was signed, they weren’t offering $2,500 an acre, they were offering $500, if that. And they’d also shut down rigs. In fact, by the late winter of 2009, the number of rigs operating in the United States declined by 45 percent, the steepest drop in seven years. The number of exploratory wells had dipped from 1,606 in September, before the fall, to 884 in early March, according to a report by Bloomberg.

  But despite what they told their boards, drillers, being drillers, knew that tinkering with their capital expenditure budgets wasn’t the answer to their problems. Drillers know only one way to fix a problem, even one as calamitous as the apparent implosion of their industry. Drillers drill.

  The only question was where. There was no debating that wherever the drillers concentrated their efforts, it had to be a shale play. There was no longer even much of a question that the unconventional plays were the future. The Barnett was largely developed; in fact, there were growing rumblings that it might soon be reaching its peak, and the Fayetteville and Haynesville shales, while both promising, had one significant drawback: they were too far from the most lucrative market for natural gas, the Eastern Seaboard.

  But the Marcellus was a different animal. There was already a basic infrastructure in place. There were already natural gas pipelines, for example, that cut right along the heart of what had emerged as the two sweet spots in the Marcellus play, the area around Pittsburgh where Range had first staked its claim and where other firms such as Atlas were now actively drilling, and the area around Dimock where Cabot was active. The drillers already had large holdings in the area, and many of them, at least those who had hit the fields before Chesapeake, had paid comparatively little to acquire their leases. Overhead was low. Yes, it could cost $3 million to drill a well, but that was a pittance compared to what that well could generate. According to industry analysts, it cost some of the drillers as little as a dollar to produce a thousand cubic feet of gas in the Marcellus, a fraction of what it cost elsewhere. What’s more, gas shipped from there to the hubs on the East Coast would, because of the intense demand, automatically be worth 10 percent more than gas that was shipped elsewhere. In short, the Marcellus was like a gift from above to the drillers. As Jeffrey Ventura, the president of Range, had put it while talking to energy reporters at the depth of the economic trough, “The best play in the United States economically right now is the Marcellus. It has the best rate of return. You can spend $3 million to drill a well and get 3 million cubic feet a day in gas … and you’re doing that in a basin that gets a premium from NYMEX.”

  But that had not been obvious at first. At that stage of the game, in the fall of 2008, the Marcellus was still largely a theory. Only a comparative handful of wells had been drilled, and by and large, the gas companies kept the production data on those wells very, very close to the vest. There was at best only scattered and anecdotal information available, and no one had yet bothered to collect it and analyze it, at least not publicly.

  At least not until Terry Engelder, who stood no chance at all of getting rich from the Marcellus, stumbled across a staggering new set of numbers. And like almost everything else in the long history of the Marcellus, it happened by accident.

  TO THOSE WHO KNOW HIM, really know him, there has never been any question that for all the dreams of wealth, for all the fantasies about new pickups and tractors that his relentless barnstorming on behalf of the Marcellus had helped conjure, the one guy who never seemed to be in it for the money was Terry Engelder.

  It’s not that he didn’t have a shot at becoming rich. He did. In the months that followed the release of his initial calculations on the Marcellus, Engelder became a much sought after speaker. He was invited to shareholder meetings of all the major oil and gas companies in Houston and beyond, and his office became a mecca for vice presidents from every business and organization that stood to gain from the exploitation of the Marcellus Shale. It wasn’t entirely his idea. The university had essentially drafted Engelder to be its point man with the media and with the industry; they had even relieved him of most of his teaching duties for the year so he could focus exclusively on positioning the university as the academic research center for the entire Marcellus Play. In that role, he became the go-to guy for just about everybody in the country—everybody in the world—who wanted information about the potential of the play.

