China Set to Frack America in Shale Deal

By Christopher Helman, Forbes

04 January 12

howing that it isn't worried about the upswell of angst over hydraulic fracking technology, the Chinese government, through state-controlled Sinopec, today struck a deal with Devon Energy to buy into five prospective new exploration areas in the U.S.

The deal, which includes $900 million in cash upfront and a promise of $1.6 billion in the years ahead to cover drilling and development, gives the Chinese a 33% stake in five of Devon's fields, and a front row seat to what is effectively the second wave of development of U.S. shale assets. The areas in question include the Tuscaloosa in Louisiana, the Niobrara in Colorado, the Mississippian in Devon's home state of Oklahoma, the Utica in Ohio and the Michigan basin.

This isn't the first time a Chinese company has bitten off a piece of shale - Cnooc has partnered with Chesapeake Energy in the Eagle Ford and Niobrara in recent years - but it is the first onshore U.S. foray for Sinopec.

Foreigners have been hot for shale in recent months, with Chesapeake also today unveiling its Utica JV partner as Total. Last week SandRidge Energy, run by Chesapeake co-founder Tom Ward, sold a $1 billion worth of its acreage in the Mississippian to Spain's Repsol. A few months back Aussie mining giant BHP Billiton continued its shale gobble with the $15 billion pick-up of Petrohawk, following its earlier $5 billion buy of Chesapeake's Fayetteville shale acreage. India's Reliance Industries, though a JV with Atlas, controls some 350,000 acres in the Marcellus shale.

Sinopec's deal makes sense - it's buying promising acreage in the U.S. at a time when the price of natural gas is low ($3 per mcf) and the value of the dollar as a reserve currency is high.

(With $3 trillion in U.S. government debt set to be turned over in 2012 we'll need to attract a lot more foreign investment than this - but that's another story.)

So what does this deal do for Devon? Bob Brackett, analyst at Bernstein Research, was scratching his head over this today. In a note Brackett wondered why Devon was doing the deal at all. "Unlike companies like Chesapeake who need JVs to fund development activity, Devon isn't in dire need of the proceeds," considering its $5.6 billion in cash on the balance sheet. What's more, Brackett thinks Sinopec got the better end of the deal; he values the deal acreage at a fair value of $5,900 versus the implied deal value of $4,800 an acre.

More important, Brackett wonders when Devon will reveal what it has in mind for its cash. A big acquisition perhaps? Share buybacks? Or maybe just some really, really nice accoutrements for the giant new skyscraper headquarters it's building in downtown Oklahoma City.

Whatever Devon decides to do with its cash, the likely destination will be onshore. The company sold its deepwater and select international assets to BP for $7 billion in 2010. With new partner Sinopec. That move was the first big one that Chief Executive John Richels made upon taking the reins of the company from Larry Nichols (who founded Devon with his father four decades ago). But divestitures don't make a legacy, and Richels is surely seeking to make a lasting mark on Devon.

The market liked today's move, pushing Devon shares up 6.63% to $66.11.