Thursday, Chesapeake Energy Corp. (NYSE:CHK) announced that it was completing two land-leasing deals – on property in the Utica Shale basin – worth as much as $3.4 billion. Chesapeake will bring in an "international major energy company" to jointly develop some of its Utica acreage. The company is not naming the major, but says the deal should be completed next month.
This marks the beginning of a new stage in shale gas development.
Chesapeake, as you know, is the second-largest natural gas producer in the country – after Exxon Mobil Corp.(NYSE:XOM) – and by far the largest independent.
Earlier this year, the company announced that it valued the land it controls in eastern Ohio at $20 billion. That set off a flurry of activity in the region. See, the Utica is somewhat special. It is an ultra-deep shale formation. Its producing regions in eastern Ohio and western Pennsylvania lie below the Marcellus – at depths of 12,500 feet and more. And as a concave-structured basin, the Utica grows closer to the surface as you move into central Michigan, but the anticipated volume extractable also declines.
Because it is so deep, it is far more expensive to develop than shallower shale plays. The average Utica well costs more than $8 million to drill, as compared to about $3 million for a "normal" shale play. However, it also carries some major potential advantages:
- For one thing, this is dry gas. That means there is far less processing expense involved than with "wet" gas – volume that has other constituents (some value-added) that need to be separated from the main gas flow.
- Second, the "pay zones" (the strata in which the hydrocarbons actually sit) are wider than in higher drilling locations. It is more expensive to reach the deeper level, but there is more target volume once you reach it.
- Additionally – and this is one of the primary attractions of dry volume – there is also the potential for significant crude oil in the pay zone, along with the gas. That boosts the profitability and makes higher costs well worth the trouble.
In some ways, the Utica shale is the perfect stage for what's coming.
The Chesapeake/Utica Model: A Potential Game-Changer
Now, it's not the farming-in of a foreign company that is new. Chesapeake has been quite successful in doing just that in earlier projects. It brought Norwegian major Statoil (NYSE:STO) into the Marcellus, Chinese CNOOC Ltd. (NYSE:CEO) into Eagle Ford in Wyoming, and French Total (NYSE:TOT) into the Barnett.
In each case, the foreign major paid more than $1 billion for 25% of the project, and agreed to accept responsibility for covering initial development costs, but CHK retained operating status.
From a regulatory and political standpoint, this approach overcomes concerns that foreign companies – especially Chinese – would end up owning drilling projects inside the U.S. CNOOC (or Statoil or Total or…) comes in as a minority partner. A U.S.-owned and run company still calls the shots.
But the Utica development Chesapeake announced Thursday is different, and it's going to usher in a new era in how we develop the vast unconventional reserves in this country.
International Access to U.S. Assets
Chesapeake continues to control the project, as before, with the foreign major essentially remaining a minority partner in a joint venture. In this case, however, the foreign major is leasing the land itself, not simply contributing to the E&P (exploration and production) budget. And that opens up a new dimension in international access to American assets.
In some cases, the foreign company's most important considerations are access to U.S. technology, expertise, field practices, and analysis.
That's certainly true with Chinese majors. China is now regarded as having the largest shale gas reserves in the world, and Beijing is committed to moving on their development as quickly as possible. And they need us to show them how to do it most efficiently.
In most other cases, however, the company entering into a venture just wants to book a portion of the field reserves as its own. This is the primary interest among publicly traded companies worldwide, anyway, since it's the most direct route to improving share value. Control over the lease, therefore – even if it is not complete – accomplishes the book-to-share value objective.
The move will also pop the price of the U.S. stock – in this instance, CHK.
Development costs are becoming a major consideration as shale gas extractions expand. This is especially the case with basins such as the Utica, where costs are higher than in many other locations.
Having an American producer control a mega domestic project, but deflecting large chunks of the expense to a foreign company, would seem an ideal solution. In the Chesapeake scenario, however, it all depends who the "internal major" in this deal turns out to be. That's because, in an election year, the identity of the "big pocket" foreigner acquiring leases of American acreage may be all that is needed to start a political firestorm.
Just ask those at Unocal Corp. a few years ago. In 2005, the California oil company ended up getting acquired by Chevron Corp. (NYSE:CVX). But the price Chevron paid was much lower than the one offered by a competing bid. Congress actually intervened to prevent that competing acquisition, even though it would have provided shareholders with an even greater return.
The move was widely regarded as protectionism, because the competing bid came from CNOOC.