Merging the Lower 48 portfolios of Chesapeake Energy Corp. and Southwestern Energy Co. is set to create the largest natural gas pure-play in the United States, becoming a “must-own” company with the resources to redefine the global energy reach of independent producers.
The $7.4 billion combination announced on Thursday was expected, as the tie-up has been rumored for months. The transaction, now set for completion by mid-year, would bring together two of the biggest natural gas independents in the United States. They built their assets across the gassy onshore basins using the unconventional drilling techniques that ushered in the golden age for U.S. natural gas in the 2010s.
The merger “is the biggest gas-focused U.S. upstream deal in more than 10 years and reflects emerging confidence around the long-term outlook for the commodity,” Enverus Intelligence Research’s Andrew Dittmar, senior vice president, said. Including debt, he valued the overall combination at around $11.5 billion.
Natural gas prices declined in 2023, hampered by strong production levels and mild weather through the second half of the year. However, both Henry Hub futures and NGI’s Spot Gas National Avg. have gathered momentum early this year, advancing alongside increasingly intense winter weather that galvanized strong heating demand and caused freeze-offs that, as of Friday (Jan. 12), had helped to trim output by 3 Bcf/d.
Henry Hub natural gas spot prices are forecast to average $2.60-2.70/MMBtu in 2024 before climbing further next year amid higher LNG exports and slowing production growth, the U.S. Energy Information Administration (EIA) said in the January Short-Term Energy Forecast. EIA called for a 2025 average Henry Hub spot price of $2.95. The benchmark averaged slightly under $2.54 in 2023, a fraction of 2022’s average of $6.42.
According to NGI’s Forward Look, the remaining 2024 Henry Hub fixed price contracts (February to December) recently averaged $2.926. For 2025, fixed prices at the benchmark were averaging $3.623.
“With its modest premium and increased exposure to the Haynesville, by adding Southwestern’s high quality acreage, plus financial accretion, the acquisition looks like a winning deal for Chesapeake,” Dittmar said.
The merger for Chesapeake may have focused on “buying Southwestern in large part to add its 286,000 net acres in the Haynesville in Louisiana,” Dittmar said. “The acreage contains about 1,300 gross operated drilling locations capable of generating a 10% return at $3.50/Mcf gas pricing or less.”
By rolling the assets together, the pro forma company “will be the largest producer in the Haynesville, with over 4 Bcf/d gross operated production, and the largest gas producer in the U.S., jumping EQT Corp.”
The Haynesville is “particularly desirable as an area for Chesapeake to grow its exposure,” he said, as the play combines high quality drilling opportunities, with proximity to a burgeoning market for gas to feed U.S. LNG exports.”
Enverus is forecasting that in 2030, liquefied natural gas will increase its share of U.S. demand to 20% from 12%, accounting for the majority of future demand growth.
“There is about 10 Bcf/d of increased LNG export capacity coming online in the next 36 months that should tighten the gap between lower U.S. natural gas prices and a stronger international market,” Dittmar noted.
The longer term gas price forecast also is a positive, he said. In the near term, though, “the market is likely to remain challenged, as supply outstrips demand and storage fills. Low and volatile gas prices have been a significant hindrance” for gas mergers and acquisitions (M&A), “with just about $6 billion in gas-focused deals transacted in 2023, compared to a massive $186 billion of oil-weighted M&A.”
We Like It. We Really Like It
Tudor, Pickering, Holt & Co. (TPH) analysts said, “We like this deal as the transaction will create the largest pure-play natural gas producer in the U.S.” It also may “open the door for inclusion in the S&P 500,” which tracks the performance of the largest 500 companies listed on U.S. stock exchanges.
“We believe the synergies are tangible near term…given the asset overlap,” with the pro forma company targeting “$200 million of corporate/regional cost reductions, $130 million of drilling and completion savings, and $70 million in other areas...
“From a marketing perspective, scale will improve the company’s position on the Gulf Coast, in our opinion, as it relates to unlocking and securing additional LNG opportunities, while increased positions in the Northeast and Haynesville will allow for capital flexibility between the two assets,” the TPH analysts said.
Investors also “may be attracted to the combined entity’s torque to the commodity upcycle, a negative talking point we’ve heard for Chesapeake standalone.” While arbitrage may influence current equity performance, “the combined story likely attracts significant long-only attention as the deal should place name alongside EQT Corp. as one investors will look to own in the 2025 upcycle.”
