Chesapeake Surges After Abandoning Birthplace of Shale Boom

  • Gas driller quitting field to escape $1.9 billion in costs
  • Company receiving zero proceeds for handing over assets

Chesapeake Energy Exits Barnett Shale

Chesapeake Energy Corp. agreed to give away its Barnett Shale holdings to a private-equity backed operator, exiting the birthplace of the shale revolution to escape almost $2 billion in onerous pipeline contracts.

Chesapeake will convey all interests in the Barnett region in North Texas to First Reserve Corp.-backed Saddle Operating LLC, according to a statement Wednesday. Quitting the gas fields will slash Chesapeake’s shipping and processing costs by $715 million between now and the end of 2017 and eliminate a total of $1.9 billion in long-term pipeline agreements. Shares jumped as much as 6.3 percent.

Battered by cratering fuel prices, credit downgrades and a shareholder revolt that cost the company founder his job, Chesapeake has been shedding fields, cutting jobs and exchanging stock for debt to revive the second-largest U.S. gas supplier. The company will receive no proceeds from Saddle for handing over the Barnett assets, which in late July were estimated to be worth as much as $1 billion.

Once ground zero for the U.S. shale boom, the Barnett Shale in North Texas faded in importance as gas prices collapsed and explorers discovered new deposits such as the Marcellus and Utica shales that are closer to urban demand centers along the eastern seaboard. For Chesapeake, the Barnett is its second-smallest production region, accounting for 10 percent of the company’s output.

The transaction will provide Chesapeake “some needed relief” from hefty, cash-draining pipeline obligations, David Tameron, an analyst at Wells Fargo & Co. in Denver, said in a note to clients.

Chesapeake was 3.1 percent higher at $4.95 as of 11:05 a.m. in New York. The shares have gained almost 10 percent this year after losing 77 percent of their value in 2015.

Pipeline Deals

During the early years of the shale boom, explorers had to slow production because of a lack of pipelines to haul their natural gas to markets in the U.S. Midwest and East. To entice pipeline operators to build networks, drillers such as Chesapeake entered into long-term contracts in which they promised to keep those lines full of gas or make up the difference to the operator with cash payments.

Related: Williams Sees a Way of Bringing Drilling Back to Cradle of Shale

As the boom morphed into a glut and gas markets collapsed, Chesapeake found itself saddled with billions of dollars in pipeline commitments in regions such as the Barnett where it no longer made sense to pump as much gas. Those contracts also made some assets harder to sell because potential suitors were reluctant to inherit them.

“Chesapeake has successfully addressed its most costly midstream contract,” James Sullivan, an analyst at Alembic Global Advisors, said in a note to clients.

Empire Deconstruction

The divestment of one of the cornerstones of Chesapeake’s portfolio expands Chief Executive Officer Doug Lawler’s deconstruction of the shale empire amassed by his predecessor, the late Aubrey McClendon. At one point during McClendon’s quarter-century reign, Chesapeake controlled drilling rights across 16 million acres, an area equivalent to half of New York state. Lawler has sold gas fields, reduced the workforce and slashed spending to cope with a debt load that was $8.68 billion at the end of the second quarter.

As recently as July 29, RBC Capital analyst Scott Hanold estimated Chesapeake could fetch $1 billion for its Barnett assets, an outcome he said would be viewed positively for its debt-reduction potential.

“While the Barnett has great potential, it simply could not compete for capital in a portfolio with the depth and breadth of Chesapeake’s at current commodity prices,” Lawler said in an e-mail to employees, a copy of which was obtained by Bloomberg. Some Chesapeake employees engaged in Barnett-related work will have an opportunity to go to work for Saddle, he said.

Abandoning the Barnett will boost the value of Chesapeake’s proven reserves by $550 million by removing assets that detracted from the overall value of the company’s portfolio.

Pipeline operator Williams Partners said in a separate release on Wednesday it’s agreed to revise Chesapeake’s contract in Oklahoma and is "conditionally committed" to new gas-gathering agreements with Chesapeake’s Barnett successor. Altogether, Williams will receive $820 million in cash up front that will go to paying down debt. 

Terminating Contracts

Chesapeake agreed to pay Williams a $334 million lump sum to terminate their Barnett gas gathering and shipping contract. Saddle is also paying an undisclosed sum to Williams as part of the deal, according to Chesapeake’s statement. Separately, Chesapeake will pay another $66 million to Williams to renegotiate the Oklahoma contracts.

The transactions mark “a major step in our continued progress to transform Chesapeake,” Lawler said in the statement.

They’ll also reduce the portion of Williams’ overall revenue that comes from Chesapeake to 15 percent, the Tulsa, Oklahoma-based partnership said in its statement.

Under the new agreement, there will be monthly gathering rates tied to gas prices on the New York Mercantile Exchange, designed to bring drilling back to the Barnett and return some money-losing wells to profitability, Williams said.

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