  Engelder kept a detailed log of all those visits, and he collected the business cards of honchos from as far away as Denmark and China who had come seeking his advice. The log, a handwritten journal, reads like a who’s who of the energy industry and the financial industry that it supports. Exxon, Devon, Chesapeake, and T. Boone Pickens’s own Mesa Power are on the list. You might think that he kept such a detailed list just because he’s a scientist and scientists do such things. Maybe that did play a part in it. But the real reason he did it was because years ago, the old wildcatter Karney Cochran had told him to. “When you go into a room, always come out being the guy who knows the most people,” Cochran had told him. Engelder, it seemed, knew everybody.

  And more than one of those big shots offered Engelder a job, in part because they thought he’d lend a veneer of academic sophistication to what had always been a kind of rough-and-tumble business, but even more because they figured Engelder would know where the best gas was. “I’ve had more than one person in effect walk into the office and put down a stack of money that was worth two, three, four million and say if you work for us exclusively, this is what we’ll do for you,” Engelder confided to me during one of our numerous chats. One company—he refused to name it—went so far as to offer him 1 percent of the royalties on every well they drilled in the Marcellus, an offer that could have brought him tens of millions of dollars.

  It was tempting, he admitted. “It’s a very interesting thing, because very few people actually have the opportunity to have that kind of money just put right in front of them. You learn something about yourself.” What he learned, he said, was that what he really valued was his ability to serve as a guide to the Marcellus, perhaps to point others toward riches, but mostly to make his mark as a geologist in much the same way that his friend Walter Alvarez had thirty years earlier. Engelder’s proclamations and predictions were news, and the more he made them, the more newsworthy they became because Engelder was making them. “You realize that this is a unique opportunity that I’ve been given,” he said, then smiled a bit as he added, “I don’t think any other geologist in this decade, or geologist ever, has been in this position.”

  It was still all terribly unreal to him, though. A natural raconteur, or at least someone who fancied himself one, Engelder had embraced the challenge with his typical gusto, despite the fact that after thirty years spent lecturing t
o groggy students at Penn State at eight in the morning, he had come to assume that virtually nobody was paying attention. Even after news of his initial calculations about the Marcellus had made international headlines, after he found himself appearing on radio talk shows and quoted in major newspapers, he still had a hard time believing that anyone was listening.

  He’d be flattered, of course, when some industry analyst pumped him for information about the potential of one area of the Marcellus versus another, or when some landowner asked his advice on whether to sign a lease, but for the most part, he figured that most of what he said, whether it be from a podium or when he was buttonholed after stepping from the stage, was likely to be forgotten. His last speech, in Texas, had certainly been forgettable.

  As he waited to board the plane that afternoon for Pittsburgh, Engelder desperately tried to think of something to make his next speech less tedious. He was poring over notes from various lectures he’d attended when he came upon something from a conference in June. Executives from Exco Resources, Inc., one of the companies drilling the Marcellus, had mentioned that they were now calculating, based on their initial production rates at a few wells, that reserves of gas in their part of the Marcellus were larger than expected. At first, Engelder hadn’t put much stock in that. It was anecdotal, and as he well knew, reserves can vary widely from place to place even in a single formation. It was interesting, of course, and it might make a good starting point for his talk. He had some time to kill, so he decided to dig a bit deeper. He flipped open his laptop and plumbed the depths of Range Resources’ most recent quarterly statement, and he found that Range had made the same claim. In fact, the numbers were almost identical. Just for laughs, Engelder took a look at the numbers Chesapeake had released at a shareholder meeting a few weeks earlier, and again, the numbers were higher than anything Engelder had predicted. Chesapeake’s findings suggested that there could be anywhere between three and five times as much gas per square mile as they had originally expected to find. If that held true throughout the 51,000 square miles in the play, it could turn out to be a significant number. Engelder did a quick back-of-the-envelope calculation. With such scant data available—he was, after all, looking at the results from only a handful of wells—it would be impossible to draw any hard-and-fast conclusions. But the way Engelder figured it, the analysts gathered for the conference might be moderately interested in the little parlor game he was playing. Besides, after three months or so of relentlessly bad news on virtually every aspect of the industry, they might be pleased to see that there was at least a glimmer of hope somewhere. He had no idea how right he was.