Chesapeake Energy Corp., Oklahoma City, (NYSE: CHK) will expand its U.S. gas strategy into the Appalachian Basin with the acquisition of Columbia Natural Resources LLC from West Virginia-based Triana Energy Holdings LLC. The deal is for $2.2 billion in cash and the assumption of an estimated $75 million working-capital deficit and up to $775 million of liabilities related to CNR's prepaid sales agreement and hedging positions. The purchase is Chesapeake's largest to date. The company anticipates acquiring an estimated 2.5 trillion cu. ft. of natural gas equivalent of proved, probable and possible reserves, including 1.1 trillion of proved (99% gas; 70% proved developed; 1,140 average Btu content). CNR's 3P reserves are estimated to be 3.9 trillion equivalent, or 56% more 3P reserves than Chesapeake will initially recognize. CNR's current daily net production is approximately 125 million equivalent. It reports a proved reserves-to-production index of 23 years and a proved developed reserves-to-production index of 16 years. The properties are principally in West Virginia, Kentucky, Ohio, Pennsylvania and New York. Chesapeake allots $175 million of the $2.2-billion purchase price to CNR's midstream gas assets and $500 million to an unevaluated portion of CNR's 4.1 million net leasehold acres, 3.5 million net in the U.S. and 0.6 million net in Canada. Chesapeake estimates its acquisition cost for the 1.1 trillion equivalent of proved reserves at about $1.45 per thousand equivalent. Its all-in cost of acquiring and developing the 2.5 trillion equivalent of reserves will be about $2.48 per thousand equivalent, the company reports. Triana was formed in 2001 by former CNR managers and by executives of Metalmark Capital LLC as a Morgan Stanley Capital Partners portfolio company. Triana purchased CNR in September 2004 for $330 million from Nisource Inc. At the time, CNR had proved reserves of 1.1 trillion cu. ft. equivalent and a forward-sales contract for 94 billion cu. ft. of gas through 2006. Chesapeake reports it has identified 1,316 proved undeveloped locations, 6,286 probable locations and 1,833 possible locations for a total of 9,435 undrilled locations, or an estimated drilling inventory of more than 15 years. As of June 30 and pro forma this acquisition, Chesapeake will own an internally estimated 13.5 trillion equivalent of reserves, including 7.1 trillion proved (92% gas, 100% onshore). Aubrey K. McClendon, Chesapeake chairman and chief executive, says the acquisition represents an opportunity to move into "the large, prolific and generally underexplored and unconsolidated Appalachian Basin...We are also attracted to the value proposition of producing natural gas at a premium price to Nymex. "In addition, we are eager to begin working in a large U.S. natural gas basin that shares many similarities to our stronghold in the Midcontinent." Morgan Stanley analyst Lloyd Byrne says, "While the $2.86-per-thousand-cubic foot-equivalent, full-cycle development cost appears high based on history, gross margin today is actually higher than in the past. "This is relevant, given the current shape of the futures curve, as Chesapeake anticipates hedging at least 50% of the production through 2008. Should [it] go even further out, given reserve life of the asset?" Chesapeake will finance the acquisition from cash on hand and by issuing stock and debt. Standard & Poor's Ratings Services affirmed Chesapeake's BB/B-1 corporate credit rating with a stable outlook. "We expect Chesapeake to finance the CNR acquisition using the company's general 50% debt/50% equity philosophy. Any significant deviance from that philosophy could prompt a negative rating action." Closing is expected by Dec. 15. Morgan Stanley & Co. Inc. and Credit Suisse First Boston LLC advised Triana.
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