Chesapeake Energy: $3.3 Billion Permian Asset Sale Disappoints

| About: Chesapeake Energy (CHK)
This article is now exclusive for PRO subscribers.

Chesapeake Energy Corporation (NYSE:CHK) announced on September 12 the much anticipated sale of its Permian Basin assets. Given the highly prospective location of Chesapeake's acreage, the $3.3 billion sale price is disappointing, both in comparison to other recent transactions and Chesapeake's own initial guidance (in the $4-$6 billion range, although for a larger set of acreage).

Chesapeake has entered into a purchase and sale agreements to sell:

  • 618,000 net acres in the southern Delaware Basin (West Texas) portion of the Permian Basin, including 26,000 Boe/d of existing production, to Royal Dutch Shell plc (NYSE:RDS.B) for $1.935 billion (see the acreage map below);
  • 246,000 net acres in the northern Delaware Basin (New Mexico) portion of the Permian Basin to Chevron Corporation (NYSE:CVX) (price and associated production not disclosed);
  • 166,000 acres in the Midland Basin portion of the Permian Basin to privately held EnerVest, Ltd. (transaction previously announced; price and associated production not disclosed).

Chesapeake is retaining approximately 470,000 net acres of undeveloped leasehold in the Midland Basin "for future sale or development," however the wording in the company's press release that the three announced sale agreements cover the "vast majority" of its Permian Basin assets may indicate that Chesapeake is not expecting to sell its Midland Basin acreage for anything close to the price it is receiving in the three announced transactions. The fact that almost all of Chesapeake's recent drilling activity in the Permian was concentrated in the Delaware Basin also indicates that the sold properties represented Chesapeake's most prospective acreage in the Permian.

(click images to enlarge)

(Source: Royal Dutch Shell September 9 2012 Press Release)

Chesapeake has been an active driller in the Permian, and operated approximately 13 rigs in the Delaware portion of the Basin as of July. Parts of Chesapeake's acreage are prospective for the Bone Spring (tight oil-bearing sandstone formation, which in some locations, has shown excellent economic results when developed with the horizontal frac technology), as well as the Avalon shale, Wolfcamp shale, and several other emerging oil and "combo" plays, both horizontal and vertical. In total, the assets being sold produced approximately 21,000 bbl/d of oil and NGLs and 90 MMcf/d of natural gas during Q2 2012. The amount of corresponding proved reserves was not disclosed.

Based on this very limited information and using certain assumptions with regard to future production declines, oil-NGLs-gas mix, and operating economics, I estimate that the amount of proved developed reserves associated with the production sold was in the 85-105 MMBoe range with an estimated PV-10 value of $1.3 billion-$1.8 billion, based on the current commodity strip prices. The balance of the price paid in the transaction implies a valuation of $1,500-$2,000 per undeveloped acre. While this valuation exceeds the likely "retail" price that Chesapeake had paid to assemble its acreage position in the Permian, it clearly is on the low side, given the strategic size of the package in this multiple stack oil-prone province.

The announced sale also falls short of the valuations implied by the recent Permian transactions by Devon Energy (NYSE:DVN) and Concho Resource (NYSE:CXO):

  • On August 1, Devon announced its agreement to sell 195,000 net acres (30% of its interest in about 650,000 net acres) in the oil-rich Cline and Midland Basin Wolfcamp shales in West Texas to Japan's Sumitomo Corp. in a deal valued at about $1.4 billion. The deal valued the largely exploratory acreage (minimal amount of production) at nearly $7,200 per undeveloped acre. Sumitomo agreed to pay $340 million in cash at the closing, and committed an additional $1.025 billion toward funding the joint venture's drilling, covering 70% of Devon's capital requirements. Devon will serve as the operator of the project and be responsible for marketing. It should be noted that JV transactions and their metrics are not directly comparable to those of asset sales.

(Source: Devon Energy September 2012 Barclays Energy Conference Presentation)

  • In May, Concho agreed to acquire 200,000 net acres (65% HBP) in the Permian Basin, including large positions in the northern Delaware Basin, the Midland Basin Wolfberry play, and the emerging southern Midland Basin horizontal Wolfcamp and Cline shale plays from the privately held Three Rivers Operating Company for $1.0 billion in cash. The transaction included estimated proved reserves of approximately 58 MMBoe (50% oil and 55% proved developed) and net production of 7,000 Boe/d. On the acquired properties, Concho had identified approximately 380 drilling locations in the Delaware Basin, almost all of which were unproved, and over 1,100 vertical drilling locations in the Midland Basin, of which over 740 were unproved. Based on the limited disclosed information, I estimate the value of the acquired proved developed reserves in the $300 million-$450 million range. This implies a valuation of approximately $2,750-$3,500 per undeveloped acre, substantially higher than what is implied by the CHK sale transactions.

The relatively low implied price received for the undeveloped acreage may reflect a variety of factors, including the percentage of the acreage prospective for the most promising oil-bearing formations, HBP status and lease expirations, operatorship, infrastructure, etc. The significant size of the acreage block offered for sale may have also played a role. Even with the properties split into three bite-size pieces, the large size of the transactions naturally limits the number of operators capable of coming up with the required amount of cash.

Despite the low implied valuation, the transaction has positive implications for stocks with portfolios exposed to the Permian emerging resource plays, such as Concho Resources, Cimarex Energy (NYSE:XEC), Laredo Petroleum Holdings (NYSE:LPI), Approach Resources (NASDAQ:AREX), and several others. The transaction signifies a strong endorsement by the oil majors of the basin's development potential. The deal also takes off the market and puts in firm hands a very large acreage package, tightening the supply and potentially improving the valuation for future transactions.

In addition to the Permian transactions, Chesapeake announced that it had sold, in four separate transactions, "noncore leasehold assets in the Utica Shale and various other areas" for approximately $600 million. Following these transactions, Chesapeake will continue to own approximately 1.3 million net acres of leasehold in the Utica Shale, in which its cost basis, net of various sales and its joint venture with Total (NYSE:TOT), will be approximately $200 per net acre (including all drilling carries in the Total joint venture).

Chesapeake's big upstream sale is not over. This year alone, the company may try to raise another $1.0 billion-$3.0 billion in divestiture proceeds. CHK has previously announced its intention to form a joint venture for its 2 million acre Mississippian Lime position (partial sale is not being ruled out). CHK may also try to divest parts of its non-priority portfolio, which includes interests in the Woodford shale, DJ Basin Niobrara and Northern Michigan.

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.