Monday, October 4, 2010

Chesapeake Pre-Sells More Production

Chesapeake Energy announced today that it has entered into yet another volumetric production payment (VPP) for natural gas production.  The new agreement, the company's eighth in three years, is with British investment bank Barclay's PLC, which is paying $1.15 billion for five years of production from a portion of Chesapeake's wells in the Barnett Shale.  The deal covers assets containing 390 Bcf of proved reserves that  currently produce 280 MMcf/day.  Unlike a joint venture, a VPP covers specific producing assets for a particular period of time.  The buyer provides an upfront fee for the commodity but doesn't own the land or specifically fund future drilling costs.

The valuation implies a price of $4.11/MMcf based on the current production but $2.95/MMcf based on the proved reserves.  Analysts are not entirely happy to see Chesapeake lock in a price below $3.  It is a testament to the unhappy outlook for natural gas commodity prices.  It can also be viewed as a negative comment on Chesapeake's business plan of getting out front in all of the new plays and outspending the competition.  How sustainable is the strategy if gas prices remain low for a long time?

While I have concerns about the deal's implications, I think it more reflects the necessary "risk premium" to get the deal done in the current environment rather than desperation by Chesapeake to generate cash.  That said, however, I do have concerns about the viability of Chesapeake's business strategy if the company can't generate more value from pre-selling production going forward.

No comments: