PA Senate Hears Drilling Complaints

A hearing last evening at Misericordia University was called by the Senate Majority Policy Committee to explore the economic and environmental impact of drilling in the Marcellus. The most common theme throughout the evening was the time-consuming and lengthy permitting process and cumbersome regulations making it difficult for them to operate in Pennsylvania.

"I have great hopes for what the Marcellus shale play might still hold for Pennsylvania. Unfortunately, my experience to date does not lead me to be very optimistic," Wendy Straatman, president of Exco-North Coast Energy Inc...........DEP permitting delays that are "unlike anything we have seen in any other state in which we operate."

Scott Rotruck of Oklahoma City-based Chesapeake Energy Corp., predicted "ominous" consequences for Marcellus development if Pennsylvania's regulatory environment doesn't become more welcoming.

The state needs to be "careful we are not killing the goose that's laying the golden egg," said Sen. Mary Jo White, R-Venango.

"There has to be a smart way to protect what we need to protect, and at the same time (prevent) a delay that really serves no purpose," said DEP Secretary, John Hanger. "I believe there's a learning curve here for everyone involved."

Industry executives also opposed a tax on natural gas that the administration of Gov. Ed Rendell has said it is considering. "New taxes will stymie Marcellus development," said Ray Walker Jr., vice president of Range Resources Corp

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Drillbits

How a Player Plays the Play

In recent days, after leasing in the Marcellus shale had stopped almost completely, the last in a long line of the major E&P companies have sent lease rescission letters out to landowners who had signed up in the past few months. Two months ago, at the head of that line was, of course, Chesapeake Energy. Within a matter of days, Range Resources followed Chesapeake's lead; then Chief followed suit, and more recently, Cabot, East Resources and XTO all did too. Along the way, most of the smaller outfits also dropped out, and finally, last week, even zero debt Rex hauled its box of letters down to the post office.

So, while all this was going on, who do you think had his landman building mailing lists for the next round of lease offers,...you know, of all of those irate property owners that were just dumped by the other companies? And, guess who just mailed a big box of those letters in Greene County, PA last week? .......yep, right again, Aubrey McClendon.

While there are legitimate concerns among some of these companies about expending cash and credit lines in the face of a credit crunch and impending recession, most, in the wake of Chesapeake's walking away, just decided to wait it out for lower lease prices. It will be interesting to see how that gambit works out. As for Chesapeake, it will be really interesting to see how the new offers stack up against its recent $5,800/acre effective flip of previously acquired leasehold to StatoilHydro.

Also last week, Chesapeake made over 25 permit applications in one of the NWPA counties...and why not? It is becoming increasingly clear that the economics of the Marcellus are the best of the shale plays. Natural gas futures are still in contango and with the Marcellus' Appalachian premium, will still bring $8.50-$9.50/mcf for the next two years while input costs: day rates, pipe, supplies and services are all coming down.

As so often happens in the O&G business.......the cycle begins anew.

Chesapeake Deals Norway's StatoilHydro into the Marcellus Shale

New Standard Set for Marcellus Shale Acreage

Well, Aubrey got 'er done. The long awaited joint venture in Chesapeake's Marcellus shale assets was announced this morning to my and most of the investment community's surprise. While the long term value of Chesapeake's acreage position was never really in question, its ability to do a deal under the current economic circumstances certainly was. Eventhough the proceeds are a little light of the last forecast, it's a good deal for Chesapeake. Fortunately, StatoilHydro took the long view and after a thorough analysis of the economics of the play, signed on for nearly $5,800 per acre at a time when Chesapeake and others are paying only $500-$2500.

Europe's #2 natural gas supplier, StatoilHydro, committed US$ 3.375 billion for 32.5% of Chesapeake's 1.8 million acre interest. $1.25B in cash will be paid at closing and $2.125B of drilling carry will be paid over the next four years to fund 75% of Chesapeake's drilling costs. The presentation from this morning's conference call shows that the company used mildly conservative economic assumptions in the decision: an average EUR per well of 3.1 bcf and drilling capex of $3.5 million per well. But, a rather aggressive drilling program over the next four years may prove an underestimated political risk. At $3,5 million per well, the drilling carry implies over 800 horizontal well completions during the next four years. Since the carry is a use it or lose it proposition, if Chesapeake is to use all of it, the number of wells would seemingly have to be even greater as drilling costs go down. The companies expect to ramp to an average of 40 operating rigs in 2012, so, at 10 wells per rig/yr, the plan is back end loaded. Also aggressive was the 87% net revenue interest assumption which seems to preclude the imposition of a severance tax in Pennsylvania.

