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BG Group, EXCO Partner to Develop U.S. Shale Gas

BG Group plc, better known for its liquefied natural gas (LNG) business, is the latest European energy company to stake a claim in North American gas shale in a $1.3 billion deal that gives it a half-stake in EXCO Resources Inc.'s holdings in Louisiana's Haynesville Shale and the Deep Bossier Sands of East Texas.

The transaction announced last week gives UK-based BG a 50% interest in 120,000 net acres in East Texas and northwestern Louisiana, and a stake in EXCO's midstream operations. Around 65,000 net acres are in East Texas; 55,000 net acres are in Louisiana. BG would add an estimated 2.6 Tcf to its resources and gain current net output estimated at 78 MMcf/d.

"This alliance brings material new resources and supply to our existing U.S. business at a competitive price and in a prime location at the heart of the world's largest gas market," BG CEO Frank Chapman said. "The transaction increases BG Group's exposure to long-term unconventional gas resources and skills."

The European shale alliance with a U.S. producer follows similar partnerships announced by Italy's Eni, London-based BP plc and Norway's StatoilHydro ASA (see NGI, May 25).

The properties to be jointly developed encompass most of EXCO's holdings in the region, which include the Haynesville, Bossier, Cotton Valley and Hosston plays, except for the Vernon Field in Jackson Parish, LA; the Redland Field in Louisiana's Bossier and Webster parishes; and the Gladewater and Overton fields in Gregg, Rusk and Smith counties in Texas.

Dallas-based EXCO would continue as operator, with oversight from the companies' joint development operating committee.

EXCO CEO Doug Miller told financial analysts during a conference call last Tuesday the joint venture (JV) is the "biggest and best transaction" in the company's history.

"This allows us to be very aggressive at a time when costs are coming down, and we've already begun negotiations with certain service companies," Miller said. "We expect more rigs to be coming...and more development at a time when we decide."

With no stipulations by BG on when and how many wells are to be drilled in the venture, EXCO will be able to control development in the region, said Miller. And with both companies interested in expanding midstream opportunities, he said EXCO is primed to grow.

"Several people over the last year wanted one but not the other," Miller said of EXCO's upstream and midstream assets in the Texas and Louisiana region. "This came together just perfectly for us and for [BG]. I can see EXCO with very significant additions to its production and its reserves over the next five to 10 years."

BG operates in 27 countries on five continents, Miller noted. "In addition, BG Group markets approximately 3.5 Bcf/d through 66 major interstate and intrastate pipelines serving markets throughout the Midwest and eastern United States."

The UK energy giant "will be an extremely valuable partner in our gas marketing efforts," Miller said. "EXCO and BG Group are both committed to increasing the leasehold position and accelerating the drilling and completion efforts in the Haynesville and Bossier shales in East Texas/North Louisiana..."

Analysts with Sanford C. Bernstein & Co. said they expect BG to use the shale gas "to meet U.S. contract commitments, thereby releasing Atlantic Basin LNG cargoes" that were destined for higher-priced global markets. BG has long been marketing LNG in the United States and in 2007 it supplied 55% of all U.S. LNG imports.

Tudor, Pickering, Holt & Co. Securities (TPH) analysts said the transaction values EXCO's holdings at a 15-20% premium and is accretive "on almost any metric." By TPH estimates, EXCO's proved reserves were valued by BG at $3.64/Mcfe versus a pre-deal valuation of $2.50. "Deal value is clearly in unbooked potential, where BG mentions paying 50% for 84,000 Haynesville acres at $19,000 per acre," said TPH.

Around 84,000 net acres are prospective for Haynesville Shale development, and most of the acreage is in the core areas of DeSoto and Caddo parishes in Louisiana and Harrison County, TX. The transaction includes 95 MMcfe/d net output from the Cotton Valley assets and 60 MMcf/d from the Haynesville Shale. At year-end 2008 EXCO said its Cotton Valley and other shallow rights included 414 Bcfe of net proved reserves and 445 Bcfe of net probable and possible reserves.

EXCO's current acreage position, most of which is held by shallow production, includes more than 1,600 undrilled Haynesville locations containing net potential reserves of 4-6 Tcfe, with "significant additional potential" in the East Texas acreage, the Dallas-based producer said. EXCO now operates five rigs in the area of mutual interest with BG. It plans to add at least three more rigs this year, and four or five in 2010.

Some of EXCO's drilling results to date in the region have been nothing short of phenomenal. Late last year the company said its first Haynesville horizontal well had an initial production (IP) rate of 22.8 MMcfe/d (see NGI, Dec. 15, 2008). EXCO said eight horizontal Haynesville wells have been drilled and completed in DeSoto Parish, LA, with average gross IP rates in excess of 23 MMcf/d on restricted chokes.

The company will lay out its strategy for the JV once the transaction closes, likely sometime before the end of September, Miller told analysts. However, EXCO's full-year 2009 budget now calls for a minimum of 34 horizontal Haynesville wells to be drilled, 27 of which would be operated by EXCO.

Under the JV with BG, EXCO would receive $655 million in cash at closing. In addition, BG agreed to fund $400 million of capital development costs and would pay 75% of EXCO's drilling and completion costs on the deep-well rights until the $400 million commitment is satisfied. The drilling and completion cost commitment is expected to be satisfied in 2011 or 2012. EXCO and BG would share equally in additional leasehold and asset acquisitions under the agreement.

In addition, EXCO plans to sell BG a half-stake in its midstream business, except for the Vernon Field assets, for $249 million cash.

"In concert with the planned Haynesville Shale development, there will be an effort to develop and grow the midstream business," EXCO said. The company now owns more than 700 miles of pipeline and gathering assets in the area and is constructing a 29-mile, 36-inch diameter header system to transport its Haynesville gas production. Throughput to be contributed to the joint venture is around 440 MMcf/d, of which half is EXCO gas and half is third-party gas.

"I see other opportunities for us to work together," Miller said of BG. "I see acceleration, and I see us becoming quite a bit more aggressive." EXCO continues to pursue potential partnerships for its Marcellus Shale acreage as well, he said.

For EXCO, the transaction alleviates funding pressures that have slammed many cash-poor onshore producers. Last week Encore Acquisition Co. agreed to pay EXCO $375 million in cash for some of its assets in East Texas and the Midcontinent (see related story).

"You will see our map trimming down, and I expect it to shrink further," Miller told analysts. "With what's going on the markets, I'm leery of 2010 gas...We're looking at $6 gas potentially for next year."

BG "does a lot of gas marketing at Perryville [hub in Louisiana], and because of their marketing efforts, they are always able to get the best price," said Miller. "They also market in the Northeast, in the Southeast and actually in the Midwest, and we'll be able to source market on interstate pipelines because of that relationship..."

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