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Category — Chesapeake Energy

McClendon’s Price Lesson at Chesapeake (“Depletable” resources expand)

“[Free energy] markets tend not only to clear, but to clear faster and at lower prices than anticipated.”

The resignation of Aubrey McClendon as CEO of Chesapeake Energy provides a good case to study in corporate strategic planning. Ignoring his financial side deals, for which he has received a good share of criticism, the wisdom of his primary strategy, the aggressive pursuit of shale resources, is an open question to many. Although he has been hailed as a pioneer and risk taker, clearly those risks have gone bad and should be examined.

Higher Prices: A Bad Bet

The core failing was his decision to bet the firm (essentially) on high natural gas prices. From 1997 to 2005, wellhead prices had increased from $3/Mcf to $8/Mcf (2010$), the highest level historically. This, combined with a neo-Malthusian mentality, convinced him and many others that prices would not be mean-reverting, but remain at levels from two to three times the historical average.

In nearly my entire working career, energy executives have complained that prices for energy were too low for them to successfully invest. At one energy economics conference, the moaning about inadequate prices was so frequent that the award winner for contributions to the profession, Richard Gordon of Pennsylvania State University, reminded the audience that markets tend not only to clear, but to clear faster and at lower prices than anticipated.

In a more practical sense, there is a tendency to ignore the fact that mineral and energy prices are both cyclical and mean-reverting, despite being “finite” and thus “running out.” Numerous market analysts have been criticized for excessive bullishness about prices in the past decade, but many have correctly described the situation as one of cyclical behavior, not of a permanent shift to a high price environment. [Read more →]

February 28, 2013   1 Comment