Chesapeake Energy (NYSE: CHK) announced a common stock offering on 8-DEC-05. This follows closely on the heels of the highly publicized announcement for the acquisition of Columbia Natural Resources (CNR). Chesapeake Energy's CNR acquisition was presented in detail during a November investor's conference call (Go to
http://www.chkenergy.com/ ; Investor Relations). The presentation offered an optimistic view by the executive team about the expected returns on a long-term play in the Appalachian Basin. However, the Northeast may offer some new challenges to Chesapeake.
Chesapeake Chief Executive Officer Aubrey McClendon repeatedly sited the untapped opportunities of this region that extends from the south in West Virginia, to the west in Ohio and to the northeast into New York State. The CEO noted the historical lack of a major explorer within the Basin, along with the close proximity to the largest US gas market here in the Northeast, which would make this acquisition a premium value for the company. Mr. McClendon also identified specific growth opportunities as well as transferable technologies and knowledge which should play well in this Basin.
Other reasons given for their optimistic outlook are that the Northeast pipeline is, and shall remain, congested from the Gulf of Mexico as a result of the Gulf gas fields. Additionally, there has been no desire to see LNG terminals built in the Northeast since the terrorist attacks of September 11, 2001. Thus, wellhead gas prices in the Basin, located "over the hill" from their targeted market remain above the prices of Mid-Continent and Rocky Mountain production by $3.00 per Mcfe, or more. Chesapeake is also able to avoid the NYMEX price discount by direct sales into the Northeast corridor.
While all this appears as good news for the Chesapeake strategists, there have been, and shall remain, several burdens for harvesting natural gas throughout this vast region. Obstacles to success include infrastructure and land development issues that plague other explorers in the region. These include access to sites in the mountainous terrain, highly fragmented land ownership and a growing groundswell of opposition to drilling throughout the Northeast based primarily on royalty and land leasing rates. Presently, land lease and royalty rates are lower than for other regions of the country.
Add to this that average property sizes per owner are smaller in the Appalachian Basin, along with escalating natural gas values and the result is, as expected, a changing attitude from property owners about signing, or re-signing, a lease agreement. A recent Wall Street Journal publication (December, 2005) regarding consumer views of corporate ethics put the energy industry clearly at the bottom of the list. What Chesapeake Energy may find in the Appalachian Basin is that permission to drill shall become harder to get from savvy landowners as a result of energy prices in the news.
In fact, the author knows of a property owner in the Trenton-Black River formation, who has benefited handsomely in royalties from a sizeable strike on his own property, yet refuses to sign another lease for a nearby family property. Having been one of the local success stories has not convinced this owner that he got the best deal. There appears to be a backlash of discontent due to climbing energy prices.
This is an emerging issue for gas explorers, such as Talisman Energy (operating as Fortuna Energy in the US), who have recently received an education in the courts of New York State. It is not the leased properties that are causing the problems. Rather, it is those property owners who refuse to lease to gas explorers that sent New York's gas drillers into the State Supreme Court and deep well drilling rigs into West Virginia. Of eight deep well rigs operating in the Southern Tier of New York at the end 2004 only one remains as of this writing. (Watch for a future article on the issue of drilling rig availability.)
Chesapeake's CEO was reasonably optimistic that his company could avoid the pitfall that caused the decline of regional gas explorer Beldon and Blake. However, it may not be the transfer of geological technology and business experience that alters the expected return on investment for Chesapeake Energy. Rather, it may be the hardened expectations of Northeast landowners, with their attorneys, who have been eyeballing the burgeoning energy sector and want a bigger slice of the pie.
In closing, Chesapeake Energy's CEO noted that the Appalachian Basin is three times the size of the state of Oklahoma, but did not expound on the fact that it may offer three times the complexity of the Mid-Continent and Rocky Mountain regions. The Appalachian Basin covers several states, but more importantly, covers a greater variety of cultures than the Central and Rocky Mountain States. Hopefully, a company that has such confidence in their team of geological and business professionals doesn't underestimate the competency of another team; that of the lawmakers here in the Northeast.
