This morning, Wildcatters Portfolio holding Linn Energy announced plans to sell 152,000 net acres of Marcellus Shale leasehold in Pennsylvania and West Virginia to fellow Wildcatter XTO Energy for $600 million in cash.

The Marcellus Shale is one of the most promising unconventional gas plays in the US right now; producers are tripping over one another trying to buy up acreage in the region. Like most unconventional plays, the Marcellus Shale requires more sophisticated technology to produce than traditional gas reserves.

I explained unconventional reserves at some length in the Feb. 20 issue of The Energy Strategist, “Growing Unconventionally.” To review, horizontal wells are more expensive to drill but produce better results in most unconventional plays. In addition, the Marcellus Shale will likely require fracturing to be produced.

Fracturing is a process producers use to improve the permeability of a reservoir by pumping a liquid into the reservoir under extremely high pressure; that liquid literally cracks the reservoir rock, creating channels for the gas to flow through. With the application of these techniques, production from wells in the area should be prolific.

Current estimates are that the properties XTO is buying have around 145 billion cubic feet of gas equivalent reserves. However, as XTO starts drilling, it’s quite likely those reserve estimates will rise. Other producers in the region have reported impressive success drilling in the region.

From Linn’s perspective, my take on this deal is mixed. On one hand, I don’t like to see Linn selling such a valuable asset in the form of acreage in one of the nation’s hottest gas plays. I’d much prefer to see the firm develop the play in house or as part of a joint venture with another producer.

However, the market likely wouldn’t support such a move. One of the main concerns surrounding Linn in recent months is that it wouldn’t be able to raise additional capital to fund acquisitions or an aggressive organic growth program. Although developing the play would produce significant growth in production, it would also be expensive; in the current credit environment, it would be tough for Linn to raise the credit needed to fund such a project.  

Some might also see such a drilling program as too risky for a publicly traded partnership (PTP) such as Linn. Typically, Linn drills within established reservoirs where gas production rates are highly predictable. But the Marcellus Shale is a relatively new play, and producers have limited experience in the region. It would be harder to predict cash flows from the play.

The $600 million Linn raised will likely be used to pay down debt. This would ease concerns about Linn’s access to capital; the market has been rewarding PTPs that have cash on the books or available cash on their credit lines. I’m attending Linn’s analyst day in New York City this Thursday and will be looking forward to asking for more details from management and its specific rationale for the transaction.

But my preliminary assessment is that this was a good way for Linn to raise capital to fund its organic growth program. I expect to hear more details about that program on Thursday and will provide my detailed takeaway from that meeting. Linn Energy remains a buy.  

From XTO’s perspective, the deal looks undeniably attractive. The $600 million purchase price includes about $50 million for pipeline infrastructure. Netting that out of the equation, XTO is paying about $3.80 per thousand cubic feet of reserves. That’s a high valuation, but I suspect proven reserve estimates will rise as XTO starts drilling and assessing the properties.

XTO has a long history of producing unconventional plays, and that experience and know-how will make it far easier to exploit this acreage. It’s an ideal asset for XTO to buy.

In the current credit and gas price environment, the deal appears to offer positives for both acquirer and seller. XTO Energy remains a buy under 65.