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Chesapeake Energy Closes Acquisition of Columbia Natural Resources

Chesapeake Energy Corp. moved in on Appalachia Wednesday, announcing it had closed its previously announced acquisition of Columbia Natural Resources, LLC (CNR) and certain affiliated entities from Triana Energy Holdings, LLC, including producing properties, reserves and midstream assets. The purchase price was $2.95 billion, which consisted of $2.2 billion in cash and $0.75 billion in liabilities assumed at closing.

Chesapeake touted the proximity of its new property to the Northeast markets, the high Btu content of the gas and the relatively unexplored and unconsolidated nature of the Appalachian Basin. The acquired reserves, estimated internally, total about 2.5 Tcfe of proved, probable and possible reserves (3P), comprised of 1.1 Tcfe of proved reserves and 1.4 Tcfe of probable and possible reserves. Current daily net production from the acquired properties is approximately 125 MMcfe, providing a proved reserves-to-production index of approximately 23 years and a proved developed reserves-to-production index of approximately 16 years, Oklahoma City-based Chesapeake said.

On the acquired properties, Chesapeake has identified approximately 1,300 proved undeveloped locations, 6,300 probable locations and 1,800 possible locations for a total of 9,400 undrilled locations, or an estimated drilling inventory of more than 15 years. The properties are principally located in West Virginia, Kentucky, Ohio, Pennsylvania and New York.

Following the announcement of the agreement to acquire CNR on Oct. 3, 2005, Chesapeake said it hedged approximately 100 bcf of natural gas production at an average price of $10.76/MMBtu. More specifically, the company hedged 7.4 Bcf of fourth quarter 2005 gas production at a Nymex price of $12.75/MMBtu, 57.3 Bcf of 2006 gas production at a Nymex price of $11.40/MMBtu, 23.7 Bcf of 2007 gas production at a Nymex price of $9.70/MMBtu and 11.0 Bcf of 2008 gas production at a Nymex price of $8.37 per MMBtu. The hedged prices significantly exceed the pricing assumptions used by Chesapeake to value the properties.

After allocating $175 million of the purchase price to the extensive midstream natural gas assets being acquired (including over 6,500 miles of natural gas gathering lines) and $500 million to the unevaluated portion of the 4.1 million net leasehold acres being acquired (3.5 million net acres in the U.S. and 0.6 million net acres in Canada), Chesapeake's acquisition cost for the 1.1 Tcfe of estimated proved reserves was approximately $2.275 billion, or $2.20/Mcfe. Based on the company's projected development plan, which includes approximately $4.1 billion of anticipated future drilling and development costs, Chesapeake estimates its all-in cost of acquiring and developing the 2.5 Tcfe of 3P reserves will be approximately $2.79/Mcfe.

Chesapeake's Appalachian proved reserves are long-lived, have low production decline rates (the proved developed producing base is projected to decline at less than 10% per year), are 99% natural gas, have an average Btu content of 1,140 per cubic foot and are 69% proved developed. In addition, gas sold from the properties generally receives a $0.25-0.50 per MMBtu premium to Nymex gas prices, compared to basis differential discounts that are currently approximately $3.00 per MMBtu in various southwestern and western U.S. natural gas supply basins. Adjusting further for the favorable Btu content, Chesapeake's Appalachian natural gas is today generating wellhead prices of up to $4.00/Mcfe more than typical southwestern and western U.S. natural gas production, the company said.

Chesapeake now owns an internally estimated 14.3 Tcfe of proved and unproved oil and natural gas reserves, comprised of 7.3 Tcfe of proved reserves (which are 92% natural gas and 100% onshore) and 7.0 Tcfe of unproved reserves. The company intends to spend at least $200 million per year for the foreseeable future in further developing the acquired properties and is budgeting production growth from the acquired assets of 5-10% per year.

Triana purchased what was then Columbia Energy Resources (CER) in 2003 from NiSource for $330 million. At the time reserves were estimated at 1.1 Tcf. The top executives of CER moved over to the top posts at Triana, which had been formed in 2001 by management and executives of Metalmark Capital LLC as a Morgan Stanley Capital Partners portfolio company (see NGI, July 7, 2003).

At the time Triana said its new management team "is largely responsible for the re-definition of the Appalachian Basin," which it believed held the promise of substantial new oil and gas production. "Triana's geo-science team is recognized as an industry leader in deep exploration throughout the Appalachian Basin. Examples of deeper gas plays developed by the Triana team are the Rose Run Formation (Ohio), the Trenton-Black River Formation (New York and West Virginia), and the Oriskany Formation (Eastern Overthrust region of West Virginia).

Aubrey K. McClendon, Chesapeake's CEO, commented, "We are pleased to have closed the CNR acquisition yesterday for several reasons. First, we have acquired very significant land and gas resource inventories to complement our already very large land and gas resource inventories. CNR's additional 3.5 million net acres of onshore U.S. leasehold and 2.5 Tcfe of 3P reserves will increase Chesapeake's leasehold and proved and unproved reserve inventories to 8.0 million net acres and 14.3 Tcfe, respectively.

"Secondly, we are very enthusiastic about moving into the large, prolific and generally underexplored and unconsolidated Appalachian Basin. The basin covers over 185,000 square miles (almost three times the size of Oklahoma) across seven states and has produced more than 46 Tcf of gas from over 400,000 wells. 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. In addition, very few horizontal wells have been drilled and very few wells have been cored, leaving a great opportunity for Chesapeake to apply new scientific approaches to gas development in the region."

McClendon also pointed to the premium price for the close-to-market Appalachian production, pointing to unfavorable basis differentials for much of the rest of the market. There also is an approximate 14% value upgrade for the rich Btu content of the gas. "We believe prices realized on Chesapeake's Appalachian gas production today would be up to $4.00 per Mcfe higher than prices received in most southwestern and western U.S. gas basins," he said.

"In addition, we are eager to begin working in a large U.S. natural gas basin that shares many similarities to our stronghold in the Midcontinent. 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 mid-sized 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."

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