Decision Making at Chesapeake Energy Corporation

Chesapeake Energy Corporation is founded by Aubrey K. McClendon and Tom L. Ward with an initial $50,000 investment.

Chesapeake completed its IPO at a split-adjusted price of $1.33 per share that valued the Company at $70 million and reduced McClendon’s and Ward’s common stock ownership position to just under 60% from 100%.

Chesapeake drilled a major deep gas discovery at Navasota River in the deep portion of the Giddings Field in Texas. During the period 1994-1996, Chesapeake and its industry partners located almost two trillion cubic feet of new gas reserves using state-of-the-art horizontal drilling technology in the deep and highly pressured Austin Chalk formation in Giddings. As the Company’s production and reserves grew dramatically, so did the Company’s common stock price. During this three-year period, the stock price increased from $0.47 per share to $34.44 per share, making Chesapeake the number one performing stock in the U.S. during that three-year period.

1995 – The Company moved from the NASDAQ to the NYSE, joining the majority of its energy-producing peers. Unfortunately, the Company’s, and the industry’s, significant investment to extend the successful Austin Chalk trend from Texas into central Louisiana proved disappointing. Higher drilling costs, unanticipated geological and engineering challenges and dramatic declines in oil and gas prices led to substantial write downs of the Company’s assets. Faced with the need to overhaul the Company’s strategy and asset base, McClendon and Ward decided that it was time to return to their roots in Oklahoma as Mid-Continent natural gas producers. They believed that U.S. natural gas prices would significantly increase in value in the years ahead, and that the Mid-Continent was a region ripe for consolidation and for the application of leading-edge deep-drilling and natural gas exploration techniques.

1997 — The Company started drilling for natural gas in Mid-Continent using the strategy of employing significant operating scale in a limited number of operating areas. By achieving this scale they are able to achieve higher per unit revenues, lower per unit operating costs, improved rates of drilling success, and in general higher returns from drilling investments. As a result of disappointing drilling results in the areas of Louisiana outside of Masters Creek, it refocused its Louisiana Austin Chalk Trend drilling program into the Masters Creek area. It also acquired two Oklahoma City-based independent oil and gas producers that owned total proven reserves of approximately 160 billion cubic feet equivalent (Bcfe) of natural gas equivalent for $193 million. These reserves are approximately 70% proved developed and will increase the Company’s proven reserves by approximately 40%. Excluding the $17 million of pipeline and marketing assets, Chesapeake’s acquisition price was approximately $1.10 per million cubic feet equivalent (Mcfe). These acquisitions established a new core area of operations for Chesapeake in the Anadarko Basin of western Oklahoma and significantly increased the Company’s inventory of drilling opportunities. They also purchased Hugoton Energy Corporation has approximately 300 billion cubic feet of gas equivalent of proved reserves which together with Chesapeake’s proved reserves of 580 Bcfe will give Chesapeake total reserves of approximately 880 Bcfe.

1998 — The Company began a strategy of consolidating onshore U.S. natural gas assets. The success of Chesapeake’s repositioning from 1998 though today resulted in becoming the nation’s fourth-largest independent natural gas producer. They also began the process of building shareholder equity through a combination of earnings, and issuance of common and preferred equity. The Company entered into an alliance with Calgary-based Ranger Oil Company to jointly develop a 3.2 million acre area of mutual interest in the Helmet, Midwinter, and Peggo areas, and purchased the Mid-Continent properties of privately owned Enervest Management Company, L.C. For $38 million. The properties include approximately 40 Bcfe of proven reserves and are expected to produce approximately 4.5 Bcfe in 1998.

The strategy of targeting the Mid-Continent region was prompted by several factors. Multi-pay geological targets resulted in decreased drilling risk with an overall average success rate of 92% during the past fifteen years. There is also a lack of almost any federal land in the area, facilitating exploration by reducing environmental restrictions. The decline curves of the properties in this area are also very predictable. Because the gas reserves in this region are in accessible areas, the costs of drilling are reduced in comparison with drilling in more remote areas.

1999 — Chesapeake acquired the Chitwood Field in southern Oklahoma and completed its initial exploratory well in the field. Chesapeake paid privately owned Ward Petroleum Corporation $34.8 million to acquire an estimated 61 billion cubic feet of proved natural gas equivalent reserves.

2000 — The Company acquired estimated proved reserves of 33 billion cubic feet of natural gas in Oklahoma’s Arkoma Basin in three transactions for total consideration of $22 million. They also acquired Gothic Energy Corporation’s common stock in exchange for four million shares of Chesapeake’s common stock.

2001 — The Company acquired three Mid-Continent gas acquisitions that will increase its proved reserves by 240 Bcfe and its production by 45,000 Mcfe per day.

2002 — Chesapeake acquired the 4.5 million shares of fully diluted Canaan Energy Corporation common stock not already owned by Chesapeake for $18.00 per share in cash. They announced a significant gas discovery at Comanche Lodge in the Greater Mayfield Area of Western Oklahoma’s Anadarko Basin, and acquired $300 million of Mid-Continent gas assets through an acquisition of a wholly owned subsidiary of Tulsa-based ONEOK, Inc.

