Chesapeake Energy Corp. shareholders gave a thumb's up to CEO Aubrey McClendon's latest joint shale exploration agreement with CNOOC Ltd. (China National Offshore Oil Corp.), and the Chinese producer, like other foreign investors, appears to have found a way to invest in U.S. energy with a minimum of federal oversight.

The transaction, the second between Chesapeake and CNOOC in less than four months, is slated for closing by the end of March (see Daily GPI, Feb. 1; Oct. 12, 2010). Chesapeake would receive $570 million in cash in exchange for giving the Beijing-based producer a one-third interest in 800,000 net acres in the Niobrara Shale, specifically the Denver-Julesburg (DJ) and Powder River basins of northeast Colorado and southeast Wyoming.

In addition, two-thirds of Chesapeake's share of drilling and completion costs are to be funded by CNOOC until an additional $697 million has been paid, which is expected by year's end 2014. CNOOC's second shale transaction with Chesapeake breaks down to a sale price of about $4,750/acre, which is higher than some previous shale deals, according to Jefferies & Co. analyst Bijou Perincheril.

"Transaction metric is better than expected," Perincheril said in a note. "Most of the Niobrara transactions and leases have been in the $2,000/acre range."

The transaction may be a little pricey but CNOOC won't have to deal with the U.S. regulatory scrutiny that derailed a bid for Unocal Corp. six years ago. CNOOC at the time offered $18.5 billion to buy Unocal, outbidding Chevron Corp. (see Daily GPI, June 23, 2005). Public outrage and threats by members of Congress to increase regulation of foreign investments eventually prompted Unocal to reject CNOOC and embrace Chevron.

However, the devil, as they say, is in the details. CNOOC and a host of other companies clamoring for a chance to earn money and gain shale drilling know-how have invested billions in domestic shale plays -- with little regulatory oversight. The transactions are structured so that the U.S.-based producer remains the operator and the majority owner. In the latest deal Chesapeake is to make all of the drilling and operating decisions. Transactions are thus completed with relatively few problems.

With those parameters, it's a win-win for both companies -- and both countries -- say analysts.

"The deal provides cash-poor Chesapeake with the money to monetize their huge resources and CNOOC the access to technology that they need," said analyst Gordon Kwan of Mirae Asset Securities. "The win-win deal valuation is fair based on our estimates and CNOOC's strategy to further expand into the oil-rich shale deposits in the U.S. The total investment of $1.27 billion in the deal through 2014 is manageable and equates to about 14% of CNOOC's budgeted $9 billion for 2011."

CNBC analyst Jim Cramer said the deals are about more than money and technology. The transactions are "the solution to many of the U.S.'s problems, which include importing too much oil and not having enough jobs...McClendon said that the deal would create about 4,000 to 5,000 additional positions in the U.S., while allowing for the production of more oil." Technology-strapped China also will gain knowledge that it needs to tap into its vast resources, said Cramer.

What CNOOC won't take back to China is any of the U.S. oil and gas output. The transactions with Chesapeake don't involve any exports of natural gas or liquids to China from the United States. Instead, the investments are seen as hedges against rising prices and falling supply, said Cramer.

China's economy is growing at a pace of about 10% a year; natural gas consumption is forecast to reach 278 billion cubic meters (Bcm) a year by 2020 from its current level of about 105 Bcm/year. The government, while it wants to reduce its dependence on fossil fuels and related carbon dioxide emissions, is hungry to tap into the country's vast resources.

To that end China-based oil companies spent an estimated $24 billion in 2010 to acquire overseas energy assets -- many of them gas-focused. Shale exploration is in its early stages in China and only a few pilot shale wells have been drilled. Learning from U.S. producers would help both sides, according to some analysts.

"Transferring technology to China to develop its shale gas fields is in the U.S.'s best interests," said analyst Paul Austick. "First, if enough gas can be developed, China will burn less coal, which the whole planet will appreciate. Second, U.S. companies like Chesapeake will earn money from working in China. Other possible beneficiaries include the oilfield services companies like Schlumberger Ltd., Halliburton Co. and Baker Hughes Inc."

CNOOC CEO Yang Hua said the second transaction with Chesapeake "represents another success in our overseas development as we implement a value-driven [merger and acquisition] strategy."

Hua in January said his company planned to increase oil and gas production by 8-12% this year. The Chinese energy explorer has spent more than $8.4 billion in the past year acquiring assets in the United States, Africa and Argentina. Output in 2010 was up an estimated 44% from 2009.

Fu Chengyu, who chairs CNOOC Ltd., said the Chesapeake deal in the Niobrara Shale "highlights the joint interests of energy companies in both [the] U.S. and China to accelerate the development of shale oil and gas, increase energy supply and reduce greenhouse gas emissions. We believe this project is meant to be mutually beneficial to both parties as well as for both Sino-U.S. energy industries."

CNOOC is not alone in looking for ways to build a shale portfolio:

Some Chinese reports estimated that the country may hold up to 30 trillion cubic meters (Tcm) of shale gas resources. The International Energy Agency recently reported that China has about 26 Tcm of shale gas. The Ministry of Land & Resource (MRL) has taken notice and scheduled its first auction of eight shale leaseholds by the end of March. MRL has set a target by 2020 to identify 50-80 shale prospects and 20-30 exploration and development blocks. But the auctions are open only to Chinese energy companies.

Whether China's producers can take their shale knowledge and translate it into meaningful production is questionable, according to Datamonitor. In a note analysts warned that "different barriers lie ahead and are likely to hinder the potential for the Chinese shale gas market," including the burdensome production sharing contracts (PSC).

"Contrary to what happens in the U.S., where a royalty-based system is in place through which developers pay a percentage of project-based revenues and corporate tax on profits, international participants in China have to share a large portion of their output with the government or the prevailing national oil company. In addition, international partners must pay corporate tax on their earnings. Such a practice is counterproductive, and lowers the attractiveness of shale gas investment in China."

Other barriers to producing shale gas in China include technical factors and infrastructure, said the Datamonitor team.

"Important shale plays in China are located on the mainland. Although significant technical advancements made the development of shale in the U.S. possible, replicating such practices in an area that has older and denser geology could prove to be tricky. As a result, the Chinese mainland would need further investment and research in order for its unique geological conditions to be addressed. On top of this, limited access to transmission pipelines, which are mostly owned and operated by the state, is also a significant barrier to the much-needed free market initiatives."

If China wants to "fully harness its shale gas potential, practices that promote diversification and competition need to be embraced," said the analysts. "With regard to shale gas, many examples worldwide, not only in the U.S. but also in Canada and Australia, show that the use of royalty tax regimes combined with free market initiatives create the most favorable conditions for success."

By the end of this year Chesapeake expects to double to 10 its drilling rigs in the Powder River and DJ basins. Twenty rigs are planned by the end of 2012 and another 10 may be added through 2013.

"It's nothing but a positive upward tick in the Niobrara because of the infusion of this capital," Chesapeake's John Dill told the Greeley-Tribune in Colorado. He said the jobs would pay 25-35% more than the state average wage level. Every rig, he said, creates about 100 jobs, which include rig workers, support personnel and others working in infrastructure capacity to keep the rigs operational.

"If you figure when this is said and done we could have up to 40 rigs in the basin alone, that could create up to 4,000 jobs when they're up and running," Dill told the newspaper. "So it's a pretty dynamic economic development story, but that's going to take some time to get there. It's certainly got the arrows going in the right direction for the state..."

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