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Will a Sinopec Deal to Take Over Chesapeake Work?


Chesapeake Energy has been in the news a great deal recently, and a new controversy may well begin to swirl around this energy producer.


The financial media was filled with reports about one of China's super major oil companies, Sinopec (SHI), as a likely buyer for a huge chunk of Chesapeake Energy's (CHK) assets. Financial Times, Reuters, and Forbes all reported that Chesapeake is talking with Sinopec and others about unloading a large body of its assets.

The troubled US energy firm, whose embattled CEO Aubrey McClendon has been under siege from angry shareholders, had announced recently that it would sell $11.5 billion of its assets to shore up its funding. Chesapeake, one of the most aggressive of the oil and gas exploration companies, has historically been a highly leveraged company, so with the recent decline in natural gas prices and the softening oil market, it has shifted focus to raising cash to fund its operations.

Sinopec, or China Petroleum & Chemical Corp., is one of the large, state owned enterprises (or SOEs) in the energy field in China, with a $75 billion market cap, and is known for its emphasis on downstream operations, which are refining and marketing. While Sinopec remains the dominant Chinese company in refining, it is active in importing crude oil, also.

Roughly three-fourths of Sinopec's petroleum which is processed is imported, and Sinopec has been active in seeking out more overseas assets. Added to this are the recent attempts at expanding its natural gas holdings. The domestic industry natural gas industry in China is one with vast potential, especially in unconventional shale gas deposits.

The asset sales Chesapeake is undertaking are substantial. Chesapeake had been an aggressive company expanding into the many shale plays, which require fracking to release natural gas.

Chesapeake has already sold $4 billion of its pipeline assets to Global Infrastructure Partners, and has 1.5 million acres in the Permian Basin it's considering selling. It also is willing to sell more than 300,000 acres of the Utica shale play in Ohio.

Chesapeake has been extremely active in Ohio, buying up leases statewide in the last year, offering increasingly higher prices to rights owners. Sinopec already has a joint venture with Devon Energy (DVN) in Ohio's Utica play, and has invested more than $2 billion with Chesapeake in joint ventures in its Eagle Ford and Niobrara plays. Sinopec holds 33% in these stakes, but does not do the drilling.

There are a number of factors at work here. China, for its part, needs to gain more assets in oil and gas. It is a voracious energy user, and as its society continues to further industrialize, it has a seemingly endless need for energy.

Additionally, it has potentially enormous unconventional shale gas and liquids reserves under its feet, but it doesn't yet have the operational experience for hydrofracking. Thus it has been undertaking domestic joint ventures and is considering additional ones. Also, the Chinese government has massive amounts of foreign-exchange reserves which are sitting around doing essentially nothing.

Buying up oil and gas assets overseas as well as other commodity assets, such as mining and metals, is a judicious way to put that capital to work, as well as deliver much needed natural resources.

Fu Chengyu, chairman of Sinopec, was at the helm of CNOOC (CEO) when it pursued Unocal for $18 billion in 2004. There was public outcry against a US asset potentially being taken over by China, so the deal was killed.

Fu has proved himself an astute executive, so the pursuit of joint ventures is probably more prudent on a public relations scale, but times have changed. No one in the US would be shocked at China buying the full stake in a company's shale play. More than that, when you have a cash-strapped seller which has possibly over extended itself as Chesapeake has, pragmatism rules.

Although Fu was Aubrey McClendon's guest at a recent NBA Finals game in Oklahoma City, there's no guarantee that Sinopec will do a major deal with Chesapeake for the assets mentioned. After all, Chesapeake was reportedly talking to as many as 20 potential buyers.

If, however, Sinopec doesn't buy these specific Chesapeake assets, look for other deals between the two, and Sinopec will continue to pursue overseas assets regardless. The other Chinese supermajors will be active, also, as we are in the beginning phase of the China oil and gas asset expansion - nowhere near the end.

Editor's Note: This article was written by Jim Trippon of Dividend Genius.

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