Through this transaction, Chesapeake anticipates acquiring an internally estimated 2.5 trillion cubic feet of natural gas equivalent (tcfe) of proved, probable and possible (3P) reserves, comprised of 1.1 tcfe of proved reserves and 1.4 tcfe of probable and possible reserves. The seller's independent third party engineering report calculated CNR's 3P reserves to be 3.9 tcfe, or 56% more 3P reserves than Chesapeake will initially recognize. CNR's current daily net production is approximately 125 million cubic feet of natural gas equivalent (mmcfe), indicating a proved reserves-to-production index of 23.0 years and a proved developed reserves-to-production index of 16.0 years. The properties are principally located in West Virginia, Kentucky, Ohio, Pennsylvania and New York.
After the preliminary allocation of $175 million of the $2.2 billion purchase price (which excludes negative working capital and liabilities associated with the assumed prepaid sales agreement and hedges) to CNR's extensive mid-stream natural gas assets being acquired (including over 6,500 miles of natural gas gathering lines) and $500 million to the unevaluated portion of the 4.1 million net leasehold acres being acquired (3.5 million net acres in the U.S. and 0.6 million net acres in Canada), Chesapeake's acquisition cost for the 1.1 tcfe of internally estimated proved reserves will be approximately $1.45 per thousand cubic feet of natural gas equivalent (mcfe). Based on the company's projected development plan, which includes approximately $4.1 billion of anticipated future drilling and development costs, Chesapeake estimates that its all-in cost of acquiring and developing the 2.5 tcfe of 3P reserves will be approximately $2.48 per mcfe, exclusive of the negative working capital and prepaid sales and hedging liabilities to be assumed.
CNR's proved reserves are long-lived, have low production decline rates (the proved developed producing base is projected to decline at less than 10% per year), are 99% natural gas, have an average BTU content of 1,140 and are 70% proved developed. In addition, gas sold from the properties generally receives a $0.50 per mmbtu premium to NYMEX gas prices, compared to basis differential discounts that currently range up to $4.00 per mmbtu in various southwestern and western U.S. natural gas supply basins. Adjusting further for the favorable BTU content, CNR's natural gas today receives wellhead prices of up to $5.00 per mcfe more than typical southwestern and western U.S. natural gas production.
On the acquired properties, Chesapeake has identified 1,316 proved undeveloped (PUD) locations, 6,286 probable locations and 1,833 possible locations for a total of 9,435 undrilled locations, or an estimated drilling inventory of more than 15 years. By comparison, the seller's independent reservoir engineers identified 1,611 PUD locations (22% more than Chesapeake will initially recognize) and over 14,000 probable and possible locations (72% more than Chesapeake will initially recognize).
As of June 30, 2005 and pro forma for this acquisition, Chesapeake will own an internally estimated 13.5 tcfe of proved and unproved oil and natural gas reserves, comprised of 7.1 tcfe of proved reserves (which will be 92% natural gas and 100% onshore) and 6.4 tcfe of unproved reserves. The company intends to spend at least $200 million per year for the foreseeable future in further developing the acquired properties and is budgeting production growth from the acquired assets of 5-10% per year.
Chesapeake has begun the process of hedging the production it will acquire from CNR. The company intends to hedge at least 50% of CNR's estimated base production through December 2008. The prices received from such hedging should significantly exceed the pricing assumptions used by Chesapeake to value the properties.
As part of the transaction, the company will assume CNR's prepaid sales agreement and its hedging arrangements. Chesapeake expects to record any potential mark-to-market loss on those obligations as a balance sheet liability when the transaction closes. The amount of the mark-to-market loss will be dependent on gas prices on the day of closing. For example, using a flat $7.00 NYMEX gas strip through December 2009, the prepaid sales and hedging liabilities would be approximately $325 million. Using gas prices as of September 30, 2005, the prepaid sales and hedging liabilities would be approximately $775 million.
