Thirteen years ago, Aubrey McClendon: and Tom Ward took their Oklahoma City-based Chesapeake Energy Corp. public, and their Austin Chalk natural gas story took off. They were 33 years old, and the company became a Wall Street darling, after an initial stutter. By 1996, however, the stock price found $34 a share and Chesapeake's total equity capitalization was some $2.5 billion.

Well, like the Austin Chalk production figures, the gas story had a half-life. In 1999, shares of the company were barely fetching $1; its equity capitalization was some $50 million and it was carrying almost $1 billion of debt; and dividends on preferred shares were in deferment.

McClendon: and Ward needed a new plan. Their solution: rebalance the company to longer-life natural gas plays; drill and buy as much natural gas as possible; and mitigate as many financial risks as possible.

Today, the company is the No. 4 owner of proved U.S. natural gas reserves, holding 8.1 trillion cubic feet (Tcf), and its unproved reserves total some 14 trillion cubic feet. It is No. 6 in U.S. natural gas production: some 1.6 billion cubic feet equivalent per day. Its total net U.S. leasehold is 9.7 million acres. And, at press time, it had 101 rigs at work for it.

Shares were trading at $32 in late July, and total enterprise value was some $24 billion.

Here, McClendon: tells Oil and Gas Investor: about his best and worst moments in the oil and gas business to date; what work life is like without Ward, who recently left Chesapeake to lead another U.S. independent producer, Riata Energy Inc.; and why Chesapeake shares are a good buy even in an under-$8 gas-price environment.

Investor: You've expanded in the past few years outside of Oklahoma into South Texas, the Permian Basin, the Barnett and Fayetteville shales, North Louisiana and Appalachia. Are any other areas in the U.S. interesting to you?

McClendon: No, we're really happy with the footprint we have now- the onshore U.S. east of the Rockies. There's a lot of gas left to be found in this area. If you take out the Rockies and the Gulf of Mexico, we're still playing in an area that is the source of 70% or 75% of U.S. natural gas.

Investor: You don't want to operate in the Rockies. Is it because of the poor netbacks?

McClendon: That's certainly part of it. Also, I like to drill wells where people want us to drill wells. In the Rockies, a lot of people don't want you to drill wells.

In 1999 and 2000, when Tom and I were reinventing the company's strategy, we either had to focus on the Rockies or Midcontinent. We have always believed gas prices would be relatively lower in the Rockies because it is the most distant supply basin from the Midwest and East Coast markets, so we thought it would always suffer from lower wellhead prices and higher costs. We chose to focus on the Midcontinent instead.

There's a lot of gas to be found in the Rockies, no doubt about it, but it's hard to get it out, it's expensive to get it out and you don't get rewarded as much financially when you do find it, compared with the price you get for gas east of the Rockies.

Investor: And you are definitely not interested in assets abroad?

McClendon: Correct. We are actually very parochial folks-"simple people doing simple things" has long been my motto. So for us, producing gas onshore in the U.S. east of the Rockies is the best way to generate attractive returns.

Investor: Why do you win so many of the best properties that are on the market-oftentimes before they're on the market?

McClendon: There are at least two reasons why we've tended to be competitive on property acquisitions during the past six or seven years. We're pretty good at identifying upside on properties. We've always had a grow-through-the-drillbit culture here, so what's separated us from others is that we identify the upside and we're willing to pay for it-we know we can drill it. That's the first advantage-the identification and quick monetization of that upside.

The second advantage is that we were pretty early to the realization that gas prices, and probably oil prices, had to go higher after the 1999 collapse. We have probably been more willing to use a price deck that was a little higher than some other people would have been comfortable with. We have tried to become students of the gas markets over time, and I believe that has helped us in the past six years to successfully execute a strategy that others might have seen as aggressive, but one we felt the fundamentals of the gas markets totally supported. Plus, because we have been willing to hedge, we were able to lock in much higher gas prices and oil prices than what we bid.

We're often surprised we are able to take advantage of that arbitrage opportunity, but as long as the market gives us that opportunity-to arbitrage the difference between where assets trade for on the market, and the returns you can generate by hedging them at higher price decks than you used to value the assets-we're going to continue to do that.

Investor: You passed on outbidding Devon Energy Corp. for Chief Oil & Gas and its Barnett Shale assets, and took Four Sevens Oil Co. and Sinclair Oil Corp. instead. Why?

McClendon: We bid on Chief, but we are not active Tier II and Tier III acreage players in the Barnett, so we were way low. We only want to be in Tarrant and Johnson counties, and 85% of Chief's acreage was not acreage that we really wanted. We really don't want to be in Parker, Erath, Palo Pinto, Somervell, Bosque and Hill counties, which were some of the counties Chief was largely in.

However, I'm sure Devon will do a great job with the properties. They clearly know what they're doing in the Barnett as its largest gas producer and largest leasehold owner. We've just taken a much more narrow view of what's going to work best in the play, and we have been buying everything we can in that fairway. Four Sevens happened to sit right in the sweet spot of that fairway, whereas Chief was not the best geographical fit for us.

Investor: Do you factor in whether personnel will come with assets?

McClendon: We always assume they will not. That practice, in the past, has been good for us: we want employees to work for us because they have chosen to do so. In the industry, there have been problems when new employees only work for you because their previous CEO sold them down the river. This is one of the reasons why we prefer asset deals to corporate deals. We just buy the properties and staff them with our own people or newly hired people, and we don't get any of the dilution of culture or integration issues you sometimes get with corporate transactions.

