Wall Street Journal

By PETER LATTMAN and BEN CASSELMAN

"Kohlberg Kravis Roberts & Co. has invested about $350 million in East Resources Inc., a privately held company engaged in natural-gas exploration and development in a rock formation stretching from West Virginia to New York.

East Resources, based in Warrendale, Pa., is one of the biggest players in an area known as the Marcellus Shale, with control of 900,000 acres. KKR's investment, structured as debt convertible into a substantial minority stake, will help East Resources reduce debt and develop its reserves. The company, which has 230 employees, already has existing oil-and-gas production properties in the region.


Bloomberg News/Landov

The number of rigs drilling for natural gas in the U.S. has plummeted.
The investment by KKR is among the largest in the region and follows several similar private-equity bets. Last week, Morgan Stanley Private Equity acquired a majority stake in Triana Energy Investments LLC, a Charleston, W.Va., natural-gas play in the area. In November, Avista Capital Partners agreed to invest up to $150 million alongside Carrizo Oil & Gas Inc. to acquire and develop acreage in the Marcellus Shale.

The cash infusions come as many gas producers are scrambling for cash. Fields like the Marcellus Shale are expensive to develop, requiring producers to drill hundreds of small wells for more than $1 million apiece.

"This investment from KKR allows us to continue our business on a larger scale" when bank borrowing is hard, said Terrence Pegula, the chief executive of East Resources, which he founded in 1983 with $7,500 of borrowed money, much of it from his parents.

Most small producers have far outspent their cash flow in recent years, relying on borrowed money in hopes of big returns in future years.

With banks reluctant to lend money for traditional buyouts, private-equity funds are using minority investments to put their clients' money to work. The small scale of the East Resources deal shows how much the deal-making environment has changed since 2007, when KKR made what was then the largest leveraged buyout ever: the purchase of Texas power utility TXU Corp. for $32 billion.

Natural-gas producers have been hit hard by tumbling gas prices, which have fallen to less than $4 per million British thermal units from more than $13 last July. Both oil and natural-gas prices have been driven down by slumping demand for energy because of the slow economy.

But unlike oil, natural gas is also suffering from an excess of supply, the result of a drilling boom spurred by rising gas prices and easy credit. Huge gas discoveries in Texas, Louisiana, Pennsylvania and elsewhere have reshaped the industry, reversing a U.S. production decline many thought was permanent.

Low prices have made many drilling projects uneconomical, and producers have sharply reduced their drilling activity. The number of rigs drilling for natural gas in the U.S. has plummeted to 700 from a peak of 1,606 in September, Baker Hughes Inc. reported Friday.

But the Marcellus Shale has bucked the trend. There were 33 rigs operating in Pennsylvania last week, up from 27 in September and 20 a year ago. The Marcellus has benefited from big production and relatively low costs, which have made wells profitable even though prices are low.

The East Resources investment has historical significance both in the energy sector and at KKR.

America's first oil field was discovered in 1859 in Titusville, Pa., near some recent Marcellus Shale drilling. And KKR's co-founders have deep ties to the energy sector. Henry Kravis grew up in Tulsa, Okla., the son of a petroleum engineer, and George Roberts's father was a Houston oilman."

Write to Peter Lattman at peter.lattman@wsj.com and Ben Casselman at ben.casselman@wsj.com