Geological risks in the Utica and, more importantly, Chesapeake Energy Corp.'s (NYSE: CHK) dangling intent to sign a joint venture (JV) in the basin have motivated Bernstein Research to maintain an underperform rating on the company.

Bernstein, a worldwide research and analysis firm, projects a $28 per share target price ahead of a potential end-of-October JV announcement. Chesapeake’s share price at the end of closing on Sept. 13 was $31.49.

The Sept. 7 analysis forecasts that Chesapeake's organic capex will exceed cash flow from operations by about $3 billion in 2012. "Given its high leverage, we don't believe that debt issuance can close the gap. Therefore, the funding gap is best closed via JV, as has been Chesapeake's track record," said Bob Brackett, senior analyst. "The Utica JV is the star opportunity to set the company up for success in 2012."

A JV between CONSOL Energy Inc. (NYSE: CNX) and the Hess Corp. (NYSE: HES) that was announced earlier this month bolsters the view that the Utica is "an exploration opportunity -- not a development opportunity," according to the analysis. The cost of land in the CONSOL-Hess deal -- $6,000 per acre -- falls far short of recent comps of $20,000 per acre in the Eagle Ford. In other words, the Utica is "not a proven thing" at this time, the analysis states.

"However, we acknowledge that the CONSOL-Hess JV demonstrates a market for taking risk on emerging resource plays," Brackett said.

In the $593 million, 50-50 JV Hess has agreed to pay $59 million to CONSOL upon the deal’s closing and as much as $534 million in drilling carries, or 50% of CONSOL's drilling costs for approximately five years.

"The structure of the JV -- little up front and the ability in a worst-case scenario for both parties to forego future activity -- provides for off-ramps that mitigate exploration risk. Furthermore, if the Utica has Eagle Ford potential, as has been advertised by several companies, then, simplistically, the transaction is pricing in a one-in-three chance of success," said Brackett, referring to land-price differences of the two shales.

Compared with the CONSOL-Hess agreement, Chesapeake investors may have reason to anticipate a better deal for its JV, Brackett said.

"The read across to Chesapeake would be that a 25% stake in the company's 1.25-million-acre Utica shale position could bring a cash payment of $180 million and a total consideration of $1.8 billion," he said, adding that Chesapeake's total position is valued at $7 billion.

However, Brackett warns, a deal that is comparable to CONSOL-Hess may not result in large movement in Chesapeake's stock price.

In conclusion the analysis observes that a "CONSOL-like deal -- with the majority of value tied to long-term drilling carries and not up-front cash -- may not be sufficient for Chesapeake, which likely needs a greater up-front component."

Contact the author, Mike Madere, at mmadere@hartenergy.com.