UBS, Deutsche Bank Buy $1.1 Billion in Chesapeake Gas

UBS, Deutsche Bank Buy $1.1 Billion in Chesapeake Gas

Jan. 2 (Bloomberg) -- UBS AG, Europe's biggest bank by assets, and Deutsche Bank AG bought rights to about 2 percent of Chesapeake Energy Corp.'s production in a $1.1 billion bet on their ability to profit from fluctuations in natural-gas prices.

The banks bought so-called volumetric production payments, or VPPs, entitling them to about 55 million cubic feet of daily gas output over 15 years and 210 billion cubic feet of reserves, Oklahoma City-based Chesapeake said today in a statement. Chesapeake, the second-biggest independent natural-gas producer in the U.S., said it will use the money to fund drilling.

UBS and Deutsche Bank, Germany's biggest lender, follow Goldman Sachs Group Inc., Morgan Stanley and other financial services rivals in acquiring energy assets through VPPs and other transactions. Merrill Lynch & Co.'s revenue from commodities, currencies and fixed-income investments jumped 71 percent in the third quarter.

``Managing commodities risk is really profitable for these banks,'' said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. ``We'll see a lot more of it.''

UBS and Deutsche Bank paid about $5.24 per thousand cubic feet of gas reserves, according to a Bloomberg calculation, and won't be responsible for any of the costs or taxes associated with the wells. The price represents a discount of about 32 percent to U.S. gas futures.

Price Risk

``Natural gas is a highly cyclical commodity, rising this time of year and falling in the spring,'' said Richard Bove Sr., an analyst at Punk Ziegel & Co. ``The risk is that natural-gas prices don't hold up over the long term.''

The deal with Chesapeake marks the first VPP for Deutsche Bank's Houston office, said Louise Kitchen, the bank's global head of commodities sales and structuring. She said a VPP is a ``commonplace vehicle in the energy business.''

``For us, it's a middle-of-the-fairway transaction,'' Kitchen said. ``We believe that to provide the wide array of risk-management solutions to clients, like VPPs where you have to take the physical supply of natural gas, you need to be in the physical business. We are working on several VPPs at the moment.''

A UBS spokesman didn't immediately respond to a message seeking comment for this article.

Rating Edge

Higher credit ratings will make it easier for UBS and Deutsche Bank to lock in gains in gas prices through hedging contracts, said Sanford C. Bernstein's Hintz. Both of the banks have the third-highest of 10 investment-grade credit ratings from Standard & Poor's. Chesapeake's debt is rated two levels below investment grade.

``The banks can buy it for them over a long period of time and charge them a lot of money for it,'' Hintz said.

The VPPs also will allow the banks to bet on the gap between electricity prices and the cost of gas-fueled power generation, called a spark spread. ``They enter a long term contract on gas and make electricity with it,'' he said.

Deutsche Bank dropped 1.9 percent to 87.75 euros in Frankfurt. U.S. shares of Zurich-based UBS fell 33 cents to $45.67.

Chesapeake rose 90 cents, or 2.3 percent, to $40.10 at 2:53 p.m. in New York Stock Exchange composite trading. The stock climbed 35 percent last year.

Divestiture Plan

U.S. oil and gas producers such as Denbury Resources Inc. and Pioneer Natural Resources Co. have sold VPPs to raise cash from their properties without giving up the opportunity to drill for more deposits. Chesapeake, which announced plans Sept. 4 to sell more than $3.5 billion in assets, said today it expects to raise at least $2 billion more from VPP sales in 2008 and 2009.

``They said they were going to do this, so it's nice to see it get done,'' said Carin Dehne Kiley, an analyst at Calyon Securities (USA) Inc. in New York who rates Chesapeake shares at ``add'' and doesn't own any. ``VPPs have come and gone in popularity.''

By raising cash through VPPs and creation of master limited partnerships that will acquire some of Chesapeake's assets, Chief Executive Officer Aubrey McClendon is eliminating or reducing the need for new borrowing to fund a drilling program that may increase reserves 40 percent by the end of next year.

Among U.S. independent producers, those that don't own chemicals plants or refineries, Chesapeake pumps more gas than all but Devon Energy Corp

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