Chesapeake Energy

With natural gas prices falling fast, Chesapeake Energy Corporation (NYSE:CHK) is caught between a rock and a hard place with respect to its huge $2 billion acquisition of lease rights to over a million acres of Ohio land.  The huge bet that these lands, known as the Utica Shale fields, could turn into oil producing money-spinners is now in question due to Chesapeake’s own cash crunch.

The leases to these lands contain a provision that Chesapeake Energy Corporation must drill wells by certain deadlines. Failure to do so would cause the company to lose the right to the properties. Chesapeake Energy Corporation is allegedly strong-arming land-owners to accept modification in the terms of the leases that would allow it to drill fewer wells, yet retain property rights.

The problem: the oil wells would cost a humongous amount of money if drilled in the numbers envisaged in these lease documents. It works this way. Properties are organized in groups known as ‘units’ and Chesapeake must drill at least one well on each unit. Chesapeake does not appear to have the cash for this.

Chesapeake’s solution, according to a report in the WSJ: Organize the leases into larger units, thereby reducing the number of wells to be drilled, yet allowing the company to retain its leaseholding rights.

This is why Chesapeake is re-arranging lease terms in the Ohio leases. Unfortunately, the move further reinforces the company’s reputation for reneging on, or changing lease terms – it faces over a 100 suits across the country as enraged landowners allege breach of contract by Chesapeake.

Though it does not deny its action in Ohio, Chesapeake has some pretty powerful arguments in favour of it. For one, bigger units imply that each land-owner’s stake in oil production would be lower, but the potential exists to share in a larger number of wells. Secondly, according to Chesapeake, a lot of the leases were entered long ago, and are out of sync with the latest drilling technology for extracting from shale rock. “Our objective is to employ the unit size that takes full advantage of breakthroughs in technology, and creates efficiencies in the use of capital,” said Michael Kehs, a Chesapeake spokesman. The company also claims that larger units improve the chances of landowners getting to share in a successful well.

However, on the flip side, some landowners who refused to toe the company’s line, allege that agents warned of their properties turning into a “hole in the map” unless they agreed to the changes. These landowners have taken Chesapeake to court to cancel the leases.