China's CNOOC Ltd. (China National Offshore Oil Corp.) has agreed to buy a one-third stake in Chesapeake Energy Corp.'s 600,000 net acres in the Eagle Ford Shale in South Texas for $1.08 billion in cash and said it will fund 75% of Chesapeake's share of drilling and completion costs up to another $1.08 billion.

Over the next several decades, the companies said they plan to develop net unrisked unproved resource potential up to 4 billion boe (after deducting an assumed average royalty burden of 25%). It was China's first bid for ownership of a major piece of U.S. oil and gas assets since its unsuccessful $18.5 billion offer for Unocal Corp. in 2005. CNOOC withdrew that offer in the face of a firestorm of political opposition (see Daily GPI, Aug. 3, 2005).

In the joint venture with Chesapeake the companies made clear that as operator, Chesapeake will conduct all leasing, drilling, completion, operations and marketing activities.

"This transaction will provide the capital necessary to accelerate drilling of this large domestic oil and natural gas resource, resulting in a reduction of our country's oil imports over time, the creation of thousands of high-paying jobs in the U.S. and in the payment of very significant local, state and federal taxes," said Chesapeake CEO Aubrey McClendon. "...[T]his project will advance the efforts of both the U.S. and China to reduce greenhouse gas emissions and accelerate commercial opportunities for the development of shale gas resources in China, furthering the objectives of the U.S. -- China Shale Gas Resource Initiative announced by the White House on Nov. 17, 2009."

Analysts at Jefferies & Co. Inc., which advised Chesapeake on the deal, noted that the price paid was in line with that of another deal announced Sunday, a transaction in which a venture of Talisman Energy Inc. and Statoil ASA are acquiring acreage in the Eagle Ford Shale in South Texas from Enduring Resources (see related story). The Chesapeake deal works out to $10,800 per acre while the Eagle Ford acquisition by Talisman and Statoil came in at $10,900 per acre, the analysts noted.

Chesapeake is currently utilizing 10 operated rigs to develop its Eagle Ford leasehold, and with the additional capital from CNOOC anticipates increasing its drilling activity to approximately 12 operated rigs by year-end, approximately 31 rigs by year-end 2011 and approximately 40 rigs by year-end 2012. About 900 wells are expected to be drilled by year-end 2012.

"The execution of this project will benefit CNOOC Ltd.'s long-term production and reserves growth and should produce considerable returns for our shareholders," said CNOOC CEO Yang Hua. "Chesapeake, as the world's leading company in the shale oil and natural gas field, has accumulated abundant experience on drilling and completion in various U.S. shale plays with world-class partners."

Currently, Chesapeake has 10 horizontal Eagle Ford wells in production with initial production rates of up to 1,160 bbl of oil and 0.4 MMcf of natural gas per day in the oil window and 4 MMcf of natural gas and 1,200 bbl of oil per day in the wet gas window. Chesapeake anticipates that the project will reach its peak production of 400,000-500,000 boe/d in the next decade.

The assets are principally in the counties of Webb, Dimmit, LaSalle, Zavala, Frio and McMullen, and are primarily in the oil window (about 85%) and the wet gas window (about 15%) of the Eagle Ford and in the dry gas window of the Pearsall Shale. CNOOC will have the option to acquire its 33.3% share of any additional acreage acquired by Chesapeake in the area and also the option to participate with Chesapeake for a 33.3% interest in midstream infrastructure related to production established from the assets.

"This brings the combined proceeds from our shale development ventures, including upfront cash payments and drilling carries, since 2008 to approximately $13 billion," McClendon said. "Chesapeake has continued to maintain a majority position in each of the five major projects subject to development arrangements ranging from 67% to 80%. The implied predevelopment value of Chesapeake's retained interest in those shale ventures is approximately $37 billion based on the valuations in the sale transactions."

Hong Kong-based CNOOC is China's largest producer of offshore crude oil and natural gas and one of the largest independent oil and gas exploration and production companies in the world. "...CNOOC Ltd. is keeping a close watch on the development of the upstream sector across the world, among which is shale oil and natural gas development," said Chairman Fu Chengyu.

Moody's Investors Service said its A1 issuer and senior unsecured ratings on CNOOC debt were not immediately affected by the deal. CNOOC's ratings remain on review for possible upgrade due to the potential upgrade of China's sovereign ratings, Moody's said.

"CNOOC Ltd.'s investment in the project is in line with the company's strategy of growing reserves partly through overseas acquisitions," said Renee Lam, a Moody's senior analyst. "The company's strong financial flexibility and liquidity, with cash on hand of approximately US$4.7 billion at June 2010, partly cushion investment risks related to this investment."

Moody's estimated CNOOC's adjusted debt/proved developed reserves at US$3.5-4.0/boe in June. The Chesapeake deal is expected by Moody's to have modest impact on leverage.

"Nonetheless, any significant increase in leverage due to further large reserve acquisitions, or higher reinvestment risk, may start to pressure the rating. Metrics that Moody's would look for include adjusted debt/proved developed reserves staying consistently above US$4/boe," Lam said.

CNOOC's adviser was Tudor, Pickering, Holt & Co. Securities Inc.

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