Drillbits

It Matters Hardly at All

As Chesapeake Energy seeks to shore up its cash position by taking on a JV partner for its Marcellus shale, a strange, but true back story may be hurting the company's chances. The consummate land man, Aubrey McClendon, might just have outdone himself.

The company’s latest investor presentation gives an implied value of $7,500/acre for its 1.8 mm acres of Marcellus leasehold (US $13.5B). So, a 25% share would be worth $3.4B. On the basis of the previous JV deals, a portion of this amount would be in cash with the balance delivered over time in the form of a drilling cost carry. According to the presentation’s tables, these JV proceeds combined with the proceeds from sales of some producing properties in Oklahoma and South Texas are projected to raise $2.5B to $3.0B. So, $1.7B from the Marcellus would seem reasonable and, thus, a critical piece of the 12/31/08 Ending Cash forecast of $3.5B.

But, there’s a problem. While advocating a lease acquisition and monetization strategy of buy low, sell high, Mr. McClendon noted:

“One of the great advantages of a time like this is we can drive down the cost of our business. That’s not only going to be true soon on the drilling side but it’s especially true today on the leasing side as we are continuing to be very, very aggressive in driving down prices in areas of shale plays so we can acquire leases we think at a lower price going forward.” …..“I can assure you that buying leases for X and selling them for 5X or 10X is a lot more profitable than trying to produce gas at $5 or $6/mcf.”

Now, that’s all well and good, if, as Chairman/CEO of the largest US gas producer, you can somehow profit by professing your abilities as a land man. Call me crazy, but I’d think the best way to profit by buying and selling leases is to keep lease prices in a play high until you sell them, not knock them down while you're still trying. Then, you could tout them by saying, as Mr. McClendon did:

“The neat thing is leasehold is always cheap in a play whether you pay $5,000 an acre or $10,000 or $20,000 or $30,000. In most of these shale plays it matters hardly at all as to what you pay for leasehold because you consume so much leasehold at 80 acres generally a well and these wells can cost $3 million to $6.5 million. So you put some leasehold on top of that, it’s just not much money at the end of the day.”

Instead, what Chesapeake has done in the Marcellus is to be “very, very aggressive in driving down prices”, by effectively pulling out of leasing completely. First in NEPA, then in SWPA, then Range followed suit….then a few smaller operators, then Chief and last week, Marathon. Prices have plummeted to $500 to $2,000/acre, and so have Chesapeake’s chances of doing a JV deal by year end.

More likely is another kind of deal; a deal following a Not Done or Failure to Deliver on the JV; a kind of Bear or Wachovia deal when someone deciding to commit $3.4B for a 25% share of the Marcellus realizes that the entire market cap of Chesapeake is only $10B. And that, if they hold up on the JV, they just might get the whole company for the same number.

Unfortunately, for Aubrey, since getting hit with those margin calls, his vote on the motion………why, it matters hardly at all.

October 15, Business Update Call Transcript