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Total E&P USA Buys into Chesapeake's Barnett Operations

Total E&P USA Inc., a unit of France's Total SA, will acquire a 25% interest in Chesapeake Energy Corp.'s upstream Barnett Shale assets under a $2.25 billion joint venture agreement, the companies said last week. The deal gives Chesapeake cash it needs to fund development activities and makes Total a U.S. shale player. The partnership joins others Chesapeake has in the Haynesville, Fayetteville, Woodford and Marcellus shales.

Total will pay $800 million in cash at closing and an additional $1.45 billion by funding 60% of Chesapeake's share of drilling and completion expenditures until the $1.45 billion obligation has been covered, which Chesapeake said it expects to occur by year-end 2012. Closing is subject to regulatory approval and is anticipated by the end of January.

The assets subject to the joint venture include approximately 270,000 net acres of leasehold in the Core and Tier 1 areas of the Barnett Shale, approximately 700 MMcfe/d of current net production and approximately 3.0 Tcfe of proved reserves (0.75 Tcfe net to Total). In addition, Chesapeake said it believes that its leasehold position will support the drilling of approximately 3,100 additional net locations (775 net to Total) with approximately 6.3 Tcfe of unrisked unproved reserves (1.6 Tcfe net to Total). Approximately 60% of Chesapeake's Core and Tier 1 leasehold is held by production and therefore considered developed.

"Our production levels continue to exceed what our budgets have been predicting and so we are able to deliver this very attractive joint venture to our shareholders yet not have to sacrifice any reported production growth to achieve it," Chesapeake CEO Aubrey K. McClendon told financial analysts during a conference call last Monday. "Said another way, we will be collecting $800 million in upfront cash 30 days from now and reducing our capex [capital expenditures] by another $1.45 billion over the next three years while selling 175 MMcfe/d yet still not reducing our previous production forecast."

McClendon noted that Chesapeake is increasing its 2011 projected production by 50 MMcfe/d, or an additional 2%.

Chesapeake said it plans to continue acquiring leasehold in the Barnett, and Total will acquire its 25% share of the new acreage on promoted terms until Dec. 31, 2015. After that date, Total's right to acquire its 25% proportionate share of Chesapeake's leasehold will be on an unpromoted basis and Total will also begin paying 25% of Chesapeake's support costs related to the joint venture's corporate development activities.

Analysts at Tudor, Pickering, Holt & Co. Securities Inc. (TPH) noted that the $800 million cash Chesapeake is to receive "fully covers 2010 spending" and with the transaction Chesapeake's net debt-to-capital ratio declines to 40% from 45%.

The "obvious benefit [to Chesapeake] is the cash inflow," TPH said. "The secondary benefit is [the] mandatory promote on further Barnett leasing; the third is [Chesapeake midstream operations] will see an increase in capacity.

"Total agreed to mandatory participation in future leasing on a promoted basis, which will expedite leasing and enable [Chesapeake] to fully capture the promote on a planned 100,000 new acres."

TPH said it expects Chesapeake and its partners to seek additional joint ventures and asset sales. "One example is the planned sale of about 100,000 net acres in the East Texas Haynesville [Shale]."

According to analysts at SunTrust Robinson Humphrey, the transaction equates to a proven reserve value of $3/Mcfe and a 12.9-times production rate multiple. "Given the supportive transaction metrics, this announcement should have a positive incremental value implication," they said. "Relative to the [exploration and production] sector, [Chesapeake] trades at a 10% discount...has 20%-plus superior capital productivity, competitive growth and 50%-plus higher cash margin."

Total CEO Christophe de Margerie noted his company's entry into the U.S. shale gas business. "This joint venture will provide us with a solid position in an attractive long-term resource base under competitive terms," he said. "It will allow Total to develop its expertise in unconventional hydrocarbons in order to expand its unconventional business worldwide.

"Additionally, this transaction adds yet another key support for Total to build the gas value chain position the group has established in the U.S., the world's largest and most liquid natural gas market, with our existing capacity rights in the Sabine Pass LNG [liquefied natural gas] terminal and our gas trading and marketing organization.

"Total is conscious of the environmental aspect linked to producing shale gas and has confidence in Chesapeake's capacity to contain the impact of the Barnett Shale gas operations on the environment and respect local and federal regulations and guidelines."

Chesapeake will be discussing with Total a possible joint venture in the Eagle Ford Shale, McClendon said, as well as helping the world's fifth-largest integrated oil company evaluate several shale plays in Canada. McClendon noted Total's presence in the U.S. Gulf of Mexico and the fact that the company was active in the U.S. onshore during the 1980s and 1990s. "Total is very keen to learn more about shale gas exploration and development," McClendon said.

Chesapeake is in the process of drilling its first well on its roughly 100,000-acre net position in the Eagle Ford, where it hopes to grow its holdings to 200,000 acres in the coming months, McClendon said.

McClendon noted that the deal is his company's fourth joint venture in the "big four" gas shales. "Total approached Chesapeake about a Barnett joint venture approximately seven months ago and during this time the companies have worked diligently and thoughtfully to structure this mutually beneficial joint venture," he said.

"This transaction will allow Chesapeake to reduce its financial leverage and future capital expenditures and further position us to deliver industry-leading finding and development costs and returns on capital for years to come. This brings our combined shale joint venture proceeds, including upfront cash payments and drilling carries, during the past 18 months to approximately $10.8 billion, which compares very favorably against a cost basis in the assets sold of approximately $2.7 billion. Chesapeake has maintained majority positions in these joint venture shale assets ranging from 67.5% to 80% that have an implied remaining value of approximately $33 billion based on the original valuations of the four joint ventures."

Other Chesapeake joint venture partners are Plains Exploration & Production Co. in the Haynesville Shale (see NGI, July 7, 2008), BP America in the Fayetteville and Woodford shales (see NGI, Sept. 8, 2008) and Statoil in the Marcellus Shale (see NGI, Nov. 17, 2008). Chesapeake recently signed up for pipeline capacity on a Spectra Energy Inc. project that would serve the New York market with gas from the Marcellus (see NGI, Jan. 4).

"We plan to continue to take advantage of our large asset base by pursuing other joint ventures, including potentially our large acreage positions in the Eagle Ford Shale and in several Midcontinent unconventional plays that we believe would be attractive to potential partners," McClendon said. "We have agreed to discuss with Total an Eagle Ford joint venture as well as joint ventures covering several Canadian natural gas shale plays in which Total has shown an interest."

Chesapeake is among U.S. independent producers that have been mentioned as potential takeover targets following the recent announcement that ExxonMobil would acquire XTO Energy Inc. (see NGI, Dec. 21, 2009). Chesapeake shares were trading at around $28.50 late last week; the stock's 52-week high is $30.

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