Calgary-based Pengrowth Corp. on Monday made a big move into the promising Montney Shale formation in northeast British Columbia with a C$375 million agreement to acquire Monterey Exploration Ltd.

Pengrowth, which administers Pengrowth Energy Trust, has been a shareholder in Monterey since 2006 and already owned about 18% of the company. Monterey, also based in Calgary, holds 19 net sections of prospective lands in the Montney's Groundbirch area of northeast British Columbia.

"The acquisition provides Pengrowth with significant and meaningful exposure to the Montney, one of the most economic unconventional gas plays in the Western Canadian Sedimentary Basin and likely in North America," Pengrowth President Derek Evans told investors on a conference call.

The arrangement provides "Monterey security holders with exposure to a well run, highly liquid, commodity-balanced entity with an excellent portfolio of low-risk, high-quality assets," said Monterey CEO Patrick Manuel. "Monterey defined and derisked a world-class Montney asset at Groundbirch; however, Monterey does not have the critical mass or cash flow to properly capitalize this asset as it moves into the development stage."

Monterey's first three horizontal wells in the Montney formation averaged 7.3 MMcf/d initial production rates. However, the ability to raise money to fund future wells has proved difficult, Manuel said.

"Over the past couple years, in an extremely challenging gas environment, Monterey was able to assemble a world-class resource play asset," said Manuel. "Based on our size and cash resources, it was going to be a continual challenge for Monterey to fund the Groundbirch development program, particularly given the cost of capital that most of the Canadian juniors face."

The agreement offers a plethora of tantalizing gas prospects for Pengrowth. It would gain a 90% working interest in concentrated acreage in what is considered to be the heart of the Montney Shale. Monterey's expected 2010 and 2011 exit production rate of 6,000 boe/d is 95% weighted to natural gas.

Pengrowth would add 11.2 million boe of proved reserves and 23.8 million boe of proved plus probable (3P) reserves, based on an independent review by GLJ Petroleum Consultants Ltd. More than 71%, or 16.9 million boe of the 3P reserves, are associated with the Groundbirch leasehold. Monterey's current Montney reserve bookings are around 101 Bcf (3P), which Pengrowth estimated represent a recovery rate of less than 5%.

Pengrowth expects to convert the "resources" to "reserves" over time, said Evans.

Under terms of the friendly takeover, Pengrowth agreed to pay 0.83/trust unit for the 82% of Monterey shares that it doesn't already own. Including Pengrowth's existing 18% equity interest, which it acquired at a total cost of C$9 million at an average cost of C96 cents/share, the total transaction is valued at around C$375 million.

"Monterey's concentrated, Montney resource-focused asset base in the Groundbirch area of northeast British Columbia will provide Pengrowth with a new core area with a deep inventory of operated, low-risk drilling opportunities that provide excellent full-cycle economics," said Evans.

"Pengrowth has been carefully monitoring Monterey's development as a company since our original investment in 2006, and Chris Webster, Pengrowth's CFO, has served on Monterey's board of directors since 2006. We believe now is the opportune time to take control of the Groundbirch development and apply Pengrowth's significant financial and technical resources to it."

Pengrowth in 2009 announced plans to search for properties with "multi-year drilling inventories and excellent full-cycle economics," Evans noted. Last year it acquired 43 net sections (28,800 acres) in the Horn River Basin of British Columbia (see Daily GPI, Oct. 7, 2009).

The Groundbirch assets are "located in one of the thickest and most prospective areas of the Montney fairway," the CEO said. In addition, Evans noted that "access to key infrastructure" includes a new 28 MMcf/d gas plant that is scheduled to be completed this year. A second 28 MMcf/d plant is to go online before the end of 2011.

"Pengrowth's internal evaluation indicates significant unrecognized upside in the Lower Doig and Doig phosphates in the Groundbirch area," Evans noted. "The future drilling inventory is sufficient to fill two 28 MMcf/d plants to capacity for about eight years."

If the transaction is completed as expected by mid-September, Pengrowth plans to increase its capital spending by around C$65 million this year, with most of the funds directed to the Groundbirch area. Pengrowth plans to drill six more wells on the leasehold (100% working interest) through the rest of the year, with additional funding set aside for new facility and tie-in activity.

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