Will BP Buy Chesapeake? (BP, CHK)

BP plc (NYSE:BP) shares are up about 2.5% pre-open today on rumors that the British petroleum giant is considering making an offer for Chesapeake Energy (NYSE:CHK). Chesapeake is the largest natural gas producer in the US, and BP has already paid more than $3.5 billion for some of Chesapeake’s assets.

At the end of the third quarter, BP had more than $14 billion in cashand short-term equivalents available. Chesapeake’s market cap as ofthis morning was just north of $13 billion. BP’s ADR price is aboutdouble Chesapeake’s share price, making some combination of cash andshares reasonable.

The AP said that it spoke to a couple of industry analysts this morning, whothought the rumors were nothing more than speculation. But are they?  Wehave our own thoughts.

It was only in September that BP’s TNK-BP joint venture was settled a dispute with its Russian partners and retain its permits toproduce crude oil. And a year ago BP was forced by the Russiangovernment to sell its 63% stake in the license to develop the massiveKovykta gas field. BP made money on the deal, but not as much as itwould have it had been allowed to produce the estimated 70 trillioncubic feet of natural gas.

If BP were to buy Chesapeake, the Brits could rest easy knowing that aUS company stays bought and isn’t magically stripped away. AndChesapeake holds more than 12 trillion cubic feet of natural gasreserves as of the end of the third quarter. The company reported totaldebt of about $12.4 billion and acquisition costs of proved reserves of$2.16 per thousand cubic feet.

The big question for BP is how big a premium would it take to getChesapeake? Natural gas prices are below $7/thousand cubic feet. Offsetthat relatively low price with easy access to the reserves, and theassumption that prices will certainly rise going forward. At about$2.50/thousand cubic feet of reserves, less debt, Chesapeake would costBP around $18 billion. That might be an offer that Chesapeake’sshareholders couldn’t refuse.  Would CFIUS allow it to proceed?

• Cheaspeake’s hedging paid off.
• CEO was margin called out of shares.

Chesapeake shares are now up over 3% at $23.15 today.

Paul Ausick
November 7, 2008