The pro forma company will be a “must own U.S. natural gas player,” Jefferies energy analysts said. “The combined strong and complementary acreage in the Haynesville and Appalachia basins well positions the company for strong free cash flow growth with a likely investment grade balance sheet and leading shareholder returns. Regulatory approval will be in focus.”
According to the Jefferies analysts, the merger “addresses the key points in the current natural gas macro, including the balance sheet,” with a target to reduce debt at the end of 2025 by $1.1 billion. It also addresses “LNG positioning,” with 20% of the targeted gas production linked to international pricing. Shareholder dividends also would strengthen, along with the potential for an investment grade rating.
“Overall, we believe the merger should be well received,” the Jefferies analysts said. The focus now goes to regulatory approval, including a review by the Federal Trade Commission, but analysts expect the deal to pass muster.
Analysts with Mizuho Securities USA LLC said the merger “not only creates a U.S. shale gas powerhouse,” but an entity with “operational and marketing flexibility,” as well as “demonstrable cost synergies” of at least $400 million a year by the end of 2025.
“Critically, we estimate the pro forma entity has a free cash breakeven of $2.50/MMBtu in 2025/26,” even with higher gathering, processing and compression fees.
Mizuho analysts acknowledged that there are risks to the deal because of “near-term natural gas price weakness, below-peer free cash flow in 2024 and higher pro forma leverage,” but overall, strong upside longer term.
Siebert Williams Shank analyst Gabriele Sorbara said the merger “marks the next stage in Chesapeake’s evolution,” which has at times been a bumpy, controversial road.
The combination would give the pro forma company “a greater beta to an improving natural gas macro and LNG growth, particularly given Southwestern’s Haynesville inventory depth…” Sorbara estimated Southwestern has “1.5 Bcf/d gross gas already sold to LNG exporters, with capacity in place to support growth.
“On the valuation front, we arrive at $2.59/Mcfe/d, with a decent value placed on its core inventory ($2.3 million per net core undeveloped location),” Sorbara said of the combination.
More Consolidation? More Than Likely
Looking ahead, “consolidation should continue with greater focus on inventory enhancement,” analyst Sorbara said. “We maintain our view that consolidation will continue to be a dominant theme in the sector.”
“This has already been on display over the past month,” Sorbara said, with two big ones that were Permian Basin-focused.
APA Corp. agreed to spend $4.5 billion to acquire Callon Petroleum Co., and Occidental Petroleum Corp. in late 2023 slapped down $12 billion to acquire CrownRock LP.
“These recent transactions underscore what we perceive as the next wave of M&A, with a greater emphasis on inventory enhancement rather than the primarily financial transactions seen in recent years, which focused on improving free cash flow yield and capital returns while keeping leverage in check,” Sorbara said.
“Going forward, we think managements’ focus will shift more toward inventory depth, potentially sacrificing near-term financial metrics for longer-term benefits…as scale is critical to driving margins/operational efficiencies and garnering investor interest.”
Long-only investors, said Sorbara, “continue to demand capital returns via dividends and buybacks,” but “based on our conversations, we may see more of these asset deals focused on addressing inventory in the coming years, which in turn should place a M&A premium in certain names.”
Midstream Impacts Too
TPH. analyst Zack Van Everen highlighted the potential midstream impacts.
“Starting with the Haynesville, Southwestern sends 60% of its volumes to DT Midstream and 40% to Energy Transfer,” he noted. “This makes up 93% of DT Midstream’s total volumes as of September ‘23, while making up 34% of Energy Transfer’s total Louisiana volumes.
“Energy Transfer also gathers for Chesapeake, which makes up 37% of their Louisiana volumes over the same period.”
In the Northeast, Van Everen said gas gathering volumes “are spread out among various parties.” DT Midstream gathers around 60% of Southwestern’s gas volumes in Pennsylvania, with Howard Energy Partners taking close to 29% and Williams with the remaining 11%.
From its fields in West Virginia and Ohio, Southwestern sends 50% of the gas volumes to Williams, 20% to partners MPLX LP and Equitrans Midstream Corp., and the remaining volumes to EnLink Midstream.
“We assume Chesapeake sends most of their gas in the Northeast to Williams, and likely utilizes other smaller gatherers as well,” Van Everen said.
“As our gas macro forecast unfolds these systems, especially in the Haynesville, we’ll see continued growth as this new combined entity adds activity to meet the upcoming gas demand ramp.”