Chesapeake will soon file its Hart-Scott-Rodino (HSR) pre-merger notification form with the Federal Trade Commission. Satisfaction of the HSR requirements should occur within 30 days after filing. Accordingly, the company anticipates closing the transaction no later than December 15, 2005. The company intends to finance the acquisition from cash on hand and by issuing a balanced combination of senior notes and equity securities. As a result of this acquisition and the contemplated financings, the company has attached its updated Outlook as Exhibit "A" to this release. The company's previous Outlook, dated September 7, 2005, is attached as Exhibit "B" for comparative purposes.
Triana was formed in 2001 by management and executives of Metalmark Capital LLC as a Morgan Stanley Capital Partners portfolio company. Triana was advised in this transaction by Morgan Stanley & Co. Incorporated and Credit Suisse First Boston LLC.
Aubrey K. McClendon, Chesapeake's Chief Executive Officer, commented, "We are excited to announce the acquisition of CNR for several reasons. First, we will acquire very significant land and gas resource inventories to complement our already very large land and gas resource inventories. CNR's additional 4.1 million net acres and 2.5 tcfe of 3P reserves will increase Chesapeake's leasehold and gas resource inventories to 8.2 million net acres and 13.5 tcfe, respectively. According to rankings published last week by the Oil & Gas Journal, Chesapeake's pro forma 6.5 tcf of proved gas reserves will be the third largest in the U.S., trailing only those of ExxonMobil and ConocoPhillips. We believe this transaction will solidify Chesapeake's position as the premier gas resource company in the industry.
"Secondly, we are very enthusiastic about moving into the large, prolific and generally underexplored and unconsolidated Appalachian Basin. The basin covers over 185,000 square miles (almost three times the size of Oklahoma) across seven states and has produced more than 46 tcf of gas from over 400,000 wells. In 2003, the National Petroleum Council estimated the basin still contained another 9 tcf of proved gas reserves and an additional 68 tcf of unproved gas reserves. In addition, much of the basin remains underexplored. Less than 1% of the 400,000 wells drilled to date have penetrated below 7,500 feet, leaving substantial deeper exploration opportunities available for Chesapeake to pursue. We believe deep gas exploration is one of our most important competitive strengths.
"Third, we are also attracted to the value proposition of producing natural gas at a premium price to NYMEX, rather than for the steep discount to NYMEX that most other U.S. natural gas sells for today. Some basis differentials now exceed $4.00 per mmbtu, creating a very pronounced value advantage for Appalachian Basin gas production. Including an approximate 14% value upgrade for the rich BTU content of the gas, we believe prices realized on CNR's gas production today would be more than $5.00 per mcfe higher than prices received in most southwestern and western U.S. gas basins.
"In addition, we are eager to begin working in a large U.S. natural gas basin that shares many similarities to our stronghold in the Mid-Continent, where 59% of our pro forma production is located. As in the Mid-Continent area seven years ago, Appalachian Basin asset ownership is very fragmented and gas production has typically been developed by a large number of very small private companies, a few mid-sized public independents and several large pipeline and utility companies. We believe that Chesapeake's significant presence in the Barnett, Woodford, Caney and Fayetteville shale plays, our expertise in tight sand and horizontal coalbed methane drilling and our commitment to deep natural gas exploration will enable us to achieve success in Appalachia.
"Although the Appalachian Basin will be a new area for Chesapeake, we have been in conversations with CNR's management for over three years and have been educating ourselves about the basin during that time. We believe the geological age of the reservoirs, the types of geological plays and the gas- prospectivity of the basin are an excellent fit with Chesapeake's existing competitive advantages. We look forward to decades of success in the Appalachian Basin.
"And finally, it has become abundantly clear in the past month that the U.S. needs significant additional supplies of clean-burning, domestically- produced onshore natural gas. During the past five years, Chesapeake has been the most active driller in the U.S. and has discovered and developed major new supplies of natural gas that U.S. consumers increasingly need. In 2006, the company plans to utilize an average of 85-90 drilling rigs to continue exploring for new supplies of natural gas. While others in the industry are increasingly focused on international projects, we remain committed to supplying consumers with as much natural gas as Chesapeake can find onshore in the U.S."
Henry Harmon, President and CEO of Triana said, "This transaction underscores the success of combining Triana management's vision and the longstanding partnership with executives of Metalmark Capital to create one of the largest gas exploration and production companies in the Appalachian Basin."
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