Overall, StatoilHydro plans commit US$ 6.0B over the next four years including $ 2.63B to the joint venture for its 32.5% share of capex. This amount, as well as the drilling carry, will be somewhat variable as it is dependent on Chesapeake's completion performance, but it does imply that Chesapeake intends to spend US$ 8.0B of its own in project capex beyond its share of the drilling costs. Chesapeake plans to continue acquiring leasehold in the Marcellus Shale and StatoilHydro will have the right to a 32.5% participation in any such additional leasehold.

Press Release
StatoilHydro Presentation

Engelder-Appalachin Fracture Systems-Platts-Marcellus Shale Presentation

Terry Engelder has provided his Platts Marcellus Shale presentation for posting. It is available by clicking either the link below, or in the "Technical Papers" section on the sidebar. He also offered a few comments:

The hard variables lending to his estimate were provided, in the main, by Chesapeake.

Professor Engelder notes, "the more important number comes from the potentially accessible fraction of the GIP which I placed arbitrarily just under 400 Tcf recoverable (One-third of the play). Range has always told people that they think recovery will be patchy…….exactly what this percentage is has yet to be discovered. "

He also pointed out those key elements of his and Gary Lash's prior 50 tcf noting, "Gary Lash and I were conservative to a fault by assuming just a 50 foot thickness (we know the Marcellus is much thicker). This meant that were also conservative in our calculation for GIP/section. Finally, we only allowed for a recovery factor of 10%. "

Factoring 100' average thickness and 30% recovery(Chesapeake) to that original estimate gets you to 300 tcf, "which is not far from taking the 1100 Tcf given by Chesapeake and allowing access to only 33% of the GIP."

Finally, he noted, that "we are all on the same page of the playbook in SIZING the resource."

Engelder- Platts Presentation

After Further Review, At Least 15 Years of Gas in the Marcellus Shale

After publishing the piece about Terry Engelder's update on the Marcellus reserve estimate, I made an inquiry to confirm my assumption about the new estimate of recoverable gas in the play. To clarify, Professor Engelder notes that the new analysis is derived from a convergence of the latest data provided by Chesapeake, Range and several other operators. He provided the following assumptions used in his analysis:

Total Acreage 31,000,000
# Sections (640 acre) = 48,437.5
GIP/Section = 75 bcf
Total Gas in Place = 3,632 tcf
Recovery Factor = 30%
Technically Recoverable Gas = 1,089 tcf

Professor Engelder cautioned that a practical assessment of the amount of gas which could be expected to be recovered would need to consider how much of the acreage is accessible. There are, of course properties that cannot be developed, existing storage fields, terrain challenged areas, etc., which must be discounted. In his present assumption, 33.33% of the total acreage in the play can be considered developable. This would leave the truly recoverable reserves at 363 tcf, a sevenfold increase of the prior 50 tcf estimate and much greater than the double I reported earlier.

Under these assumptions, the Marcellus could now provide all of the natural gas consumed in the US for 15 years.

Marcellus Potential Doubled

Yesterday, according to the attached report of his talk at the Platts Appalachian Gas conference in Pittsburgh, Terry Engelder, Professor of Geoscience at Penn State, doubled his estimate of Marcellus GIP to 1,100 tcf. Last January, the professor surprised the natural gas industry with his upside estimate of 516 tcf. I believe the article incorrectly states that his estimate of recoverable gas is now over 1 tcf. It should actually read over 100 tcf; also, a double from his earlier 50 tcf estimate.

Full Story

Drillbits

It Matters Hardly at All

As Chesapeake Energy seeks to shore up its cash position by taking on a JV partner for its Marcellus shale, a strange, but true back story may be hurting the company's chances. The consummate land man, Aubrey McClendon, might just have outdone himself.

The company’s latest investor presentation gives an implied value of $7,500/acre for its 1.8 mm acres of Marcellus leasehold (US $13.5B). So, a 25% share would be worth $3.4B. On the basis of the previous JV deals, a portion of this amount would be in cash with the balance delivered over time in the form of a drilling cost carry. According to the presentation’s tables, these JV proceeds combined with the proceeds from sales of some producing properties in Oklahoma and South Texas are projected to raise $2.5B to $3.0B. So, $1.7B from the Marcellus would seem reasonable and, thus, a critical piece of the 12/31/08 Ending Cash forecast of $3.5B.

