Should You Fear the Skeleton Lurking in Chesapeake Energy’s Closet?

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Photo credit: Copyright © Encana Corporation. All rights reserved.  

On Wednesday, the state of Michigan charged Chesapeake Energy (NYSE: CHK  ) and Encana (NYSE: ECA  ) with colluding to keep oil and gas lease prices artificially low in the state. These charges which have penalties that could include prison terms for individuals and up to a million dollar fine for the companies adds a new layer of risk to an investment thesis in Chesapeake Energy. The question is if this unknown and another still to be uncovered is something to be feared by investors.

History lesson
The case against Chesapeake and Encana dates back to 2010 when the oil and gas leasing boom hit Michigan. Both companies were interested in securing drilling rights to the Collingwood Shale region and according to the state colluded to avoid paying risings prices for leases with landowners. The land rush in the state had pushed lease prices to as high as $3,000 per acre by the middle of 2010, however, soon thereafter lease prices began to plunge.

While both companies deny collusion, the two did hold talks about forming a joint venture in the state that year. While no joint venture agreement was reached, emails surfaced from high-ranking executives at both companies that discussed ways to avoid "bidding each other up" according to an investigation by Reuters. If its true that these two companies did engage in anti-competitive practices it opens up a whole other layer of legal issues.

Photo credit: Copyright © Encana Corporation. All rights reserved.  

The skeleton
In addition to the charges brought forth by the state of Michigan, Chesapeake Energy and Encana both could face federal charges under the Sherman Antitrust Act. Penalties for violating it are severe. Criminal penalties of up to $100 million can be levied on a corporation found in violation of this law. However, under federal law the maximum fine can be increased to twice the amount the conspirators' gain from illegal acts or twice the money lost by victims of the crime if either of those amounts are over $100 million. Because of this there is a risk that these companies could be forced to pay out stiff penalties in the future if found guilty. Needless to say, that unknown is a big risk facing investors.

While both companies are hoping for a civil resolution to the matter, it might not be that easy. The other issue is the fact that the U.S. Department of Justice is looking at more than just the leases in Michigan. Chesapeake Energy was engaged in an aggressive land grab that saw it spend billions of dollars to lock up millions of acres across the U.S. As a leader in the land grab the company will be at the forefront of any future action taken by the government on leasing issues. One of the problems is the perception out there that the company as well as its competitors didn't use the most ethical approach when securing its leases.

Photo credit: Chesapeake Energy 

The movie Promised Land, for example, tells the fictional story of a drilling company's pursuit of drilling leases in a small town. While that company doesn't collude with a competitor, it does use less than ethical means to sway public opinion so that it's easier for the company to secure the drilling rights. This perception of loose ethics within the oil and gas industry is really what's at the core of the collusion charges against Chesapeake Energy and Encana. The wildcat mentality of landsmen and drilling executives could come back to haunt the industry if its found that these companies went too far when locking up leasing rights. 

Investor takeaway
The charges levied against Chesapeake Energy and Encana are pretty serious and could have a financial impact before all is said and done. In addition to the potential financial consequences there is always the possibility of additional penalties such as being barred from signing new leases for a period of time, for example, could be levied. That said, given that the land rush in America is largely over it's unlikely that any negative outcome such as that will have a significant long-term impact on either company's ability to grow. So, while this legal matter is something investors need to keep an eye on as it adds a big new risk it's not yet a reason to sell.

The energy boom has OPEC on edge

Shale drilling is revolutionizing America's energy future. But, its not your best way to profit from the energy boom. Instead, imagine a company that rents a very specific and valuable piece of machinery for $41,000... per hour (that's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click HERE to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable LANDSLIDE of profits!

Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2867975, ~/Articles/ArticleHandler.aspx, 8/28/2015 11:09:37 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Matt DiLallo

Matthew is a Senior Energy and Materials Specialist with The Motley Fool. He graduated from the Liberty University with a degree in Biblical Studies and a Masters of Business Administration. You can follow him on Twitter for the latest news and analysis of the energy and materials industries:

Today's Market

updated 1 hour ago Sponsored by:
DOW 16,643.01 -11.76 -0.07%
S&P 500 1,988.87 1.21 0.06%
NASD 4,828.33 15.62 0.32%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/28/2015 4:00 PM
CHK $7.39 Up +0.37 +5.27%
Chesapeake Energy CAPS Rating: ****
ECA $7.08 Up +0.23 +3.36%
EnCana Corp (USA) CAPS Rating: ***