Chesapeake Energy Corp., steadily expanding beyond its traditional Midcontinent holdings, recently made a geographic leap by announcing plans to enter the Appalachian basin by acquiring Columbia Natural Resources LLC.
Chesapeake is buying CNR from Triana Energy Holdings LLC for $2.95 billion, including the assumption of $75 million in debt and liabilities related to CNR’s prepaid sales agreement and hedging positions (OGJ, Oct. 10, 2005, p. 35).
The transaction is expected to close in mid-December. Afterward, Chesapeake will be the fifth largest US gas producer and the second largest independent US gas producer.
“We should have the highest, or close to the highest, organic growth rate capability in the industry,” said Aubrey McClendon, Chesapeake chairman and chief executive officer. He describes the Okalahoma City independent as a large company with diverse holdings that offers the growth potential characteristic of a smaller company.
McClendon is dedicated to discovering and developing US gas. In 2006, Chesapeake plans to use 85-90 rigs nationwide, about 20% more than the company has drilling this year.
Chesapeake’s current onshore US leasehold inventory is 4.1 million net acres. The CNR transaction provides an additional 3.5 million net acres of onshore US leasehold and 600,000 net acres onshore in Maritime Canada.
“We are very enthusiastic about the exploration upside associated with moving into the large, prolific, and generally underexplored and unconsolidated Appalachian basin,” McClendon said. “Less than 1% of the 400,000 wells drilled to date have penetrated below 7,500 ft, leaving substantial deeper exploration opportunities.”
Chesapeake’s acreage in the basin will be primarily in West Virginia, Kentucky, Ohio, Pennsylvania, and New York. The basin itself covers 185,000 sq miles.
Basis differentials
Chesapeake began looking at the Appalachian basin 3 years ago. McClendon said the area was appealing because expanding basis differentials-differences between local spot prices and near-month futures prices-increase the premium Appalachian gas receives relative to futures prices and other US gas, which normally sell at a discount to futures prices.
“In this post-Katrina and Rita gas world, some basis differentials in the US now exceed $4/MMbtu, creating a very pronounced value advantage for Appalachian basin gas production, including an approximate 14% value upgrade for the rich btu content [of the gas],” McClendon said. “We believe prices realized on CNR gas production today would be almost $5/MMbtu higher than prices received in most Southwestern and Western US gas basins.”
As a result of hurricane-related supply disruption, the US saw a shortage of gas moving to the Northeast from the Gulf Coast, McClendon said. In early trading on Oct. 4, gas prices in West Virginia were $4/MMbtu higher than in Oklahoma and $4.50/MMbtu higher than in the San Juan and Rockies areas.
Years ago, Chesapeake hedged almost 1 tcf of Midcontinent basis differentials out to 2009 based upon its analysis of the fundamentals behind basis differentials.
“We also determined that most new supplies of LNG would most likely be forced to enter into the Louisiana and Texas Gulf Coast energy corridor,” McClendon said. “We simply did not believe that people on the East Coast would allow more LNG terminals to be built. So we believed all gas produced west of the major pipelines going from the Henry Hub to the East Coast would begin to trade at a deeper discount as a result of the greater imported volumes of Gulf Coast LNG.”
Acknowledging that basis differentials probably will narrow in the months ahead, McClendon expects Appalachia basin gas always will be worth more than gas produced in the West and Southwest.
Appalachia
Chesapeake sees many similarities between its Appalachian acquisition and its traditional Midcontinent stronghold. McClendon said asset ownership is very fragmented in Appalachia, as it was in the Midcontinent 7 years ago.
Appalachian production traditionally was handled by small private companies, a few midsized public independents, and large pipeline companies and utility companies, he said.
“We think the basin is open for a fresh look from a company that is truly an exploration company,” McClendon said. “We believe that Chesapeake’s significant presence in the Barnett, Woodford, Caney, and Fayetteville shale plays, our expertise in tight sand and horizontal coal methane drilling, and our commitment to deep gas exploration will enable us to achieve great success in Appalachia.”
Currently, CNR is drilling with four rigs and has invested $65 million/year in recent years.
“In 2006, Chesapeake expects to increase the pace of spending to around $200 million/year, and we would expect to deliver a 5-10% production growth rate using an average of around 10 rigs,” McClendon said.
The producing formation primarily is Devonian shale. Chesapeake said it has not booked much reserves volume in the Ordovician Trenton-Black River formation or other strata deeper than Devonian shale.
McClendon said Chesapeake plans some drilling and completion techniques not used previously in the area. Horizontal drilling or deep gas exploration could enable Chesapeake to test formations possibly overlooked by others, McClendon said.
For the first year, Chesapeake has what McClendon calls a vertical plan, hoping to find numerous plays below the Devonian.
Midcontinent
Meanwhile, Cheasapeake continues to build, explore, and develop its Midcontinent holdings, where it has conventional gas assets, unconventional assets, and emerging plays.
Chesapeake has acquired 600,000 prospective net acres in the Sahara area of the northwestern Anadarko basin, 100,000 net acres in the Mountain Front Deep Springer play in the western and southern Anadarko, 200,000 acres in the Granite Wash and Cherokee-Atoka Wash plays in the western Anadarko, and 250,000 prospective acres in the Hartshorne coal and Caney, Woodford, and Fayetteville shale plays in the Arkoma basin (OGJ Online, Feb. 22, 2005).
Chesapeake is shooting 3D seismic surveys in its Mountain Front Deep Springer program in western Oklahoma. The previous seismic information was 10 years old.
McClendon expressed optimism for the Granite Wash and Cherokee-Atoka Wash plays across western Oklahoma and in the Texas Panhandle.
“That has proved to be a terrific area for us. We probably have close to 10 rigs working,” he said. Higher gas prices and different drilling techniques have revived the economics of the play.
“The formations once were just an aggravation,” McClendon said. “There was some gas as you drilled but never anything commercial when you produced it. This is all changing, and we are right there in the heart of it.”
Chesapeake is drilling its first well in the Arkoma basin Mississippian Fayetteville shale play, and it plans to drill at least five more before yearend, he said. The company expects to drill thousands of wells there.
“When we announce our third quarter results on Oct. 31, I think people are going to be pleased with the amount of new acreage that we have bought since the second quarter in the Fayetteville shale,” McClendon said.
Chesapeake also seeks more acreage in the Barnett shale near Fort Worth, Tex.
“We have carved out a really nice presence for ourselves in Dawson County. We have six rigs working in that area, and we’re getting great results. We hope to buy more acreage there over time,” McClendon said. “We are not playing the Barnett shale out to the west but are just concentrating on Dawson County.”
Chesapeake has drilled more than 1,000 wells in the Sahara play in northwest Okalahoma. McClendon believes the company has 10,000 more wells to drill there.
“We are virtually in every important play in the country outside of the Rockies,” McClendon said. He has no desire to enter that region, noting that it’s a highly competitive area with poor gas prices compared with the Appalachian basin.
“Everybody wants to be in the Rockies,” McClendon said. “We picked an area where nobody from Houston really wants to go, and we like that.”✦
Career highlights
Aubrey K. McClendon has been chairman, CEO, and a director of Chesapeake Energy Corp. since founding the company with Tom L. Ward in 1989.
Employment
McClendon was an independent oil and gas producer in affiliation with Ward from 1982 to 1989.
Education
McClendon was graduated from Duke University in 1981 with a degree in history. He is a member of the board of visitors of the Fuqua School of Business at Duke University.