Follow the Money Before You Lose Yours (Part I)
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It’s scary to realize that what’s here today could truly be gone tomorrow. Accidents and disasters happen for no rhyme or reason, leaving behind lives that need mending. While you can’t completely prevent their affects, you can at least for the most part protect yourself by taking certain steps beforehand.
The same is true for those non-accidents out there. Unfortunately there are those that would do you harm if given the chance, maybe not physically but financially. For whatever reason, the pursuit of the almighty dollar can lead some to do crazy things.
Sometimes it’s understandable; they have a family to feed or feel an insurmountable pressure to relieve some financial strain. Other times, however, you’re left scratching your head and asking why. Warren Buffett once quipped that there are those out there who, “To make money they didn’t have and didn’t need, ... risked what they did have and did need. And that’s foolish. It’s just plain foolish. If you risk something that important to you for something that is unimportant to you, it just does not make any sense”
Few industries are untarnished by those who went too far to make money not worth the risks they took to get there. We typically learn of them after the bubble burst and we watch as the pieces are being picked up by those who didn’t see the signs. The recent boom and subsequent bust of the natural gas industry is but one of a long line of examples where the drive for “more” was never met with the satisfaction of “enough.”
In a recent NY Times article, “After the Boom in Natural Gas,” the authors highlight several examples of drillers who got in over their heads in striving for more. The poster child for the great gas rush is Aubrey McClendon, CEO of Chesapeake Energy (NYSE: CHK). In the NY Times article they detail what they called a “cash and carry” type of deal, which was both innovative and aggressive.
In one such deal with Plains Exploration (NYSE: PXP), they paid Chesapeake $1.7 billion for ownership of about a third of the drilling rights Chesapeake had in the Haynesville. In addition, Plains would pay out another $1.7 billion to cover half of Chesapeake’s drilling costs. What it amounted to was flipping gas leases, as Chesapeake spent about $7,100 an acre to lease the land and flipped it to Plains for what amounted to $30,000 an acre, according to the article.
Fast forward a few years later, and Plains is looking to unload their stake in order to fund their deal to buy some of BP’s (NYSE: BP) oil assets in the Gulf of Mexico. They’re hoping to get between $1.5 and $2 billion for this and another non-core and non-operated low margin gas asset. After getting burned from the Chesapeake deal, in which they bought high and are now selling low, they’ve turned the tables and are now buying low from BP as they need to shed assets to pay for their previous Gulf of Mexico woes.
Plains isn’t the only company that got burned as the gas bubble burst. The article also mentions the misfortunes of Exco (NYSE: XCO), who in following Chesapeake’s lead signed their own cash and carry deal with BG Group. In the $1.3 billion deal Exco received $655 million up front while PG agreed to pay 75 percent of the future drilling costs. Under the terms of the deal, Exco was required to keep drilling no matter what the cost.
I personally met with Exco employees at their Marcellus headquarters, and it was interesting to hear their perspective of the marriage with BG Group. One of the partners wanted to get involved in the community and be an active marketer of the benefits that drilling was bringing to the region, while the other was more focused on safety and wanted to maintain a low profile. The organization I work for was seeking to have Exco educate business leaders about all the jobs the industry was bringing to the community, an offer they eventually declined.
At one point we thought they would emerge as a good community partner, but in the end all those jobs ended up falling by the wayside. While Exco was forced to keep drilling at all costs, another operator, Talisman (NYSE: TLM), pulled out of the region completely.
Without leases that were years from expiring and no joint venture partner or other financial agreements forcing them to drill, Talisman could shift all of their focus to higher return areas. In this case, they switched their focus to their liquids-rich Eagle Ford acres. While none of the companies mentioned have been unscathed, both Talisman and Plains have been better than Chesapeake and Exco as you can see from this chart:
Energy investors need to know what the company they are investing in has gotten themselves into when they enter into these joint venture and other exotic agreements. Be vigilant of those companies that are striving for growth at all costs, because those costs can blow up if trends begin to reverse. In the second part of this series, dig a little deeper into this subject by following what fellow blogger Bob Zimmerman has discovered as he’s followed the drill bit. Following the money is the most important thing investors can do to ensure that disaster doesn’t befall their portfolios.
latimerburned has no positions in the stocks mentioned above. The Motley Fool has the following options: long JAN 2013 $16.00 calls on Chesapeake Energy, short JAN 2014 $15.00 puts on Chesapeake Energy, long JAN 2014 $20.00 calls on Chesapeake Energy, and long JAN 2014 $30.00 calls on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.