Wednesday, July 1, 2009

Big News, Big Capital

News of EXCO's joint venture deal with BG Group for its Haynesville Shale acreage (see post below) has generated lots of press in the past couple of days (WSJ, Bloomberg, overseas, among others). I think this is partly the result of the dearth of big deals this year and the attractive pricing of the transaction. It was a full priced investment by BG rather than a bottom fisher snapping up assets on the cheap. A feel good story for the economy.

But this is an important deal for lots of reasons. I made the comparison earlier to other deals made between domestic shale players and multinational oil and gas companies. The interest by international players is something we will continue to see. The U.S. shale plays will become the great demonstration grounds for advanced natural gas technology that will be used to tap shale plays all over the world. I wouldn't be surprised to see other foreign producers like France's Total, S.A. partner with U.S. shale players. Chesapeake is the recognized leader in technology (I can't say that for sure, but the market seems to believe it), but technology transfers quickly in the oilfield, so Chesapeake isn't going to be the only desirable partner.

The other big concept in play with this deal is the need for massive amounts of capital to successfully exploit the Haynesville Shale. Based on the geology in hand, companies can be fairly certain that they won't drill a dry hole. But there is a different kind of risk involved, one that is more Wall Street than oilfield.

Because there was a massive land rush to acquire acreage, much of which went for inflated prices, most of the Haynesville participants have already expended large quantities of cash. Because leases expire in three to five years, they must now drill and produce to avoid relinquishing the leases. The clock is ticking and the price of gas doesn't show signs of improving. Since drilling deep horizontal wells can cost between $7 million and $10 million a pop, producers need to expend lots of money very quickly. The payoff can be huge, but they have to be able to climb the mountain first.

That's why we've seen so many debt and equity offerings in the past year, and it's why the credit crunch really hit the exploration companies. Big companies like Chesapeake, Petrohawk, XTO and the like can now access the capital markets - at a price - while little guys like Cubic are often shut out.

In its presentations, Chesapeake often talks about the shale "haves" and "have nots," inferring that gas producers who have not joined the shale frenzy will be handicapped for years to come. Not stated is that to be a "shale have" a company needs to take on a great deal of financial risk. It's great to be a "shale have" but it is no panacea because the financial risk a company undertakes can hobble it for years to come and ultimately (or quickly) put it under.

I think we are going to see more deals where explorers sell off a portion of their leased acreage or bring in a joint venture partner because they've bitten off more than they can chew. It reminds me of the Far Side cartoon where the dog catches the car. That's great, but what do I do with it now?

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