Investors favored Chesapeake Energy Corp.'s Jan. 25 announcement that it will increase its focus on natural gas production with a $2.6 billion deal to acquire Marcellus Shale neighbor Chief Oil & Gas LLC while selling oil assets in Wyoming's Powder River Basin to shale oil driller Continental Resources Inc. for $450 million.

Analysts expect the deal to be the first of several Appalachian shale gas transactions in 2022 as the play consolidates in the hands of a few large operators.

Chesapeake sweetened the deal for investors by bumping up its fixed annual dividend by 14%, to $2.00 per share, and recommitting to an already announced $1 billion stock buyback. More shareholder returns are possible through a variable dividend equal to 50% of quarterly free cash flow, the company said. Based on current futures prices for natural gas, Chesapeake estimated that it will pay out roughly $1 billion in dividends this year for a 13% yield on its stock. Chesapeake estimated that it could keep up the $1 billion per year payout pace for the next five years.

Veteran shale analyst Gabriele Sorbara with investment research firm Siebert Williams Shank & Co. LLC said the deals "should be positively received as they improve Chesapeake's free cash flow trajectory, accelerating its cash returns to shareholders." Sorbara raised the price target for Chesapeake 8% to $92 per share.

By early afternoon, Chesapeake shares were up 5% to $66.83 in a down market on heavier than normal trading.

Powder River Basin assets

Chesapeake will get $450 million in cash for its Powder River Basin operations and use that to defray the $2 billion cash portion of the Marcellus deal. In addition to Continental's money, Chesapeake planned to use cash on hand and borrow roughly $500 million from its credit revolver to round out the deal. Chesapeake is also giving the privately held Chief 9.44 million shares of Chesapeake stock with a nominal value of $599 million, based on the Jan. 24 share closing price.

"One of the very many things we like is the fact that we are doing Powder River at the same time as Chief," newly appointed Chesapeake CFO Mohit Singh told analysts on a conference call to discuss the deal. "On a pro forma basis, the actual drawdown on the revolver would be sub-$500 million. We are very comfortable with that level: [It] still retains a lot of liquidity and undrawn capacity on it."

Singh said Chesapeake planned to pay off that debt in short order while still paying dividends from an expected free cash flow of $9 billion over the next five years.

Marcellus Shale

Combining the midstream commitments of two companies will add 200 MMcf/d of new outbound capacity from the constrained northeast portion of the Marcellus Shale.

"The map really highlights that the Chesapeake and Chief acreage fit hand in glove right next to each other," Chesapeake President and CEO Domenic Dell'Osso told analysts. "But what may be a little bit less obvious and is really important to the deal is that we share a lot of gathering system capacity here, and we gain a lot of access to incremental delivery points in the marketing across the basin."

"So, we gain access to delivery points on [Tennesee Gas Transmission Co.], on [Transcontinental Gas Pipe Line Co. LLC] and Atlantic Sunrise," Dell'Osso said. "And what that means is that we have access to better out-of-basin pricing."

The deal will add roughly 835 MMcf/d of new net production in Pennsylvania to increase Chesapeake's company-wide production to 3,643 MMcf/d. The deal will leave Chesapeake firmly in place as the second-largest gas producer in Pennsylvania, behind the nation's largest producer, Pittsburgh-based EQT Corp.

Chesapeake said it would keep two rigs operating on Chief's leases for now, while keeping four to five rigs and one to two fracturing crews in operation in the Marcellus in 2022.

Chesapeake anticipates bringing the Chief production volumes into its certified responsible natural gas program, designed to document low carbon emissions. Chesapeake expects that its current Marcellus operations will complete certification by mid-year and the new Chief assets will be certified by the end of 2022.