But, there’s a problem. While advocating a lease acquisition and monetization strategy of buy low, sell high, Mr. McClendon noted:

“One of the great advantages of a time like this is we can drive down the cost of our business. That’s not only going to be true soon on the drilling side but it’s especially true today on the leasing side as we are continuing to be very, very aggressive in driving down prices in areas of shale plays so we can acquire leases we think at a lower price going forward.” …..“I can assure you that buying leases for X and selling them for 5X or 10X is a lot more profitable than trying to produce gas at $5 or $6/mcf.”

Now, that’s all well and good, if, as Chairman/CEO of the largest US gas producer, you can somehow profit by professing your abilities as a land man. Call me crazy, but I’d think the best way to profit by buying and selling leases is to keep lease prices in a play high until you sell them, not knock them down while you're still trying. Then, you could tout them by saying, as Mr. McClendon did:

“The neat thing is leasehold is always cheap in a play whether you pay $5,000 an acre or $10,000 or $20,000 or $30,000. In most of these shale plays it matters hardly at all as to what you pay for leasehold because you consume so much leasehold at 80 acres generally a well and these wells can cost $3 million to $6.5 million. So you put some leasehold on top of that, it’s just not much money at the end of the day.”

Instead, what Chesapeake has done in the Marcellus is to be “very, very aggressive in driving down prices”, by effectively pulling out of leasing completely. First in NEPA, then in SWPA, then Range followed suit….then a few smaller operators, then Chief and last week, Marathon. Prices have plummeted to $500 to $2,000/acre, and so have Chesapeake’s chances of doing a JV deal by year end.

More likely is another kind of deal; a deal following a Not Done or Failure to Deliver on the JV; a kind of Bear or Wachovia deal when someone deciding to commit $3.4B for a 25% share of the Marcellus realizes that the entire market cap of Chesapeake is only $10B. And that, if they hold up on the JV, they just might get the whole company for the same number.

Unfortunately, for Aubrey, since getting hit with those margin calls, his vote on the motion………why, it matters hardly at all.

October 15, Business Update Call Transcript

Honey, It Was Just a Mirage

Interesting that during the last two or three Chesapeake calls, very little, other than the announcement of a monetization plan, was said about the Marcellus. The Haynesville was all the rage. During last week's Investor & Analyst meeting, the company left no doubt that the development of the Marcellus is a major priority and one that will contribute more than any other to the bottom line. The company plans to ramp production from 20 mmcfd to 60 mmcfd by the end of '09 and to 130 mmcfd through '10 with the rig count going from 4 to 10 to 20 during the period. With the lowest finding costs and highest net selling price, the Marcellus will provide, by far, the highest IRR of any of the shales; at $7 gas about 200% BFIT as compared to 25% in the Fayetteville and Barnett and 50% in the Haynesville.

Some of Aubrey McClendon's more interesting comments:

"We did everything that we said we were going to do during the quarter and ended up with a stock price at $38 on September 30. Today we wake up 15 days later and the stock price is $16. So what’s happened at the company? We’re still going to earn almost $10 a share of cash flow in 2009. We’re still going to earn over $3 a share of earnings, and nothing’s changed.

...I can’t do anything to convince anybody here or anybody listening that we have enough money. We've told you that we have enough money, $1.1 billion. I think we’ll end the year at $3.5 billion. I just read that at September 30 British Petroleum had $3.6 billion. I’m sure they have more resources than us, but the point is that we have plenty of cash today, we’ll continue to build cash through the quarter and into ’09 and ’10.

...I guess another thing that’s been a little surprising to me is I’ve seen some analyses where if gas prices go to $5, people go out and spend their cash resources. Why would we do that? Why are we not capable of decreasing our capital expenditures? We are not going to spend more cash than what we can generate.

...I can assure you that buying leases for X and selling them for 5X or 10X is a lot more profitable than trying to produce gas at $5 or $6 mcf.

...The neat thing is that leasehold is always cheap in a play whether you pay $5,000 an acre or $10,000 or $20,000 or $30,000. In most of these shale plays it matters hardly at all as to what you pay for leasehold because you consume so much leasehold, 80 acres generally a well and these wells can cost $3 million to $6.5 million. So you put some leasehold on top of that it’s just not much money at the end of the day.

