Chesapeake Energy: Oklahoma Asset Sales May Surprise To The Upside

| About: Chesapeake Energy (CHK)

Chesapeake Energy Corporation (NYSE:CHK) has initiated a process to sell two significant asset packages in the Anadarko Basin in Oklahoma as part of the company's continued effort to reduce its budget deficit. The first package includes 40,000 net acres in the core of the southern extension of the Cana Woodford Shale play. The second package comprises approximately 28,000 acres adjacent to the Colony Wash Field. While the size of the properties put on the block is small in comparison to the roughly one million acres in the Permian Basin that Chesapeake agreed to sell a month ago for $3.3 billion, the company may be able to generate as much as $0.7-$1.0 billion, in my estimate, from the sale of these two assets.

With the market focused mostly on Chesapeake's larger divestitures, the proposed divestitures have received very little attention from analysts. A sale announcement may come as a positive surprise to the market (the Woodford Shale sale, if successful, could be announced within the next few weeks). The proposed sales involve relatively little existing production and should be accretive to Chesapeake's credit metrics. The transactions, particularly if priced closer to the high end of the estimated range, would illustrate the significant "hidden" value potential of Chesapeake's vast acreage portfolio.

South Cana Woodford Assets

In the first package, Chesapeake is selling approximately 40,000 net acres (80,000 gross) located in the heart of the southeast extension of the Cana Woodford Shale play within Grady, Stephens and Garvin Counties of Oklahoma; 98% of the leases are held by production. The bids are due October 19 (Meagher Energy Advisors are managing the sale). The selling summary states that "CHK is planning to exit its legacy Chitwood-Knox area because it does not have the drilling budget to adequately develop the abundant additional opportunities in the area."

In my estimate, a portion of the acreage is located within the most productive part of the condensate window in the southeast corner of Grady County and the northeast corner of Stephens County, as well as along the prospective western flank of the play's oil window. Some of the acreage may also extend into the deeper (and, arguably, less valuable) dry gas window. Assuming that only half of the acreage is within the narrow "premium" sector of the fairway, the package may have, in my estimate, a value as high as $475-$750 million (I attribute approximately $75-$100 million value to the 14 MMcf/d of net existing production and wells in progress, $15,000-$25,000 per acre to the assumed 20,000 net acres within the most productive part of the acreage, and $5,000 per acre to the remaining 20,000 net acres).

The rationale for the high per-acre valuation for the "sweet spot" acreage is best illustrated by the slides from a recent Continental Resources' (NYSE:CLR) presentation which show a remarkably thick, premium quality Woodford Shale deposition underlying the area in which a significant part of Chesapeake's acreage is located (Continental refers to the southern extension of the Cana Woodford play as "SCOOP," which stands for South Central Oklahoma Oil Province). On the map below, Chesapeake's acreage is located inside and in the vicinity of the larger dark spot approximately in the middle of the "SCOOP" ellipse (the darkest shading indicates the thickest shale).

Click to enlarge
(Source: Continental Resources October 9, 2012 Analyst Day Presentation)

The slide below shows a cross-section of the Woodford shale zone along the red line from the map above. CHK's acreage should be located close to the middle of the right hand side V-shaped cone ("SCOOP").

Marathon Oil (NYSE:MRO), Continental, and Newfield Exploration (NYSE:NFX) are the three largest acreage holders and operators in this area. Marathon may have the most significant overlap of the acreage positions with Chesapeake in the Knox Field area. Arguably, each of the three companies would be a logical acquirer of Chesapeake's acreage. However, the block's multi-year inventory of drilling locations and exceptional economics make the acquisition by a "newcomer" to the play also possible. Devon Energy (NYSE:DVN) and Cimarex Energy (NYSE:XEC), who have large operated leaseholds in the original Cana Field, have missed out on the southern extension play and may also be among potentially interested parties.

The selling summary states that the acreage has significant development upside in the Woodford Shale and supports drilling of an additional 476 net horizontal Woodford wells (1,379 gross) with expected "post processing" EUR per well of 2.1 MMBoe (6.3 Bcf of gas, 220 Mbbls of oil and 830 Mbbls of NGLs) and net PV-10 per well of $11 million, based on a $9 million completed well cost. Average royalty burden is 17.857%. There are currently 24 non-operated wells waiting on completion and 10 non-operated wells drilling (9 horizontal and 1 vertical).

