Dominion's Louis Dreyfus Deal Adds Gas Reserves, Trading Power

Taking advantage of falling natural gas prices that have pushed down the worth of energy companies, Dominion announced last week it will acquire Louis Dreyfus Natural Gas Corp.-- with 89% of its production in natural gas -- for $2.3 billion in cash, stock and assumed debt. The deal will improve the utility giant's gas reserves by 60% and grow its energy trading business, which in turn could lead to some generation acquisitions down the road, according to Dominion's CEO.

With the Louis Dreyfus acquisition, Dominion's exploration and production unit would have 4.6 Bcfe more of proved reserves and production would grow to more than 450 Bcf a year, a 40% hike. Its existing 22,000 MW generation portfolio capabilities also will jump to more than 3 trillion Btus a day.

As impressive are the utility giant's gains in gas and electricity trading. Over the next three years, Dominion expects the acquisition will double its energy trading and sales volumes to increase to 2.4 Tcf a year from its current 1.2 Tcf, with electricity trading volumes increasing to 254 million MWh annually from its current 136 million MWh a year.

"We are bearish on natural gas," said CEO Thomas E. Capps during a conference call last Monday. "We see the best opportunity to create new value is to buy when others are selling." Dominion, headquartered in Richmond, VA, was not intent on becoming a larger E&P company, said Capps, despite the fact that Louis Dreyfus is a gas-rich independent producer. Rather, the acquisition will "enhance our portfolio of fully integrated energy businesses. We're still comfortable with our target of a 25% earnings contribution over the long term from our E&P operations." However, he noted that the acquisition offered "the right set of assets, at the right price, for the right reason."

Geographically, he said, the Oklahoma City-based Louis Dreyfus complements Dominion's drilling program with its concentrated assets in the Permian Basin, Mid-Continent and the Gulf Coast. "From an economic and strategic standpoint, quality of assets matters in the natural gas business." He said the "long-lived reserves and extensive leasehold acreage complement the quality of Dominion's existing natural gas properties."

Asked whether the Louis Dreyfus acquisition could lead to further buys, Capps said that Dominion was "comfortable" with about 25% of its income coming from oil and gas operations, but added that "we're looking for other generating assets now."

Duane C. Radtke, CEO of Dominion Exploration and Production, added that Louis Dreyfus' "low-risk asset base fits very well into our long-term strategic plan." He said that along with the company's "nearly 2 Tcf of proved reserves, there are 2 Tcf of low-risk, non-proved locations to drill over the next 10 years."

The agreement, expected to be approved in the fourth quarter, was approved unanimously by both boards of directors, giving Dominion 100% of Louis Dreyfus' outstanding shares. Subsidiaries of S.A. Louis Dreyfus et cie, which as a group own and control more than 42% of the shares, also have voted by separate agreement in favor of the acquisition.

Each Louis Dreyfus shareholder would receive $20 in cash and a fixed exchange ratio of 0.3226 shares of Dominion common stock for each share of Louis Dreyfus common stock. Louis Dreyfus shareholders would receive about 14.4 million shares of Dominion stock -- worth about $900 million based on a closing price of $62.63 on Sept. 7 -- along with $890 million in cash. Dominion also would assume about $505 million of Louis Dreyfus' debt.

The acquisition still has to be approved by Louis Dreyfus' shareholders as well as federal regulators. Louis Dreyfus also has agreed to a $70 million breakup fee.

Calling the ability to acquire Louis Dreyfus a "rare opportunity," Capps said that the pullback in natural gas prices was "indeed temporary," giving companies a chance to "build reserves at a fair price." Capps said that one of the "biggest obstacles" to increasing gas production has been in a decline rate of 35% in the Gulf of Mexico, which he said accounts for about 26% of annual domestic production.

"To grow production, we as a nation have to add production each year, something industry has been unable to do." With the Louis Dreyfus assets, Capps said it would not only increase Dominion's physical assets, but "give us an expanded platform" for its electricity and gas trading arm. "You have to have assets to back up sales." Buying a natural gas company, he said, will improve Dominion's electricity trading capabilities.

As one of the largest domestic energy producers, Dominion has a 22,000 MW generation portfolio that is expected to grow to more than 28,000 MW by 2005. It has 3 Tcfe of reserves and more than 300 Bcfe of annual production, and also owns and operates 7,600 miles of natural gas transmission pipeline with a delivery capability of 6.3 Bcf/d. It also operates the largest underground natural gas storage system in the United States, with more than 950 Bcf of capacity, and serves almost 4 million retail natural gas and electric customers in five states.

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