...Natural gas is simply the fuel that is going to continue to make an enormous impact in our country and in our world. My own view is that we’re near a point of peak oil production whether it’s today or two years ago or five years from now or 10 years from now. It doesn’t really matter to me if it’s geological or if it’s geopolitical or a little bit of both."

Full Transcript

Drillbits

Up From the Ground Come a Bubble

In what must be one of the greatest sector collapses in market history, participants in the nation's shale plays have had to move quickly to pare back risk. In an industry where the taking and management of risk are at the core of a company's success, it's not surprising that dramatic steps had to be taken. Most dramatic of all, beyond the deals falling through, capex being cut, leasing being stopped, wells being shut in and rigs being let go, was the quickness of some companies and individuals to cut debt exposure. Some, voluntarily and some not, and some more quickly than others.

This writer has long praised Aubrey McClendon for his bullishness and quickness in exploiting the shale plays and putting Chesapeake at the top of the producer list. The most remarkable part this ascent was his willingness to put his personal wealth on the line. Nobody did that better than Aubrey. Had I known that he'd also bought the last several million shares on margin, my remarks might not have been so laudatory. It's hard to say what his net equity was at the top when his holdings were worth $1.9 billion, but by the day of the first call, it had dropped to $750 million and after three days of selling, at Friday's close, it was worth $31.9 million. Nonetheless, I'll still root for him as long as he's capable of learning THE LESSON OF A LIFETIME and managing the company with the knowledge that there's so much more to lose if he's not.

Bob Simpson of XTO also did some heavy selling. Apparently, not by force as in McClendon's case, but Simpson cited cleaning up some debt as one of his reasons for disposing of 2.777 million shares or about 30% of his holdings.

Stories:
McClendon
Simpson

Chesapeake Provides Operations Update

After the close today, Chesapeake released an operations update. The highlights:

-Company Reduces Drilling Capital Expenditure Budget through 2010 by Approximately $3 Billion and Expects Approximately $2 Billion of Excess Cash Generation in 2009 and 2010 to Be Directed Primarily to Debt Reduction

-Lower Capex and Asset and VPP Sales Lead to Lower Production Growth Forecasts for 2008 of 18% from 21% and for 2009 and 2010 of 16% from 19%

-Company Closes Fayetteville Shale Joint Venture Transaction with BP America; Discussions Progress on Marcellus Shale Joint Venture; Company Resumes Plans to Sell a $1 Billion Minority Interest in its Midstream Business Company Provides Hedging Update;

-Substantial Decline in Natural Gas and Oil Prices Has Led to an Approximate $6 Billion Favorable Mark-to-Market Change in the Company's Hedging Positions Since June 30, 2008

-Company Completes Three New Haynesville Shale Wells in September with Average per Well Initial Production Rates Exceeding 10 MMcfe per Day

A conference call to discuss this release has been scheduled for Tuesday morning, September 23, 2008, at 9:00 a.m. EDT

Full Story

Marcellus Shale Activity Updated

Where You Stand Depends on How You Sit

So far, this earnings season has provided some interesting insights into the Marcellus play. Pardon my above mild rework of Miles' Law but the frontrunner views of the Marcellus are generally gung-ho while those looking at the hind teat are considerably less so. We'll see if the trend continues this week with coming reports from Atlas, Exco, Carrizo and Rex. Highlights from the latest conference calls and presentations are below.

Anadarko and its partners commenced drilling operations on two wells in the Marcellus Shale play in the Appalachian Basin with encouraging results. The wells have been cored and further evaluation is under way. Anadarko has access to approximately 625,000 gross acres in the fairway of the Marcellus Shale play. This is an increase of 25,000 acres in the quarter. Responding to an analyst's question about the impact of increased drilling in the Marcellus, the company echoed the sentiments expressed in Chesapeake's call that the time required to develop the play will mitigate any over supply concerns now being bandied about.

Chesapeake has completed two horizontals in West Virgina with a combined current production of 7 mmcfd. These wells were announced one month ago with initial production of 9 mcfd. CEO McClendon viewed as "reasonable" Range Resource's announcement that it has boosted its EUR per well to the 3.5-4 bcfe range. Interesting that Chesapeake's EUR for the recently completed pair is 5.5 bcfe. In response to questions about the impact of Marcellus development on natural gas prices, McClendon noted that there "are way too many regulatory, topographic, water, and infrastructure issues that will keep the Marcellus from making a meaningful contribution to our country’s gas production until at the least 2013 to 2015 time frame." Acreage in the play increased by 400,000 acres during the quarter to 1.6 million. The company also restated its intent to monetize 25% of its Marcellus assets by taking on a partner in the same manner as in the Haynesville transaction with Plains Energy. During that conference call, CEO McClendon had placed a $12,500/acre on its Marcellus rights.

