Big fish eat smaller fish in Appalachia: More consolidation expected in 2022

Chesapeake Energy Corp. will get a discount on Chief Oil & Gas LLC if it goes through with a rumored $2.4 billion deal for the privately held Marcellus Shale driller that would continue a trend of consolidation in Appalachian shale gas operations.

Citing unnamed sources, Reuters reported Jan. 19 that Chesapeake was finalizing a deal for Chief, Chesapeake's neighbor in the dry gas window of northeast Pennsylvania and one of four Marcellus drillers considered prime buyout targets.

Chief had no comment on the news, and Chesapeake has not responded to inquiries. But analysts said the potential deal has benefits for Chesapeake.

"We think this deal is more likely with the valuation reset from more than $3.0 billion in October to $2.4 billion," said veteran shale gas analyst Gabriele Sorbara, a managing director at boutique investment services firm Siebert Williams Shank & Co.

In October 2021, Reuters reported that Chief was marketing its assets, consisting of just over 1 Bcf/d of production from 450 active wells in five counties, for $3 billion.

"Given the quality of the Chief assets, we do not see this potential deal as a major concern, as it should be accretive to free cash flow and capital returns at the right valuation," Sorbara said in a Jan. 20 email, noting that Chesapeake is already a nonoperating partner in some of Chief's wells. "That said, this chatter around M&A will further weigh on shares."

Chesapeake shares lost 4% on Jan. 20 in heavier-than-normal trading in a down market.

"Assuming the deal is confirmed, it seems that Chesapeake lost out to EQT Corp. on the $3 billion [Alta Resources LLC] deal and didn't want to miss out on the last real opportunity for consolidation in northeast Pennsylvania," credit research firm CreditSights senior analyst Charles Johnston said. "Chief's acreage position is a strong fit for Chesapeake and some of the best dry gas acreage in the Marcellus."

At the start of the year, CreditSights predicted shale oil and gas M&A would continue in 2022 with operators buying out their neighbors. Shale oil and gas equities have seen healthy gains over the past year, making company stock a viable currency and reducing the amount of cash that must be borrowed to finance a transaction.

EQT bought the southwest Pennsylvania operations of Chevron Corp. in 2020. The same year, northern Pennsylvania operator National Fuel Gas Co. bought Royal Dutch Shell PLC's operations along the New York border, and Southwestern Energy Co. purchased Marcellus and Utica shale driller Montage Resources Corp.

"Deals are growing in size with a greater focus on consolidating around a core asset base rather than expansion into new growth areas," CreditSights said Jan. 4. "Energy M&A has also been balance sheet friendly, with the vast majority of deals entirely (or largely) equity funded and accretive to credit profiles. In a slower growth world, consolidation reduces costs, improves scale and increases operator efficiency with greater blocks of contiguous acreage for upstream players."

Pennsylvania's five largest producers — EQT, Chesapeake, Coterra Energy Inc., Range Resources Corp. and Southwestern — account for about three-quarters of the state's shale gas production.

Founded in 1994, Chief is still led by its founder, Chairman and CEO Trevor Rees-Jones, a former oil and gas lawyer. It began drilling unconventional wells in Texas' Barnett Shale and moved to the Marcellus after selling its Barnett assets to Devon Energy Corp. for $2.2 billion in 2006. Currently, Chief operates one rig across its leasehold in the northeast Pennsylvania counties of Lycoming, Bradford, Sullivan, Susquehanna and Wyoming.