Shares of Chesapeake Energy Corp. (NYSE: CHK) rose on Thursday after the top natural gas producer agreed to exit the Barnett Shale operating area located in North Texas. It is terminating future commitments associated with the asset. Saddle Barnett Resources, a company backed by private equity firm First Reserve, will be taking over this asset. Overall, this is a longer term play that ultimately will be in the best interest of Chesapeake, according to management.

Williams Partners L.P. (NYSE: WPZ) and Chesapeake will also end their gathering agreement, for which Chesapeake expects to pay roughly $334 million in cash to Williams. Saddle Resources is expected to pay an additional sum as well.

Although the transaction is still subject to closing conditions, it is expected to close in the third quarter of 2016. This matters for Chesapeake, and maybe more than the market is giving it credit for.

The company updated its outlook for the remainder of 2016 and for 2017. Chesapeake expects to have adjusted production growth (thousand barrels of oil equivalents) in the range −2% to +3% in 2016, and in the range of −7% to −2% for 2017.

This matters for Chesapeake because this is effectively a renegotiation of the cost of service gas gathering into a fixed fee in the Mid-con, and it will reduce the related gathering fees by 35% or more. The transaction also will remove close to $1.9 billion of future midstream and downstream commitments. Now consider that Chesapeake has a market cap of just $3.8 billion. The company’s 2015 revenues were $12.76 billion, and normalized operating costs were about $10.3 billion.

In terms of the impact of the transaction, Chesapeake expects the following:

• Increases operating income (before charges and termination costs) by roughly $200 million to $300 million per year from 2016 through 2019.
• Reduces remaining 2016 gathering, processing and transportation (GP&T) expenses by approximately $250 million, including $170 million for a projected minimum volume commitment (MVC) shortfall payment.
• Reduces GP&T expenses by about $465 million, including $230 million of projected MVC shortfall payments.
• Eliminates future Barnett Shale midstream and downstream commitments of approximately $1.9 billion.

Doug Lawler, CEO of Chesapeake, commented:

Today’s announcements mark a major step in our continued progress to transform Chesapeake. By exiting the Barnett, we expect to increase our operating income for the remainder of 2016 through 2019 between $200 and $300 million annually, eliminate approximately $1.9 billion of total future midstream and downstream commitments, and increase the PV-10 of our proved reserves. Given the significant negative cash flow profile of the Barnett assets, the net cash paid out in these transactions has a payback of less than 18 months, and it will be partially funded by the $146 million sale and assignment of our long-term gas supply contract.

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Shares of Chesapeake were trading up nearly 3% at $4.94 on Thursday, with a consensus analyst price target of $4.78 and a 52-week trading range of $1.50 to $9.55.

Williams Partners was last seen up 1.5% at $35.58. The consensus price target is $55.00, and the 52-week range is $12.69 to $42.44.

This is one of those deals that do not come without a cost. Otherwise Chesapeake shares would likely be far higher. Still, it may remove some overhang and allow Chesapeake to focus on other operations that it feels may help return the company closer to being profitable again. The verdict remains out, so stay tuned.

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