A joke in the industry these days has a producer saying he's selling his assets to Chesapeake Energy Corp.-no matter if the assets are in Oklahoma or Alaska. The word is out, and Chesapeake's hunt for an ever-increasing amount of Midcontinent reserves and production has left many other prospective buyers on the sidelines. "Everyone treats Chesapeake differently. It makes it tough to get a seller's attention," says one buyer in the region. Some operators say Chesapeake is driving up area sellers' price expectations. But, that might not be the case, says Rob Bilger, president of negotiated-transaction advisory firm Petroleum Place Energy Advisors, Houston. "It all depends on the property. Someone could say, 'Well, if El Paso got X [from Chesapeake] then I should get Y.' But every deal is negotiated separately and has different metrics." Chesapeake has purchased nearly 1.6 trillion cubic feet of gas equivalent (Tcfe) of reserves in the region in the past three years at an average price of $1.23 per thousand cubic feet of gas equivalent (Mcfe). Marc Rowland, executive vice president and chief financial officer, says he considers at times whether the company is making each of its next deals more expensive. "You have to think of that, especially when you've been as active in one area as we are." So, he took a look. The analysis shows the company doesn't win every offering, or even most. Since 1998, it has pursued more than 1,000 deals (valued at more than $1 million each); has made firm cash offers on 113; and has won approximately 65, or about 8% of the total. "So it's not like we are setting the market and we buy everything we make an offer on, and it's not like we aren't frequently the loser. We are frequently a loser, and we lose to people who bid more for an asset than we do," Rowland says. Most offers are based on a gas-price forecast of $4, unescalated, for proved producing reserves. "Typically that will yield a rate of return in the low double digits. Then, for proved undeveloped reserves the price deck will be based on a higher-teens rate of return." The company hopes to get probable and possible reserves for free. Competing buyers are sometimes surprised by Chesapeake's offers. "Everybody has a different way of evaluating properties but there's no question a lot of people see the numbers Chesapeake pays and wonder how in the world they got there," one says. Rowland says, "Most of our competitors simply don't have the drillbit expertise that we have. We are the third most active driller in the U.S. and our large proprietary 3-D seismic database we have gives us advantages our competitors simply don't have. "Frequently sellers and our competitors won't even be aware of the exploration upside reserves that we can see on the properties we're buying. In addition, as the largest producer in the region-with 14% of all gas produced-we have enormous and unique advantage of scale. We can always reduce operating costs and can almost always eliminate G&A costs. Our competitors really can't do that." Lloyd Byrne, an E&P-stock analyst for Morgan Stanley, says the amount of proprietary 3-D seismic in Chesapeake's possession-combined with Oklahoma's forced-pooling provisions-actually adds a degree of asset "extension" to the story, an element "not as common among other producers, and not fully appreciated by the equity markets, in our view." Randy King, a principal at investment-banking firm Petrie Parkman & Co. in Houston, worked with Chesapeake on its plan late last year to trade its Permian Basin assets for Midcontinent properties. King found many interested parties. "A common reaction was that Chesapeake is a strong competitor-a so-called 800-pound gorilla-in the Midcontinent and it may be hard to compete with it, that it may be better to get out of the Midcontinent and trade for Permian assets. Chesapeake is very formidable in the Midcontinent," King says. The deal went undone, however, when Chesapeake's exploitation drilling in the Permian produced good results, so Chesapeake kept the assets. Currently, 91% of the company's assets are in the Midcontinent. Most of the rest are in the Permian Basin and in the Austin Chalk in Texas and Louisiana, a chapter in Chesapeake's past production story. A small amount is in the Williston Basin in North Dakota and nets approximately 10 million cubic feet of gas equivalent per day. "That is a question mark," Rowland says of whether Chesapeake will keep this. "It is the smallest and least strategic. If we were to sell anything, it would be in that area." Continued expansion The company's plans for consolidation in the Midcontinent are not done, he adds. "It may slow down but not due to any inaction on our part. The fact is that the larger, particularly distressed, Midcontinent sellers have now sold-Williams, El Paso, Gothic, to name some of them. I really don't see the companies that remain being in any particular financial difficulty." XTO Energy Corp. walked away recently with some Midcontinent assets from The Williams Cos., but that offering was comprised largely of non-Oklahoma properties, so Chesapeake wasn't interested in the entire package. Its largest deal yet-for $500 million worth of prime El Paso Corp. reserves and production-was one the company had been working on relentlessly since 2001. When the giant diversified energy company ran into more liquidity trouble earlier this year, it caved and Chesapeake was at the front of the line, making an offer of $1.49 per Mcfe of total reserves. And it was able to close quickly-it wrote the check to El Paso on March 14; the deadline was March 31. Cash was raised from common and preferred stock sales, plus a long-term debt offering. Persistence pays? "Sometimes," Rowland says. "There are other companies we're still persistently following and it hasn't paid off yet." Capital structure Chesapeake's financing strategy matches long-term capital with long-term assets-its reserves' average life is now more than 12 years-and it doesn't often use its revolving credit facility, which is currently undrawn. "Short-term bank debt can be called when, typically, situations are at the worst for the industry," Rowland says. "We don't think that has a place in our permanent capital structure." Its ratio of debt vs. its total market capitalization is currently about 50% but Rowland says the more important credit statistic is Chesapeake's debt vs. proved reserves. "We're currently in the high 60s. We would like that number to be around 55 cents per Mcfe." Its full-cycle costs are about $18 per BOE or $3 per Mcfe. "And I would say that's the very bottom end of breakeven for the industry on a wellhead basis at this time. I think that's one quick indicator of why gas prices are not lower than most people would like them. "That's why we're such bulls on long-term prices being well above that level-the industry is just not going to continue to invest in long-term projects with relatively higher risk when all they're doing is possibly breaking even." Chesapeake hedges much of the production it buys, assuring the transactions will pay for themselves. King says the increasingly higher prices Chesapeake is paying for gas assets in the Midcontinent are a function of higher gas prices and not of overpaying. "Values are going up because gas prices are going up." Are Chesapeake's competitors for assets losing because they're not as confident in gas futures? "It's hard to say," Rowland says. "We lose out to them too. It may be because of the proprietary seismic we have. I would guess it's probably more that the industry as a whole is not focused on the Midcontinent as a major base of expansion, while we're the No. 1 producer here." Apache Corp. and BP have significant production in the Midcontinent but are not expanding in the area, for example. "I would rather think that the competitors we have are simply focused on other basins." According to Byrne, out of roughly 120 rigs drilling in Oklahoma in mid-April, 30 were working for Chesapeake and the company was participating in 40 to 50 more-for a total presence in more than half the drilling activity in the state. The company has an excellent reputation as a fair closer, says a competitor. "Chesapeake doesn't play the game." Some buyers will go into due diligence and come out complaining about this or that, knocking the offer down to something smaller but not so much smaller to make it worth canceling the agreement and putting the assets back on the market. "They close for what they offered," he says. Rowland says Midcontinent gas assets should be brought to Chesapeake for a look-over. "Word on the street is accurate," he says. "Chesapeake is a good buyer and a good closer."