Chesapeake Scores

For one Saturday in October, Texans and Okies don’t particularly get along, as the universities of Texas and Oklahoma square off in the Cotton Bowl. On the other 364 days of the year, though, the two states are united by their common energy bond. The relationship has only been strengthened by the announcement of a joint venture between Oklahoma City-based Chesapeake Energy (NYSE: CHK  ) and Houston's Plains Exploration & Production (NYSE: PXP  ) .

It's a straightforward deal, and I think it's another example of the steady leadership that Chesapeake CEO Aubrey McClendon and his team have provided for their company and its shareholders. Chesapeake will sell a 20% interest – or about 110,000 acres -- in its promising Haynesville Shale gas play in northeast Texas and Louisiana to Plains for $1.65 billion.

There are a couple of other key points to the newly announced deal:

  • As Chesapeake buys more acreage in the Haynesville, Plains will be able to maintain its 20% interest.
  • Plains will fund half of Chesapeake's 80% share of drilling and completion costs on Haynesville wells, until it's spent another $1.65 billion.

It appears that the Haynesville is turning into the whopper of a play that McClendon has indicated for several months now. The first eight wells drilled there have had initial production rates of 5 million to 15 million cubic feet of natural gas equivalent (mmcfe) per day on restricted chokes. Without lapsing into more jargon, I'll just say that that's Texan -- or Okie -- for “big gas wells.”

On the basis of these early tests, it appears that the Haynesville represents considerably more reserve potential than either the Barnett Shale or the Fayetteville Shale, two other big Chesapeake plays. Specifically, the company now pegs the midpoint of the Haynesville's estimated ultimate reserves (EUR) at about 6.5 billion cubic feet of natural gas equivalent (bcfe).

That compares to estimates of 2.5-3.0 bcfe for the Barnett and 2.2-2.8 bcfe for the Fayetteville. Further, and more importantly, the Plains transaction effectively places an impressive $16.5 billion value on the company's Haynesville acreage -- clearly more than the market had been giving for the play.  

I suppose the solid management that's made evident again in its new venture has Chesapeake poised to move past BP (NYSE: BP  ) and Anadarko (NYSE: APC  ) as the largest natural-gas producer in the U.S. It's also the primary reason why the Motley Fool Inside Value selection's share price has about doubled in the past year. And finally, it's why I believe those same shares should remain close to the top of Foolish watch lists.

Further clean-burning Foolishness:

Chesapeake Energy is an Inside Value recommendation. Try out the value-focused newsletter service free for 30 days.

Fool contributor David Lee Smith doesn't own shares in any of the companies mentioned, but he is endeavoring to be adopted by Aubrey McClendon. He welcomes your comments. The Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 03, 2008, at 1:00 PM, carbonates wrote:

    To be more clear, it should be pointed out that your number of 6.5 Bcfe is PER WELL, not for the whole play. When stating these types of figures for gas shales it also becomes important to state the number of acres that this recovery will come from. While I don't know where your numbers came from, I do know that Chesapeake is planning 80 acre spacing, suggesting they have the potential to drill 6,875 wells on the acreage they now have under lease.

    Chesapeake has publicly stated they believe they have about 20-22 Tcfe ultimate recovery potential for this play. That works out to a price to PXP of about 39 cents per mcf. If you add in the additional $1.65 Billion PXP has committed to drilling costs, that tells me that PXP may have gotten the better end of the deal here. In any case, if the play has results as promising as Chesapeake expects (and it may not) both companies have added a significant amount to future revenues. My own rough numbers suggest they may be making about $26 Million per well, or a total of $179 Billion, with no calculations for overhead beyond drilling costs or net present value figured in. Not a bad deal. The majors appear to have missed the boat on gas shales.

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