Chesapeake has entered into an agreement with Hallwood Energy Corporation to acquire Hallwood's 18,000 acre North Block property in Johnson County, Texas for $277 million in cash. This property is located immediately north of Hallwood's 30,000 acre South Block property, in which Chesapeake acquired a 44% working interest through its June 2002 acquisition of Canaan Energy Corporation.
• Company to Acquire 18,000 Acre North Block Property in Johnson County, Texas, Located Just North of Chesapeake's Existing 44%-Owned 30,000 Acre South Block
• Transaction Includes Production of 25 Mmcfe Per Day and 280 Bcfe of Internally Estimated Reserves, Consisting of 135 Bcfe of Proved Reserves and 145 Bcfe of
• Acquisition Boosts Chesapeake's Production Forecast By 3.6% for 2005 and 5.8% for 2006 as Estimated Production on Acquired Property Increases to 40 Mmcfe per Day in 2005 and 70 Mmcfe per Day in 2006
In this transaction, Chesapeake anticipates acquiring an internally estimated 135 billion cubic feet of natural gas equivalent proved reserves (bcfe), 145 bcfe of probable and possible reserves and net production of approximately 25 million cubic feet of natural gas equivalent production (mmcfe) per day from 31 vertical wells and 11 horizontal wells. Chesapeake has identified approximately 70 proved undeveloped and 90 probable and possible horizontal drilling locations on the 18,000 acre North Block that it believes can be drilled at an average cost of approximately $2.2 million per well to develop estimated ultimate reserves (EUR) of 2.5 bcfe per well. Pro forma for this acquisition, Chesapeake's proved oil and natural gas reserves will increase to an internally estimated 4.6 trillion cubic feet of natural gas equivalent (tcfe) as of September 30, 2004.
After allocating $98 million of the $277 million purchase price to undeveloped leasehold, Chesapeake's acquisition cost for the 135 bcfe of internally estimated proved reserves will be $1.33 per thousand cubic feet of natural gas equivalent (mcfe). Including $303 million of anticipated future drilling costs to fully develop the proved, probable and possible (3P) reserves, the company estimates that its all-in acquisition cost for the 280 bcfe of 3P reserves will be $2.07 per mcfe. In addition, Chesapeake has agreed to purchase Hallwood's North Block gas gathering, compression and water disposal assets for $15 million.
The North Block proved reserves have a reserves-to-production index of 14.8 years, are 100% gas, are 15% proved developed, have current lease operating expenses of $0.22 per mcfe, have severance taxes of 1.3% of the wellhead revenue value and will be 100% Chesapeake-operated. The property's very low lease operating expenses (approximately $0.53 per mcfe below the industry average) and unusually low severance taxes (approximately $0.37 below the standard 7.5% Texas severance tax rate at $6.00 per mcf because of severance tax reductions applicable to certain types of newly drilled wells in Texas) create an approximate $0.90 per mcfe economic advantage over typical Mid-Continent natural gas properties.
Through the use of a three-rig drilling program, the company believes it can increase gas production on the acquired property from 25 mmcfe per day in December 2004 to at least 55 mmcfe per day by December 2005 and to at least 85 mmcfe per day by December 2006. If these production increases are achieved, Chesapeake estimates that its average daily production in 2005 and 2006 will increase by 40 and 70 mmcfe per day, respectively. The company has hedged the current 25 mmcfe per day of acquired production at NYMEX gas prices of $7.15 per mmbtu and $6.63 per mmbtu for 2005 and 2006, respectively, well above the gas prices used to evaluate the property.
The acquisition is expected to close on December 15, 2004 and is subject to customary closing conditions. The company intends to finance the acquisition using a portion of the proceeds from a new $600 million private issue of senior notes.
Hallwood is a private company and was advised in the sale by Albrecht & Associates, Inc. of Houston, Texas.
Aubrey K. McClendon, Chesapeake's Chief Executive Officer, commented, "We are pleased to announce today's acquisition of the Hallwood North Block acreage for several reasons. First, we are building our Barnett Shale ownership and creating economies of scale by leveraging off our acquisition of Canaan Energy Corporation in June 2002. In that $120 million transaction we inherited an initial Barnett Shale leasehold position in Johnson County, Texas, to which we initially gave no value. Today it appears that Chesapeake's South Block Barnett Shale position may be worth more than what we paid for the entire Canaan transaction.
"Second, Chesapeake is well positioned to continue Hallwood's successful production ramp-up currently underway, having worked closely with Hallwood for two years in the South Block and because of our extensive experience with horizontal drilling (more than 285 horizontal wells drilled in Texas since 1990) and 3-D seismic (more than 9.0 million acres owned). Hallwood's use of horizontal drilling, innovative completion techniques and 3-D seismic information during the past few years has been very effective on both the 18,000 North Block property and the 30,000 acre South Block property.
"Finally, we believe we have been conservative in our reserve estimates for the acquired property, both with regard to our estimated EUR's of 2.5 bcfe per horizontal well and to our planned PUD drilling pattern of 140 acres and 2,000' standoffs for horizontal wellbores. Over time, we are hopeful that our reserve estimates can increase and that our well spacing can decrease, leading to significantly higher recoverable proved reserves than currently projected. We look forward to adding further value to this prolific gas-producing area of the Mid-Continent region in the years to come."
