Chesapeake Files to Spin Out Royalty Trust (CHK)

Chesapeake Energy Corp. (NYSE: CHK) has filed a preliminary S-3 with the US SEC for the IPO of a company to be called Chesapeake Granite Wash Trust.  According to the filing, the trust will own term and perpetual royalty interests in oil, natural gas and natural gas liquids properties leased by Chesapeake in the Colony Granite Wash in Oklahoma. The Granite Wash is high-quality shale gas play in the Anadarko Basin.

The filing registers approximately 29.2 million common units at a proposed maximum offering price of $20/unit, for a proposed maximum offering price of about $584 million. A royalty trust operates in a manner very similar to a master limited partnership. Chesapeake did not specify a ticker symbol for the shares.

Chesapeake will offer 27.375 million common units to the public. The company will retain ownership of 12.7 million common units and an equal number of subordinated units which together will represent 50% of all outstanding units. The underwriters for the deal are Morgan Stanley and Raymond James, which may exercise an overallotment option on 3.8 million units, reducing Cheasapeake’s stake in the trust to 42.5%.

The trust’s royalty interests include “(a) 90% of the proceeds attributable to Chesapeake’s net revenue interest in the sale of production from 60 horizontal producing wells and (b) 50% of the proceeds attributable to Chesapeake’s net revenue interest in the sale of production from 122 horizontal development wells to be drilled within an Area of Mutual Interest consisting of approximately 45,400 gross acres (28,700 net acres) held by Chesapeake.”

According to the filing, at the end of March 2011 total reserves attributable to the trust amounted to 43.2 million barrels of oil equivalent, of which 47% was crude oil and natural gas liquids.

The trust will not be responsible to pay any drilling or other production and operating costs, but will pay a share of post-production expenses, which are costs related to gathering, storing, transporting, and marketing production.

The trust will also hedge a portion of its production through March, 2016. The filing does not specify the amount either of production that will be hedged or the expected revenues from that production. Because the trust will be a counterparty to the hedging arrangements, “the trust will receive payments directly from its counterparties and be required to pay any amounts owed directly to its counterparties.”

The filing lists the quarterly target distributions the trust expects to make through March 2031, the expected lifetime of the trust. The first distribution will include royalty interests from April 1, 2011, through August 2011. After that royalty payments will be made quarterly.

Paul Ausick