Analyst Says Sale by Chesapeake Of Shale Assets 'a Natural Evolution'

Chesapeake Energy Corp.'s decision to sell $5 billion worth of Fayetteville Shale assets may has as much to do with its balance sheet as it does with the long-term viability of the north-central Arkansas natural gas reserves, according to an industry analyst.

"This is something that happens in the business over and over again," Chris McGill, managing director of policy analysis for the American Gas Association, said of last week's announcement. "It's called flipping a piece of your position. In most cases, it's simply there to get something back."

As of Sept. 30, the publicly traded corporation headquartered at Oklahoma City reported nearly $15 billion in long-term debt - so much that its public filings included a plan to pay off 25 percent of that debt by 2012. Proceeds from the recently announced sale - together with the company's joint venture with China National Offshore Oil Corp. - should retire between $2 billion and $3 billion of shorter-date senior notes as well as reduce bank debt.

Exploring for gas in shale plays like the Fayetteville is an expensive proposition, with most of the cost on the front end.

"They could be paying a thousand dollars per acre or more in one of these play areas," McGill said. "A million acres, which certainly a company the size of Chesapeake could have, at a thousand an acre - that's a billion dollars right out of the chute, and you haven't produced anything yet."

And even when production does begin, companies are not likely to see a fast return. "Even if you started drilling, even if you started making money on gas, you're probably still way more invested in than you are getting out. It's just a natural evolution of the business portion of it to turn or to flip in order to improve or change your cash position."

Chesapeake's competitors in the Fayetteville Shale may also have had something to do with its decision to sell, McGill said.

"In terms of the Fayetteville Shale specifically, Chesapeake was competing against Southwestern Energy," he said, referring to the Houston corporation that is the largest exploration company working in Arkansas. "I don't know precisely how 'good' their acreage was compared to others."

Kathy Deck, executive director of the Center for Business & Economic Research at the University of Arkansas' Walton College of Business, said that Chesapeake's announcement wasn't surprising considering the depressed price of natural gas.

"When you look back over when we did a study at the beginning of the Fayetteville Shale [development], natural gas prices were much higher. It is not surprising that these companies are seeing a lower return on their investments than they expected back in the beginning."

Deck agreed with McGill that ownership change was a natural part of the natural gas business.

"I don't think it's surprising, and I think that we would expect to see over time companies either shedding assets or being acquired by other companies and buying and selling strategically," she said.

The timing, according to McGill, is also pretty much on track.

"Usually this kind of thing happens in the three- to five-year time frame once a play gets started, and that's kind of where a lot of shale plays are right now. We're seeing a lot of this turning of acreage. What we're seeing today is really a natural evolution. I would call it almost typical of a resource development. It's not that particularly different than things I've seen for 30 years."


Who Will Buy?

Chesapeake, the second-largest player in the Fayetteville Shale, gave no clue as to who might buy the assets it has on the block, which include about 415 million cubic feet of natural gas equivalent production per day and about 487,000 net acres of leasehold. Chesapeake is also selling its 25.8 percent interest in Frac Tech Holdings LLC of Cisco, Texas, and its 20 percent interest in Chaparral Energy of Oklahoma City, which operates a handful of wells in Crawford, Johnson and Logan counties.

Jim Gipson, director of media relations for Chesapeake, said that it would still be a few weeks before the company could talk definitively about potential buyers and what the sale of the assets could mean for Chesapeake's employees in Arkansas.

Both McGill and Deck believe that Exxon Mobil Corp. could be a possibility. Last year, Exxon Mobil bought XTO Energy Inc. of Fort Worth, Texas, which was the third-largest player in the Fayetteville Shale. Then in December, XTO Energy announced that it would buy $575 million in Fayetteville Shale assets from Petrohawk Energy Corp. of Houston, the fourth-largest gas producer in Arkansas.

McGill said that though Exxon stayed out of the initial "shale frenzy," it is now positioned to benefit from its decision to wait. Companies that get involved in shale play often experiment with technology at the beginning of shale exploration. A company as big as Exxon, however, can "come in and just buy" other companies and benefit from the technology that's already been established.

"Whether Exxon has a strategy to come in and build a bigger corporate presence in the Fayetteville Shale ... I have no idea," McGill said. "But they certainly have the wherewithal and the financial wherewithal to move into this play as a purchaser of acreage and resources, not necessarily as an initial developer of them."

Deck said it was still too early to tell whether the sale of Chesapeake's assets would prove to be good or "catastrophic" for the Fayetteville Shale. "It depends on the strategic direction of the purchasers. It depends on the price at which these assets are sold, and on wherever the purchasers are in their plan."

In an e-mail to Arkansas Business, Gipson said that the sale was expected to be completed in the "first half of 2011."