Gas Deposit Lures Hedge Funds

Dow Jones Newswires

From the Wall Street Journal via Dow Jones Newswires, May 14, 2008

A natural-gas deposit deep beneath parts of Arkansas, eastern Texas and northwest Louisiana is the focus of the latest U.S. energy boom, with hedge funds betting on the three companies vying to develop the area.

Chesapeake Energy Corp., an Oklahoma City, Okla., natural-gas producer, has thrown its weight behind a push to extract gas from what is known as the Haynesville shale play, a largely untapped vein of shale as much as 11,000 feet deep. But some hedge funds are seeking better returns from Haynesville through smaller energy companies Petrohawk Energy Corp. and Goodrich Petroleum Corp., both of Houston.

Clough Capital Partners of Boston has invested in all three companies. It gradually increased its stake in Chesapeake to 750,000 shares in the fourth quarter from 599,000 shares in the first quarter of 2007. The firm, which has invested in 20 natural-gas companies, also acquired 50,000 Goodrich shares in the fourth quarter and raised a long-standing position in Petrohawk to 562,000 shares in the fourth quarter from 453,800 shares in the previous quarter.

"The shale plays are important to natural-gas production capabilities. In the U.S., each reservoir is part of the puzzle," said James Canty, a partner at Clough. "We're looking at natural-gas prices, and we want to own companies that grow production, but if you want a concentrated bet, you're better off with Petrohawk."

Clough spread its money by investing in 20 energy companies that produce natural gas in Haynesville and elsewhere. Some of Clough's energy holdings mine for shale in the Southwest and West, and other producers tap conventional sources in the Rocky Mountains or Canada.

Chesapeake Energy has snapped up more than 300,000 acres of potential mineral reserves and is bargaining for 200,000 more in the Haynesville area. The company, which has vast resources to unearth gas deposits, accelerated a real-estate bidding war in April, when it declared that Haynesville "could potentially have a larger impact" than any of its previous energy investments.

Sidestepping Chesapeake comes with some risk for investors because Petrohawk and Goodrich have fewer resources to acquire real estate and conduct expensive mining. Chesapeake already has drilled four functioning wells, and it plans to complete three more within a few weeks. But Petrohawk is working to close the gap by raising funds and moving to acquire more land.

Some funds are betting more heavily on Petrohawk than on Chesapeake. Owl Creek Asset Management, a New York hedge-fund firm that invests in more than $3.2 billion of equities, held 4.5 million Petrohawk shares at the end of the fourth quarter, filings show. The firm, which declined to comment, passed on Chesapeake's stock last year.

Highbridge Capital Management, also based in New York, has maintained small positions in Petrohawk since 2005, and it acquired 2.39 million shares in the fourth quarter, a significant increase from 85,777 shares held during the previous quarter. The hedge fund simultaneously trimmed 1.65 million shares of Chesapeake held during the first quarter of 2007 to 85,394 shares by year end. Highbridge declined to comment.

The race to acquire Haynesville acreage started less than two years ago. Petrohawk was already drilling a gas deposit known as Cotton Valley, a separate deposit that runs roughly 3,000 feet above parts of Haynesville's deposits, when it became aware of Haynesville in 2006. Chesapeake later raised expectations with claims that Haynesville holds large quantities of natural gas.

The real-estate frenzy, largely inspired by Chesapeake's initial claims of vast resources, has created a short-term windfall for Goodrich, which has acquired most of its Haynesville land at an average price of $350 per acre. New territory in Haynesville is selling for more than $4,000 per acre, according to a senior official at Goodrich. The rush to develop Haynesville is also being fueled by natural-gas futures prices that recently reached $11.17. All three energy producers are in a hurry to begin drilling while natural-gas prices are high.

Goodrich's stock shot up to $35.65 recently from $22.96 on Jan. 1. Petrohawk rose to $26.36 from $17.89 and Chesapeake rose to $56.12 from $39.61 in the same period.

Petrohawk, which owns, or has commitments to acquire, more than 150,000 acres in Haynesville, has set up one rig for drilling and plans to erect at least five more by year end. Efforts to increase those holdings to 400,000 acres were buttressed by a private placement offering for $500 million of senior notes due in 2015 that are currently being issued. The company is also working with Merrill Lynch & Co. and Lehman Brothers Holdings to issue 21 million common shares.

Goodrich has conducted limited drilling for research purposes within its 50,000 Haynesville acres. This year, the company plans to spend $275 million drilling in Haynesville and on other properties. Preliminary data from Chesapeake suggests adjacent property held by Goodrich contains one trillion cubic feet of gas, which would provide a significant boost to the company's 1.7 trillion cubic feet of reserves, if the estimates are correct. "It's a game-changer for the smaller companies," Goodrich President Robert Turnham said in an interview.

There is always the risk that Haynesville's reserves were overstated. But if the territory turns out to hold vast resources, Goodrich might double in size within a few years, said David Adams, an analyst at Jefferies & Co., who has a "buy" rating on the company's stock. Goodrich has already exceeded his $32 target set March 25.

Alydar Capital, a Boston hedge fund that invests $1.6 billion, acquired 2.3 million Goodrich shares in the fourth quarter without investing in Petrohawk or Chesapeake during that period. The hedge fund didn't return a call seeking comment.

Size may be a disadvantage for Chesapeake, which needs to sell more gas than Petrohawk or Goodrich to generate strong returns for investors, hedge fund managers said. "A hundred thousand acres in Haynesville is a lot more meaningful to Petrohawk than Chesapeake, and 50,000 acres is a lot more meaningful to Goodrich," said a hedge-fund manager who invested in Petrohawk but skipped Chesapeake.

A number of hedge funds are also bearish on Chesapeake because of the debt it has taken on to finance other energy projects. The company, which announced plans to issue $1 billion of convertible senior notes earlier this month, maintained a net debt-to-capitalization ratio of 57% during the first quarter, up from 52% during the first quarter, according to a research report issued by BMO Capital Markets on May 5.

Petrohawk had a 47% net debt-to-capitalization ratio during the fourth and first quarters, according to another BMO report. BMO was involved in underwriting a secondary offering for Petrohawk's common stock offering.

BMO maintains a market perform rating on Chesapeake and a target price of $55, which the stock surpassed recently. BMO also has an outperform rating and $40 target for Petrohawk.

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