CNX Gas Corp. has agreed to acquire the coalbed methane (CBM) and gas interests of approximately 1,037,000 gross acres from Peabody Energy. The transaction will increase CNX Gas' acreage position from 2.5 million gross acres at year-end 2006 to 3.6 million, or an increase of 44%.

This deal and other recent transactions give CNX substantial growth, particularly in the CBM arena, where the company is becoming one of North America's largest developers. CEO Nicholas J. Deluliss called the deal a "win, win, win" for all parties. An analyst at Friedman, Billings, Ramsey & Co. Inc. (FBR) was enthusiastic, too.

"Most importantly, from our vantage point, CXG [CNX] was able to add more than 1 million acres of leasehold for only $66 million in cash," FBR's Andrew Coleman wrote in a note Monday. "Total 3P [proved, probable, possible] reserves also increased at least 260 Bcfe, implying no more than 26 cents/Mcfe on a 3P basis...[W]e see the company taking strides to become the preeminent CBM operator in the country, effectively lowering its cost of capital through asset diversification."

The deal involves three parties. CNX will first acquire certain coal assets from CONSOL Energy Inc. for $45 million cash, plus a future payment estimated at $6.5 million. CNX will then convey those coal assets plus $15 million cash to Peabody in exchange for the Peabody CBM and gas rights. CNX is acquiring rights on 654,000 acres in the Illinois Basin, 153,000 acres in northern Appalachia, 171,000 acres in the San Juan Basin, 47,000 acres in the Powder River Basin, and 11,000 acres in the Rockies.

There are no proved gas reserves associated with the acreage. Much of the acreage needs to be evaluated in order to obtain an estimate of unproved reserves. Within the Illinois Basin, however, CNX is acquiring 114,500 acres of conventional gas acreage with development potential in the New Albany Shale. CNX said it believes this acreage alone contains at least 258 Bcf of net unproved reserves. This and other action since year-end 2006 will increase total proved and net unproved reserves of CNX from 3.119 Tcf to 3.668 Tcf, or 18%.

"This is a substantial deal for CNX Gas," said Deluliss. "It enables us to significantly increase the size of our already-large inventory of low-cost, low-risk opportunities. CNX Gas is receiving a large block of unproved reserves at a very economic price. If the entire $66.5 million transaction price were allocated to only the 258 Bcf we expect to see in the New Albany Shale, it would mean that those unproved reserves were being obtained for less than 26 cents/Mcf. This assumes no value for the remaining 922,500 acres.

"We are continuing to consolidate our position in the New Albany Shale. Some of Peabody's acreage in the New Albany Shale is near our existing acreage, allowing for increased economies of scale in the important exploratory play we refer to as Cardinal. We believe that when the Peabody deal closes, CNX Gas will be the leading acreage holder in the New Albany Shale, with control of 254,500 gross acres. CNX Gas also now controls the leading coalbed methane positions in central Appalachia, northern Appalachia and the Illinois Basin."

During a conference call with analysts Monday, CNX executives highlighted the Illinois Basin acreage, namely the New Albany Shale play. With the Peabody transaction, CNX has potential for 1,270-1,432 well sites in the New Albany Shale and net unproved reserves of 907-1,092 Bcf.

Also in the Illinois Basin, the Peabody deal takes CNX from 92,000 gross CBM acres to 575,000 gross CBM acres. In the Northern Appalachian Basin CNX's gross CBM acreage is now 660,000 acres after Peabody adds 137,000 to the 523,000 previously held.

CNX is a leader in CBM in Appalachia (see Daily GPI, June 4). In April the company agreed to lease about 20,000 acres in southwestern Pennsylvania from a subsidiary of Massey Energy Co. The companies said they planned to jointly develop the property with CNX serving as operator and majority working interest partner. The project is focused on CBM.

"This [Peabody] deal, coming just after the CNX Gas-Massey deal, clearly establishes our lead role as the aggregator and developer of CBM properties," Deluliss said. "If you consider coalbed methane alone, it's mind-boggling."

Earlier this year CNX significantly increased its capital spending, raising its exploration and production (E&P) budget 84% to $312 million to test the viability of some CBM plays. CNX predicted its gas output will reach 64 Bcf in 2007, increasing by 15% in both 2008 and 2009 (see Daily GPI, Jan. 9).

"The diversification made possible by this transaction gives CXG's management greater flexibility in its operations going forward, though we expect the near term to be biased toward its existing plays," Coleman wrote.

CNX said it is not altering its production guidance of 15% growth per year, DeIuliis said. "We believe this transaction increases the likelihood, over time, of achieving that growth because of more locations, an increased ability to high-grade locations, an increased ability to build permitting and land flexibility into our operational plans, and increased areas of unassessed plays that could end up being very economic. The challenge now will be to prepare a plan to monetize the value of these assets sooner rather than later."

DeIuliis noted that the deal capitalizes on CONSOL's majority ownership of CNX. "This transaction would have been more difficult to conclude had CNX Gas been a totally stand-alone entity," he said. CNX was established in June 2005, and CONSOL contributed its gas assets to the company in August 2005. CONSOL has an 81.5% ownership interest in CNX.

The coal component of the deal amounts to 41 million tons of high-Btu reserves in West Virginia and Kentucky. "This transaction adds high-Btu reserves that will enable Peabody to double the remaining reserves and expected life of our Federal No. 2 Mine in northern Appalachia," said Peabody CFO Richard A. Navarre. Peabody is the world's largest private-sector coal company, with 2006 sales of 248 million tons of coal and $5.3 billion in revenues.

The Peabody transaction is expected to close by the end of the second quarter, CNX said.

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