Also, the properties we tend to buy tend to be sold by people who are going to start up and do it all over again. They want to keep their own people, and that's fine with us.

Investor: You have had no staffing problems?

McClendon: Well I wouldn't say that! We do have 4,100 employees; five years ago we only had 500-so we clearly have been aggressively hiring. Now, among our 4,100 today, about 1,200 work in our service companies and 2,900 in the E&P company. Also, we've hired hundreds of young people during the past five years. But are we done or is every position filled? Absolutely not. We receive more than 125 resumes a day and we want them to keep coming in.

Our acreage position continues to expand, and our rig count continues to expand, so we continue to need to hire new, great people. But the good news is that, if you're a geologist and you're born to find natural gas, or an engineer born to drill wells, there's no better place to be than at Chesapeake. So, that level of activity, and our willingness to use the newest technologies and compensate people aggressively, particularly through restricted stock grants, have created and fostered a very entrepreneurial culture here even as the company has become significantly larger in the past few years.

I personally very much like the human-relations dynamic that exists when you have a new generation of young people working side by side, learning the industry ropes from large numbers of people who are my age and older. As everyone knows, our industry missed a whole generation of potential employees between 1983 and 1999, but it is exciting for the young folks today because they see there is no generation sitting on top of them. They have clear sailing in 10 or 15 years to inherit the leadership of the world's biggest, most profitable, and in my view, most exciting, industry.

Investor: What is your forecast for gas prices?

McClendon: I am not a gas-price forecaster, first of all. But we are pretty good at anticipating big price moves and then we're pretty good at just recognizing when they're high and when they're high enough. I like volatility in pricing much more than I like high prices, which are difficult for gas consumers to handle. Keep in mind we have 8 Tcf of proved reserves and 14 Tcf of unproved reserves, so we need to sell 22 Tcf of gas to some group of gas consumers someday. We need gas consumers to be able to stay in the game.

Periods of lower gas prices like this are good because they keep acquisition costs lower, take some of the steam out of drilling costs, and give gas consumers a much needed break. I don't need consistently high gas prices for Chesapeake to be successful. In fact, consistently and predictably high prices would be very debilitating to Chesapeake's business model. What I do absolutely need, though, is gas-price volatility. I need low average gas prices with periodic spikes caused by any number of things, and that's when we get our hedging done and take a lot of risk out of the business. Mostly these days, it's more a weather call than anything else. That's why we have a weather department.

Investor: You have a weather department?

McClendon: Of course, why shouldn't we? Three years ago we recognized the single biggest influence on the health of our business would be the weather. We try to mitigate every risk we can identify in our business, so hiring Citibank's weather department three years ago is an example of the lengths we will go to to mitigate risk.

Investor: How has the management of Chesapeake changed since Tom Ward's departure?

McClendon: Last winter, Tom decided he wanted to slow down a bit and he retired from the company he co-founded 16 years ago. I was surprised, certainly, but probably not so surprised when in his customary, man-of-action Tom Ward fashion, he slowed down for only about two weeks and then jumped right back into the fray with his purchase of Riata. We're still great friends, and we talk or e-mail generally at least once a day, and we still have a lot of business interests outside of Chesapeake that we own 50-50. I know he's rooting me on and I'm certainly rooting him on. He still owns 25 million shares of Chesapeake, so I've got to do the best I can to keep him happy, as I have tried to do for all shareholders.

He has a good company there in Riata, and I'm sure they will go on to do some great things. I believe the change has been good for Tom, and it gives him a different platform where he is fully in charge rather than being co-in-charge.

Investor: What has been the best moment of your career to date?

McClendon: The past few years have been really enjoyable for me, to have people appreciate that we did our homework seven years ago and were early to catch a big-time upward move in natural gas prices.

As for an exact best moment, that's hard to say, but it was probably the day we went public: February 4, 1993. Tom and I were 33-year-old landmen at the time, and most people didn't think we had a clue of what we were doing, and probably in hindsight, they were at least partially right. But we've done okay since then, I guess.

Investor: The worst moment?

McClendon: Back in the dark days of 1999 and early 2000, our stock price was below $1. I thought, "Are we really so bad that an Investor: wouldn't risk $1 on us? Are we really only worth 75 cents?" To look at the quote-machine screen every day back then and think "You're not even worth $1" was probably a worst period of our careers.

But those tough times made us think about some gas-market factors that other people didn't have to think about back then because their lives were not as desperate as ours were. That we struggled maybe more than most has enabled us to think through some issues some other guys might not have ever been forced to think about.

Investor: What does the marketplace "miss" right now about the value and potential of Chesapeake?

McClendon: For a lot of Investor:s, we've become a proxy for natural gas prices, so sometimes it's a little frustrating to, for example, go through a summer like this (at $6 gas) when we're hedged at more than $9 and yet we trade down with a group that's unhedged. We're seen at times as a play on natural gas when we're really much more than that.

We haven't spent a great deal of time with our Investor:s, educating them about the vast potential inside our leasehold inventory. Part of that is for competitive reasons: we haven't been willing to educate our competitors through our Investor: education.

But I have no complaints about how Investor:s have treated us; they have been very helpful to us along the way, and in return we have delivered them a stock that's up 25-fold in 13 years. And we're not done yet, not even by a long shot.

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