Dominion is selling its natural gas and oil exploration and production (E&P) business to a newly formed subsidiary of major coal player Consol Energy Inc. for $3.475 billion in cash, the companies said Monday. The deal includes rights to about 491,000 acres in the Marcellus Shale.

“It really is a double-down right in our own backyard,” Consol CEO J. Brett Harvey told financial analysts Monday, noting that the company is not leaving the coal business by any means.

Consol produces high-Btu thermal coal, metallurgical coal and natural gas and claims to be the second largest holder of coal reserves among U.S. publicly traded coal companies. Dominion is one of the oldest and most active drillers in Pennsylvania and West Virginia. Consol said Dominion’s operations complement its existing gas business, which is operated through CNX Gas, of which it owns 83%.

On a pro forma basis, Consol said it will be the largest gas producer in the Appalachian basin. The deal triples the company’s position in the Marcellus Shale fairway to about 750,000 acres by adding Dominion’s approximately 500,000 acres in Pennsylvania and West Virginia.

The deal grows Consol Energy’s proved gas reserves by more than 50% from 1.9 Tcf to approximately 3 Tcf and doubles its potential gas resource base to approximately 41 Tcf, the company said. Consol is to acquire 1.46 million oil and gas acres from Dominion along with more than 9,000 producing wells, which are expected to produce more than 41 Bcfe in 2010, approximately 27 Bcfe of which will be imputed to Consol Energy between May 1 and the end of the year, assuming an April 30 deal closing. Consol Energy’s gas business is expected to account for as much as 35% of the company’s total revenue after the deal closes.

“Consol Energy’s acquisition of Dominion’s Appalachian E&P business is a strategically compelling transaction that will transform Consol Energy into a leading diversified energy company with a strong position in natural gas as well as coal,” Harvey said. “Since 2005 Consol Energy will have doubled its annual gas production to 100 Bcf in 2010. This acquisition will further accelerate that trend with the addition of the extremely attractive resource-rich, low-cost Marcellus Shale assets.

“Two compelling aspects of this transaction are that 98% of Dominion’s Marcellus acres are held by production and the average net revenue interest is 87.5%. These characteristics will enable Consol Energy to implement development plans that are driven by technical and marketing fundamentals rather than lease conditions — for example, expirations or drilling commitments.”

Consol has been active in lobbying on behalf of coal interests (see Power Market Today, Oct. 20, 2009). During a conference call with financial analysts Monday, Harvey noted that Dominion has been a long-term customer of Consol’s on the coal side of its business. He predicted further business opportunities on the gas side as Dominion assets will likely carry Consol-produced gas.

“They want to move the gas and we want to extract it,” he said. “We see a potential energy alliance across the board with Dominion in all of these energy fields, and we’re very enthusiastic about working with them to transport the gas…”

Harvey emphasized that Consol is not leaving the coal business, but rather is adding substantial low-cost gas to its energy portfolio. “We see five years of growth in the gas business and 10 years of growth in the coal business probably right behind that…It’s a play in energy, not in coal or gas…” he said.

On the Dominion side of the deal commodity price sensitivity at the company is expected to be cut by more than 20%, said Dominion CEO Thomas F. Farrell II. Farrell said late last year the company planned to sell its Marcellus assets (see Daily GPI, Nov. 2, 2009). Dominion sold most of its E&P assets in several transactions in 2007, but it kept its leasehold in the Appalachian Basin (see Daily GPI, Aug. 14, 2007).

“The decision to sell our E&P business came as a result of our previously announced plan to monetize our Marcellus acreage, either in multiple transactions or all at once,” Farrell said. “As we analyzed the various alternatives, and their respective impact on the value of the remaining business, we determined that combining our conventional Appalachian E&P operations with the rights to the Marcellus formation resulted in the best long-term value for our investors.

“Our regulated businesses are now expected to contribute about 70% of our consolidated operating earnings in 2011, up from less than 45% in 2006. Exiting the E&P business will enhance the visibility of our core natural gas pipeline and storage businesses and reduce our ongoing capital expenditures by approximately $200 million per year. Our activities in the Appalachian region will focus on investments such as the Appalachian Gateway project as well as the significant amount of new gathering and pipeline infrastructure that development of the Marcellus formation will demand.”

Earlier this year Dominion said it was moving forward with the sale of its Pittsburgh-based Dominion Peoples to Peoples Hope Gas Co. LLC (PH Gas), a company that was created by a San Francisco-based infrastructure investment firm to carry out the deal (see Daily GPI, Jan. 5).

Standard and Poor’s Ratings Services (S&P) said the deal would not affect the ratings of Dominion. “The elimination of the relatively small E&P operations and attendant commodity exposure will have a mildly confirmatory impact on Dominion’s excellent business profile. Decisions on investing the expected $2.2 billion-2.4 billion of after-tax proceeds will influence forecasted credit metrics and our opinion on management’s regard for credit quality,” S&P said.

Moody’s Investors Service affirmed its rating on Consol. “The affirmation of the Ba2 corporate family rating reflects Consol’s leading position in the Northern Appalachian coal basin, its vast, high-quality coal reserves, the value of its 83.3% ownership position in CNX Gas and the strong earnings generated in 2009 on a consolidated basis,” Moody’s said. “The rating also recognizes the company’s low debt level prior to the announcement, and its portfolio of long-term coal supply agreements, which lessen revenue and earnings volatility.”

The sale to Consol is expected to close by April 30, subject to customary conditions.

“Not only is our Appalachian footprint growing wider with this transaction, but more importantly, it is growing deeper as we substantially increase our opportunities to extract incremental value through stacked pay zones of surface assets, coal, coalbed methane, shale gas and conventional gas assets,” Harvey said.

Consol said it is considering options for structuring its business, including acquisition by Consol of the shares of CNX Gas common stock it does not already own, something it has pondered before (see Daily GPI, Jan. 30, 2008). “Consol Energy will be in a position to use its capital and free cash flow from its coal operations and newly acquired gas assets to fund the development of both its coal and natural gas activities,” Harvey said.

Consol expects to raise $4 billion and is targeting a balanced mix of equity and debt to fund the acquisition and development of the acquired acreage.

©Copyright 2010Intelligence Press Inc. All rights reserved. The preceding news reportmay not be republished or redistributed, in whole or in part, in anyform, without prior written consent of Intelligence Press, Inc.