EOG Chairman & CEO Mark Papa reports having 220,000 net acres in the Marcellus and is operating one rig and will have some results by year-end. He said this will be a very slowly developing play in the macro sense because of the major infrastructure issues. He also estimates that the Marcellus, if it works, would not contribute meaningfully to the macro domestic gas supply picture until 2012 plus. He also noted that the thickness is an issue, in some cases pressure is an issue but probably the most unknown risk factor that we and others are dealing with right now is frac efficacy; frac barrier containment in the Marcellus itself. "The kind of results that we are hearing about in parts of Pennsylvania that are showing 3 Bcf to 4 Bcf really does not comport well with the kind of IPs that we are seeing in rest of the play and really, with the way we model the plays north of 1.5 Bcf to a 2 Bcf kind of play, particularly if you're looking at big program averages. It's really, really difficult to average 3 Bcf to 4 Bcf over the whole play." To another question he replied, "I think there are differences in the frac barriers throughout the play, from one geographic area to the next, and I think that's the biggest unknown in the play right now for most of the operators." Comparing it to the Barnett he noted that when you are "dealing with Marcellus, which is less geo-pressured and much thinner, it just doesn't make good reservoir engineering sense that you're going to get recoveries of 4 Bcf per well when that hadn't been average in Johnson County. So, we just think that that number is probably a number that's we believe is unrealistic. And then, you clearly do have a problem with containing the fracs within that relatively thin zone. You have more of a problem in the Marcellus than you do in the Barnett."

Equitable Resources reported having completed four Marcellus wells including three verticals in Northern WV and one horizontal in Greene County, PA. The verticals have been on line for less than 30 days but are expected to average 600 mcfd while the horizontal has averaged 1.9 mcfd for its first 30 days. The horizontal cost $6 million to complete. Expectations are for an average of $3-4 million to complete the remaining eight horizontals planned for this year and though still experimenting, the company plans to adapt its considerable experience with air drilling to the Marcellus and further reduce cost to $3-$3.25 million. Equitable raised capex from $1.2b to $1.6b with 55% of it going to the Marcellus and now plans to drill 75 wells by the end of 2009. Acreage stands at 400,000 acres, unchanged during the quarter. On infrastructure issues, the company announced plans to support other producers by building two 20 mmcfd stripper plants in the play and noted that "there are a bunch of other mid-stream players entering the area which will also resolve those concerns." Regarding water resource and disposal issues, it was noted that the SWPA-NWV is not regulated by a regional commission as is the case in the northeastern part of the play so that the issues facing development in the area are just "growing pains."

Penn Virginia continues its leasing effort in the Marcellus Shale, primarily in Pennsylvania, having acquired approximately 21,000 net acres to date at an average cost of approximately $400 per acre. Additional increases are expected during the balance of 2008 and beyond. One vertical Marcellus exploratory well was completed in southern WV and is currently being tested. Initial exploratory drilling is expected to continue during 2009, subject to rig availability, takeaway capacity and other potential constraints.

Transcripts available at http://seekingalpha.com/tag/natural-gas

Mr. McClendon Goes to Washington

Aubrey McClendon, Chairman & CEO of Chesapeake Energy, is making the rounds on Capitol Hill today armed with a new study showing that US natural gas reserves are 50% higher than recently thought and equate to 118 years (2,247 tcf) of supply. He follows T. Boone Pickens in a quest to make natural gas the primary fuel to lead us away from foreign sources of energy. He also appeared on CNBC this morning to discuss the findings.

According to McClendon, whose company helps funds the foundation, the new study is a real time analysis that includes current assessments of the major shale plays in the US. The study was done by Navigant Consulting.

Full Story at http://www.accountability-central.com/single-view-default/single-view-lexis-nexis/article/study-raises-estimates-of-us-natural-gas-reserves-could-be-50-bigger/?tx_ttnews%5BbackPid%5D=1&cHash=fd08742dd4
Video at http://www.cnbc.com/id/15840232?video=807915389