2003 — Chesapeake acquired 25% of Pioneer Drilling, and certain assets of wholly owned subsidiaries of ONEOK, Inc., El Paso Corporation, and Vintage Petroleum, Inc. They also acquired $530 million of Mid-Continent natural gas assets in two transactions. From El Paso Corporation, Chesapeake is acquired an estimated 328 billion cubic feet of gas equivalent of proved gas reserves. They also acquired of $220 million of Mid-Continent gas assets through its acquisition of privately owned Oxley Petroleum Company, and $510 million of Mid-Continent, Permian Basin and onshore Gulf Coast oil and natural gas assets through agreements to acquire privately-owned Concho Resources Inc.

2004 — The Company acquired $100 million of Mid-Continent, Permian Basin and Texas Gulf Coast oil and natural gas assets in four separate transactions. Through these agreements, Chesapeake anticipates acquiring an internally estimated 68 billion cubic feet of gas equivalent proved reserves. They also acquired natural gas assets in the Ark-La-Tex region of northern Louisiana through the $425 million acquisition of the equity interests of Houston-based, privately-held Greystone Petroleum LLC, Hallwood Energy Corporation’s 18,000 acre North Block property in Johnson County, Texas for $277 million in cash, and Tulsa-based privately-held BRG Petroleum Corporation and related partnerships for $325 million in cash. By the end of this year, the Company had completed a seven-year period in which it acquired $4.5 billion of proven properties at an estimated cost of $1.18 per Mcfe of proven reserves.

Chesapeake has achieved a 96% success rate for both operated and non-operated wells through December 31, 2004. This extraordinary success is a result of years of prudent acquisition of valuable assets. It was accomplished by a series of acquisitions that either increased ownership in existing wells or added additional locations in the Mid-Continent area. The strategy has been to seek out small companies with valuable assets in need of capital infusion to solve liquidity problems. It has also targeted larger companies that were seeking to divest non-core assets.

2005 — Recently, the Company entered into four independent agreements with private sellers of oil and natural gas assets located in South Texas, East Texas and the Permian Basin for an aggregate of $686.4 million in cash. Through these transactions, Chesapeake anticipated acquiring an internally estimated 566 billion cubic feet of natural gas equivalent.

Conclusion

One problem the Company has had over the last few years has been a class action on behalf of purchasers of the common stock between January 25, 1996 and June 27, 1997. It was alleged that in 1995 and 1996, Chesapeake reported that it had acquired leasehold rights to drill and explore for deep oil and natural gas deposits in geological formations underlying more than one million acres of Louisiana land, known generally as the “Louisiana Trend.” Throughout this period, it was alleged, the Company told investors, securities analysts, and the financial press that it was enjoying tremendous success in its exploration and drilling activities in the Louisiana Trend. The plaintiffs alleged that Chesapeake’s stock traded at artificially inflated levels throughout the period as a result of defendants’ constant barrage of announcements of alleged oil and gas strikes. During the period, the Company’s stock (when adjusted for stock splits) traded as high as $34 1/8 per share and no lower than $12 1/16 per share. The truth was not revealed to the market until June 27, 1997, when the Company suddenly announced that it would “refocus” its drilling in just a small parcel of the Louisiana Trend, and for the first time conceded that the rest of that land was not productive. As a result, the Company said it would take a charge against earnings of $l50 to $200 million, and its capital expenditure budget would significantly decrease for the next two to three years. The foregoing was expected to lead to reduced production and revenue growth in those years, compared to previous projections. This announcement caused the Company’s stock to decline 25% in one day on trading volume of over 8 million shares, more than ten times the Company’s average daily volume. While the investing public was stunned by this announcement, the Company’s insiders do not appear to have been. Many of them sold significant portions of their own personal holdings in Chesapeake’s stock throughout this period at prices that were artificially inflated.

This complaint was dismissed on March 3, 2000 in favor of the Company. The Court found that throughout the alleged class period, Chesapeake had disclosed to its investors the precise risks associated with its investments and activities in the Louisiana Trend. The court also determined that the plaintiffs had provided no factual support for their allegations of misstatements or omissions by Chesapeake. In spite of the court victory for Chesapeake, the fact that Company insiders sold during this period, does not look appropriate.

Other than this legal challenge, it does not appear that Chesapeake has done much wrong over the last fifteen years. Rising from nothing, it has become one of the preeminent energy companies in the U.S. It developed a strategy of seeking reserves in an area that it knew well and stuck to that strategy. The Company looked for targets of opportunity, but did not overbuy.

On the financial side, Chesapeake started a program on improving the balance sheet by seeking equity capital. Between 1998 and 2005, they increased their shareholders equity by $3.4 billion. This gave them the capital resources to pursue acquisitions and acquire gas-producing properties. The Company has always operated on the basis of keeping costs under control, minimizing lease operating costs and general and administrative expenses. They have effective cost control programs in place and look for economies of scale. Their goal in the future is to increase overall production by ten to twenty percent per year and grow the internal assets by ten percent. This should bode well for them in the future with the tight supplies of natural gas and recent price increases.