If one were to apply a deep "haircut" to both the number of viable drilling locations and the PV-10 value suggested in the listing, giving credit to 300 potential net well sites with $8 million PV-10 value, the estimated M&A value of the Woodford undeveloped potential would still be above $500 million (I apply a 15%-20% discount rate range and assume a five-rig development program). The biggest potential limitation to the valuation could be from the tightness of the NGL processing and off-take capacity in the area which may impact the play's economics and delay the development.

Average production per day from the properties for the twelve-month period ending 5/31/2012 was 342 barrels of oil, 240 barrels of NGLs, and 10,747 MMcf of natural gas (approximately $1.7 million per month net operating cash flow). The production comes from 289 wells (138 operated and 151 non-operated) from a variety of producing formations, which include Sycamore, Woodford (vertical & horizontal), Hunton, Viola, Simpson, Hoxbar, Deese, Morrow and Springer.

In addition to the Woodford potential, the properties offer development opportunities in other zones of the multi-stack stratigraphic column, including: 40-acre vertical infilling of commingled Sycamore (Mississippi Lime equivalent), Woodford, Hunton, Viola & Simpson; scattered pockets of vertical potential in the Deese, Morrow & Springer; possible horizontal development of the Sycamore, Hoxbar, Deese & Springer.

Colony Granite Wash Properties

The second package offered for sale includes a contiguous block of approximately 28,360 net acres located directly west of the Colony Wash Field within six townships in Beckham, Custer and Washita Counties of Oklahoma. Bid date is November 20, according to Meagher Energy Advisors' listing (Meagher is managing this sale as well). The acreage is prospective in multiple zones, including Des Moines Granite Wash, Hogshooter Wash, Cottage Grove, Red Fork, Atoka and Morrow. Of the approximately 100 gross sections included in the block, 51 sections are held by production and 43 sections are operated.

(Source: Meagher Energy Advisors' listing).

The Colony Granite Wash play was discovered by Chesapeake in February 2007 and is a subset of the greater Granite Wash plays of the Anadarko Basin. Chesapeake has been the largest leasehold owner and most active driller in the Colony Granite Wash with approximately 60,000 net acres, predominantly in Custer and Washita counties in Oklahoma. Last year, CHK created and took public Chesapeake Granite Wash Trust (NYSE:CHKR). Chesapeake's royalty arrangements with the Trust cover approximately 29,000 net acres in the Colony Wash Field located to the east of the West Turkey Creek properties being offered for sale.

Average net production from the West Turkey Creek area over the twelve-month period ending July 2012 was approximately 19 MMcfe/d (765 bbls/d of oil, 684 bbls/d of NGLs, and 9.9 MMcf/d of natural gas). Net operating cash flow for the period averaged $3.2 million per month. There are 117 wells (113 producing, 2 horizontal wells currently drilling and 2 shut in). Average royalty burden is under 20%.

The M&A value of this package could be, in my estimate, in the $250-$400 million range. That includes $75-$100 million estimated value of the existing production. In a comparable transaction last summer, Apache Corporation (NYSE:APA) paid $2.85 billion to acquire Cordillera Energy Partners III, a privately held company with approximately 254,000 net acres in the Granite Wash, Tonkawa, Cleveland and Marmaton plays in western Oklahoma and the Texas Panhandle and 18,000 Boe/d of production. Apache's acquisition was approximately eight times larger than the West Turkey Creek acreage in size and 6 times larger in terms of associated production.

Other Divestitures

Additional proceeds that Chesapeake may generate from asset sales this year may be significant. The biggest remaining piece in Chesapeake's divestiture program for this year is a potential joint venture in the Mississippian Lime play in northern Oklahoma and southern Kansas. In addition, last summer Chesapeake also listed significant acreage positions in Michigan, Colorado and Wyoming with Meagher. The listings are still shown as "open," although some of the properties may have been sold and included as part of the "various other" category in Chesapeake's September 12 asset sales announcement:

…In four separate transactions, Chesapeake has recently sold or entered into purchase and sale agreements to sell noncore leasehold assets in the Utica Shale and various other areas for approximately $600 million, the majority of which has already been received.

If all the announced asset sales came to fruition, Chesapeake could potentially generate over $2.5 billion in total consideration.

Disclaimer: This article is not an investment recommendation and does not provide a view on the value or price direction of any security. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.