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An Old Ghost Comes Back to Haunt Chesapeake Energy Corporation

By Matthew DiLallo - Mar 2, 2016 at 12:05PM

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The hits just keep coming as the natural gas driller just can’t seem to get out from underneath its troubled legacy.

Image source: Encana Corporation. All rights reserved.

While the shale drilling boom might still be gasping for air amid a devastating plunge in oil and gas prices, the land rush that preceded it has been dead for a few years now. It's a bubble that burst after natural gas prices peaked and subsequently crashed, leaving companies like Chesapeake Energy (CHKA.Q) with more land than they could ever afford to drill. That being said, while the land rush has long since been deceased, its ghost continues to haunt Chesapeake Energy. That's after a new revelation this week that its former CEO, Aubrey McClendon, has been indicted by the Justice Department for his alleged role in trying to suppress land lease prices.

The mastermind
According to the Justice Department, McClendon masterminded a conspiracy with another large oil and gas company to not bid against each other for leases in Oklahoma from 2007 to 2012. In doing so, he and his yet unnamed co-conspirator decided ahead of time who would win the bids and then gave an interest in the leases to the other company. That kept them from bidding against each other, thus keeping a lid on lease prices. According to Assistant Attorney General Bill Baer of the Justice Department's Antitrust Division, McClendon's "actions put company profits ahead of the interests of leaseholders entitled to competitive bids for oil and gas rights on their land."

It's a very serious charge because it puts him in violation of the Sherman Act, which carries a maximum penalty of 10 years in prison and a $1 million fine. That said, it's important to note that the indictment is against McClendon and not Chesapeake Energy, which doesn't expect to face criminal prosecution or fines, according to a the company spokesman. Still, the whole ordeal is another black eye for the company, which continues to be haunted by McClendon's past actions.

A pattern of haunting actions
This isn't the first time Chesapeake Energy nor McClendon have been accused of antitrust violations stemming from aggressive leasing practices. Just last year, the company reached a $25 million settlement after the state of Michigan brought antitrust, fraud, and racketeering charges against it. In that case, it pleaded no contest to charges that it and Encana (OVV 10.37%) discussed dividing up their bids for leases in Michigan to avoid driving up lease prices. Encana, likewise, settled by agreeing to pay $5 million in a civil settlement in 2014 to close its involvement.

On top of that, Chesapeake Energy has been settling a myriad of lawsuits stemming from alleged miscalculation of royalty payments to landowners who have gas wells on their properties. For example, in Texas it settled a number of cases, including one with the city of Fort Worth, whereby Chesapeake Energy allegedly breached contracts, resulting in $33.5 million in damages. Meanwhile, in another lawsuit in that area, the company owed at least $8.6 million to several land owners, including a school, due to improper royalty calculations. There are similar claims in Pennsylvania, Texas, and Ohio, where Chesapeake allegedly miscalculated the price of gas sold at wellheads and then wrongly deducted expenses, including those paid to Chesapeake affiliates, resulting in lower royalty payments for landowners. In fact, last year more than 400 lawsuits, involving 25,000 property owners, were consolidated into a massive case with upward of $1 billion in unpaid royalties potentially at stake.

Investor takeaway
While it has been a few years since McClendon walked the halls of Chesapeake Energy's corporate headquarters, his past actions are still haunting the company today. The company is devoting quite a bit of its time dealing with his past dealings, including his liberal use of large sums of debt to grow itself. That debt, as well as the legal overhang, won't stop spooking the company until it can finally bury its past by settling these lawsuits and paring its debt to a more manageable level. That said, both are getting much harder to do in the current environment, which is increasing the odds that Chesapeake Energy could suffer the same fate of the leasing boom and go bust.

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