Watching Chaparral Energy Inc. develop its CO2 tertiary-recovery business in Oklahoma and Texas, Aubrey K. McClendon, an astute observer of industry trends, knew he wanted to buy the company. After all, Oklahoma doesn't have a good source of CO2, notes the chairman, president and chief executive of Oklahoma City's Chesapeake Energy Corp.

Despite the lack of Sooner CO2 sources, privately held, Oklahoma City-based Chaparral had gained control of outlets from a couple of fertilizer plants in the state and used their CO2 to reinvigorate a couple of oil fields. It was looking for more such opportunities.

At the same time, Midwestern U.S. production of ethanol has been growing, and the No. 1 byproduct of ethanol manufacturing just happens to be CO2.

"It's a virtuous cycle with value creation that could really separate Chaparral from other up-and-coming companies," McClendon says. "Everybody needs a hook. For Chesapeake it has been horizontal drilling and unconventional resources; for Chaparral, it will be tertiary recovery in oil fields using CO2."

Hence, Chesapeake's interest in Chaparral. But Mark Fischer, Chaparral president and CEO, had no interest in selling the company.

Instead, he had an eye on growing it, particularly by obtaining the North Burbank Unit in Oklahoma. The North Burbank is the single largest oil unit in Oklahoma and has a large prospective amount of remaining production that could be realized using CO2 tertiary-recovery methods.

The field has produced approximately 315 million barrels of oil through primary and secondary recovery. Fischer anticipated that, by using generalized recovery factors for tertiary operations, he could recover more. He thus estimated the North Burbank Unit still holds some 160 million barrels of oil that could be recovered through use of CO2.

He too encountered a problem with his acquisition plan: The field was owned by privately held, Tulsa-based Calumet Oil Co., which had no plans to sell.

In the end, however, these transactions were achieved, with the application of creative deal-making acumen to oilfield opportunity. Chesapeake convinced Fischer to sell it a 32% stake in Chaparral. Armed with capital from that deal, Fischer eventually walked away owning not just the North Burbank Unit, but Calumet in its entirety.



Done deals

The road to purchasing oil and gas properties that aren't for sale has forks and detours. Although it failed to acquire Chaparral, Chesapeake was willing to invest in it, if that was the only way to gain access to Chaparral's work in CO2-enhanced recovery.

McClendon decided to invest $280 million in Chaparral for the 32% stake. This was the sum of the amount needed to partially buy out the original investors in Chaparral, to allow Fischer to take some of his own money off the table, and to provide capital that Chaparral needed to persuade Calumet to sell, McClendon explains.

Now that Chesapeake owns a stake in CO2-enhanced oil recovery through Chaparral, McClendon says he doubts Chesapeake will venture down that path itself. "Now that Mark and his team have already started down that road, it would be a little tough for us to go around them. I think he's done enough preliminary work to make it difficult for anyone to compete with his Oklahoma CO2 ideas," he says.

"He has the first-mover advantage and he has been able to box out some other people. That's why we felt there was so much upside embedded in the company and decided to invest in it."

McClendon had been wanting to buy Chaparral for several years. "I've always admired Mark and his company. They have a good base of production in Oklahoma and Texas. We thought they would make a good acquisition for Chesapeake, but Mark had other plans."

Indeed, Fischer wanted to continue as president and CEO of Chaparral. Although he wasn't ready to exit, he was ready to do something, enabling his investors to liquidate their equity and enjoy the fruits of their 18-year investment. That was easier said than done.

Fischer says, "We had been trying to provide some equity to some of the stockholders who had been with me since the beginning." A couple of years ago, he tried to do a private placement, but did not meet with much success. "We then went down the route of a reverse-merger with a public company, and we did not have any better success with that."

The company filed to go public in an IPO, but this fell apart in April 2006 when energy-stock prices declined. "We then turned back to a private-equity scenario, and as you might expect, Chesapeake's name came up."

After the equity sale to Chesapeake, Fischer paid off investors and had $102 million left, an amount he needed to convince Calumet to sell the North Burbank Unit.

"When we initially approached Calumet several years ago, they pretty quickly told us they had no interest in selling," Fischer says. "But with my tenacity, I just stayed after it."

A major roadblock was that reserve information was hard to get. "Calumet was private and didn't have any debt, so there were no internal reserve reports, no third-party reserve reports and no reports done for the bank," Fischer says.

And, Calumet did not want to provide any information, while concerned word would get out that it was for sale, since its position was that it was not for sale.

"We had to go to all the public websites we could find and download data on every operated property, place value on those properties, and ultimately give Calumet an offer to show our willingness to get in the ballpark."

Eventually, Calumet's owners could see a viable deal. "Then they began to provide us with some information to finalize our proposal," he says.

The offer that Calumet finally accepted was for $510 million in cash, which Chaparral funded from an increased credit line and the $102 million remaining from Chesapeake's investment in the company.

Chaparral gained the North Burbank Unit and other properties, including the Fox Deese Springer Unit, in Oklahoma. The purchase increased its production by 28 million cubic feet of gas equivalent per day and its proved reserves by 410 billion cubic feet equivalent.



What's next

Fischer still plans to take Chaparral public, perhaps as soon as this April, and looks forward to running a public company, while acknowledging that many public-company executives wish their firms were private.

"I could tell you I have somewhat the same sentiment, but I view it as a challenge. Ultimately, for this company to continue to move forward, probably the public route is the appropriate way to go," he says. "It will provide additional equity to the shareholders."

After the difficult process of buying Calumet, he doesn't plan to shy away from buying properties, or companies, that aren't for sale. "We do have other acquisitions in mind. A couple we're looking at right now are probably more difficult and larger than the Calumet transaction."

He also plans to continue focusing on CO2-enhanced oil recovery.

McClendon would consider investing more in Chaparral. "We'll become bigger partners if they see a project where they need some help, or they find a bigger acquisition they'd like to bite off that's maybe more than they can chew," he says.

"If they wanted to sell off a stake in their CO2 business, we'd certainly take a look at it."