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Chesapeake Midstream Buys Marcellus System, Eyes More Growth

With one transaction, Chesapeake Midstream Partners LP (CHKM) has become the "biggest gathering system in the Marcellus Shale," CEO J. Mike Stice said Thursday.

The 18-month-old master limited partnership (MLP) moved into the lead after agreeing to pay parent company Chesapeake Energy Corp. $865 million to acquire Appalachian Midstream Services LLP (AMS).

Once the deal closes, which is expected on Friday, CHKM would own about 47% of an integrated system of assets that include close to 200 miles of gathering pipelines. Throughput as of Dec. 15 was just above 1 Bcf/d. The gathering lines are co-owned by Chesapeake, Anadarko Petroleum Corp., Statoil ASA, Mitsui & Co. Ltd. and Epsilon Energy Ltd.

CHKM would operate the assets under 15-year fixed-fee gathering agreements, which include acreage dedications and annual fee re-determinations that target a "mid-teens return" on all invested capital in the acquired assets, said CEO J. Mike Stice. He touted the new assets during a conference call on Thursday.

"On the business model side, the contract itself is consistent with our overall commitment to risk management," said Stice. "There's also unparalleled growth in the Marcellus. We have access to liquids-rich growth and significant organic growth with a natural consolidator footprint, basin diversification and third-party upside."

With the transaction, "we will be the biggest gathering system in the Marcellus..."

CHKM COO Bob Purgason told analysts there are "10 distinct gathering systems" included in the purchase and CHKM has an aggregate 47% interest in the subsidiaries, with 67% in some units and 33% in others, depending on the partners.

"What's really important is that the operating structure is contracted directly with the producers/shippers," and CHKM would operate 100% of the business. The producers have "opportunities for over 5,500 drilling locations within our dedication and 250 wells now connected to the system," Purgason said.

"When you look at the Marcellus and the basin diversification that this brings to us, there is no better shale in North America than the Marcellus. We are right in the heart of it...in the north in Bradford and Sullivan counties [in Pennsylvania] and in the south in the wet, rich area."

The deal also offers "substantial asset scale" that includes substantial throughput and miles of pipeline, as well as 18 compression facilities with 57 hp of compression and 13 dehydration units. "We can continue to connect and watch the growth continue in the asset," said Purgason.

CHKM eventually will "try to aggregate other producers" within the Marcellus system, said Stice. "Initially it starts off with what we are bringing to the table and what are the common interests in the gathering system."

The MLP's expansion plans won't necessarily end by adding more gas gathering lines, said Stice. "The most profitable area for the region today is because of the wet gas component...it's extraordinary," he said. And while "everyone likes to discount dry gas these days...when you look at all of the dry gas in the north [area of the Marcellus], it has an attractive netback..." Each area offers "distinct" options.

The Northeast region is "an exciting part of the country" because not only is it gas-rich, it also has substantial natural gas liquids (NGL). "We thought about building a gas plant ourselves and we we got down and looked at the infrastructure, we felt the best way was to have a contract relationship," which it has with MarkWest Liberty Midstream & Resources LLC (see Shale Daily, Jan. 21, 2011).

"We've always been appreciative of their services and what they provide to Chesapeake marketing," Stice said. "That's not to say that we wouldn't invest in something in the future but for now we have processing that we need and we're not engaged in processing per se...This deal, in concert with Utica [shale] development, over time will increases NGLs in the region. As a result, we must have an alternative location for product and most specifically, ethane must find a home."

CHKM was formed in 2009 in a 50-50 transaction by Oklahoma City-based Chesapeake and private equity firm Global Infrastructure Partners. At the time Chesapeake contributed most of its midstream assets in the Barnett Shale and most of its nonshale midstream properties in the Arkoma, Anadarko, Delaware and Permian basins.

Chesapeake has been "very supportive of both opportunities to move ethane out of the region and we're also supportive of any opportunities in the local market," said Stice. "If a petrochemical plant is justified in Ohio, West Virginia, Pennsylvania to take advantage of he ethane, we're more than willing to support that effort. We're excited about the local market and ethane opportunities today. It's important to have strategies to have ethane available to all comers. When you combine the Marcellus South with Utica's ethane, there's plenty for everybody."

The dropdown to CHKM by Chesapeake is the second since August 2010, when the initial public offering (IPO) for the midstream unit was launched, Stice said. A year ago CHKM acquired the Springridge gas gathering system and related facilities in the Haynesville Shale for $500 million (see Shale Daily, Dec. 20, 2010).

There likely will be more dropdown contributions from Chesapeake in the future, said Stice. "Given Chesapeake's dynamic growth potential and industry-leading leasehold position in the Lower 48, Chesapeake Midstream expects to pursue a substantial number of asset dropdowns from Chesapeake in the years ahead."

Chesapeake CEO Aubrey K. McClendon called the Marcellus assets "a truly unique platform for growth that will benefit CHKM for decades...We look forward to continuing to build Chesapeake's midstream systems in the Haynesville, Eagle Ford, Greater Anadarko (including the Cleveland, Tonkawa and Mississippian), Niobrara and Utica plays, all of which will be available to CHKM for future dropdowns."

The AMS acquisition is to be financed by $600 million of cash drawn from CHKM's revolving credit facility and $265 million of equity (9.8 million common units), which would increase Chesapeake's limited partnership ownership to 46.1% from 42.3%. CHKM has total borrowing capacity of $1 billion. Terms of the transaction were unanimously approved by Chesapeake's board of directors and by the board's conflicts committee, which is comprised of independent directors.

To date, CHKM has about $3.9 billion of invested capital, which includes 3.8 million dedicated acres, 3,711 miles of pipeline and 5,249 wells, Stice said. By area CHKM has 1,075 miles of gathering lines in the Barnett, 578 in the Haynesville and 573 in the Midcontinent. With the AMS deal it would have 470 miles in the Marcellus. About 135 employees are to move from Chesapeake to CHKM, bringing its workforce to 434.

"The organic base that we have in this asset base is, we think, second to none," said Stice. The Marcellus transaction will "make us the largest MLP in the sector. Who would have thought that in only 18 months we could create the largest [MLP] by volume? And we have to realize that our cupboard is still full. There is substantial growth potential from dropdowns..."

In its "current footprint," CHKM has the "potential to access over 10,000 wells on 72 million gross acres of high-quality unconventional assets." The MLP has a "bright future...It's neat to know that only only the largest but also the ones with great growth potential. We plan to leave most [of the competitors] in the dust."

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