Chesapeake Energy Corp. pushed itself into a top tier of domestic natural gas producers last week after agreeing to acquire Columbia Natural Resources LLC (CNR) from Triana Energy Holdings LLC for $2.2 billion in cash and $75 million of assumed debt related to prepaid sales agreements and hedging positions. The CNR properties are located in the Appalachian Basin, principally in West Virginia, Kentucky, Ohio, Pennsylvania and New York.
According to Chesapeake, the deal will give it an internally estimated 2.5 Tcfe of proved, probable and possible (3P) reserves, comprised of 1.1 Tcfe of proved reserves and 1.4 Tcfe of probable and possible reserves. CNR's independent third party engineering report calculated 3P reserves to be 3.9 Tcfe, or 56% more 3P reserves than Chesapeake will initially recognize.
Chesapeake CEO Aubrey K. McClendon said the CNR acquisition will increase the company's leasehold inventories to 8.2 million net acres and its gas resource inventories to 13.5 Tcfe. Of the Appalachian Basin, McClendon said, "In 2003, the National Petroleum Council estimated the basin still contained another 9 Tcf of proved gas reserves and an additional 68 Tcf of unproved gas reserves. In addition, much of the basin remains underexplored. Less than 1% of the 400,000 wells drilled to date have penetrated below 7,500 feet, leaving substantial deeper exploration opportunities available for Chesapeake to pursue. We believe deep gas exploration is one of our most important competitive strengths."
Chesapeake is "eager to begin working in a large U.S. natural gas basin that shares many similarities to our stronghold in the MidContinent, where 59% of our pro forma production is located," the CEO said. "As in the MidContinent area seven years ago, Appalachian Basin asset ownership is very fragmented, and gas production has typically been developed by a large number of very small private companies, a few midsized public independents and several large pipeline and utility companies.
"We believe that Chesapeake's significant presence in the Barnett, Woodford, Caney and Fayetteville shale plays, our expertise in tight sand and horizontal coalbed methane drilling and our commitment to deep natural gas exploration will enable us to achieve success in Appalachia."
McClendon indicated Chesapeake and CNR had "been in conversations" for more than three years concerning the acquisition." Now, "it has become abundantly clear in the past month that the U.S. needs significant additional supplies of clean-burning, domestically produced onshore natural gas."
Next year, Chesapeake plans to average 85-90 drilling rigs to continue exploring for new supplies of natural gas. "While others in the industry are increasingly focused on international projects, we remain committed to supplying consumers with as much natural gas as Chesapeake can find onshore in the U.S."
CNR's current net production is 125 MMcfe/d, "indicating a proved reserves-to-production index of 23 years and a proved developed reserves-to-production index of 16 years," Chesapeake said in a statement.
Chesapeake estimated the acquisition cost for the 1.1 Tcfe of internally estimated proved reserves is about $1.45/Mcfe. The price was calculated by allocating $175 million of the $2.2 billion purchase price, excluding debt, prepaid sales and hedges, to CNR's midstream natural gas assets, which include more than 6,500 miles of natural gas gathering lines, and $500 million to the unevaluated portion of 4.1 million net leasehold acres, which include 3.5 million net acres in the United States and 0.6 million net acres in Canada.
Based on Chesapeake's projected development plan, which includes $4.1 billion of anticipated future drilling and development costs, the all-in cost of acquiring and developing the 2.5 Tcfe of 3P reserves will be $2.48/Mcfe, excluding debt, prepaid sales and hedging liabilities.
CNR's proved reserves are long-lived, with low production decline rates, Chesapeake said. The proved developed producing base is projected to decline at less than 10%/year. They are 99% natural gas, have an average BTU content of 1,140 and are 70% proved developed.
On the acquired properties, Chesapeake has identified 1,316 proved undeveloped (PUD) locations, 6,286 probable locations and 1,833 possible locations for a total of 9,435 undrilled locations, or an estimated drilling inventory of more than 15 years. By comparison, CNR's independent reservoir engineers identified 1,611 PUD locations (22% more than Chesapeake will initially recognize) and more than 14,000 probable and possible locations (72% more than Chesapeake will initially recognize).
As of June 30, 2005 and pro forma for the acquisition, Chesapeake will own an internally estimated 13.5 Tcfe of proved and unproved oil and natural gas reserves, comprised of 7.1 Tcfe of proved reserves (which will be 92% natural gas and 100% onshore) and 6.4 Tcfe of unproved reserves. The company intends to spend at least $200 million per year for the "foreseeable future" to develop the properties, and it is budgeting production growth from the acquired assets of 5-10% per year.
Chesapeake has begun the process of hedging the production it will acquire from CNR. The company intends to hedge at least 50% of CNR's estimated base production through December 2008. The company will assume CNR's prepaid sales agreement and its hedging arrangements, and Chesapeake expects to record any potential mark-to-market loss on those obligations as a balance sheet liability when the transaction closes. The amount of the mark-to-market loss will be dependent on gas prices on the day of closing. Using gas prices as of Sept. 30, 2005, the prepaid sales and hedging liabilities would be approximately $775 million.
Chesapeake expects to close the transaction by Dec. 15. It will finance the acquisition from cash on hand and by issuing a balanced combination of senior notes and equity securities.
Triana was formed in 2001 by management and executives of Metalmark Capital LLC as a Morgan Stanley Capital Partners portfolio company. Triana was advised in this transaction by Morgan Stanley & Co. Inc. and Credit Suisse First Boston LLC.
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