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Wheeling and Dealing in the Utica Shale

By Peter Staas on November 10, 2011

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When state-controlled Norwegian oil and gas firm Statoil (Oslo: STL, NYSE: STO) announced the USD4.4 billion acquisition of US independent Brigham Exploration (NYSE: BEXP), shares of companies with solid acreage positions in the Bakken Shale and other oil-rich unconventional plays received a welcome boost.

This deal, coupled with BHP Billiton’s (ASX: BHP, NYSE: BHP) USD12.1 billion takeover of Petrohawk Energy Corp (NYSE: HK) in July, fueled speculation that integrated energy companies would pursue additional takeovers and joint ventures to add exposure to US tight-oil plays. Not only do these transactions provide a source of low-risk production growth relative to deepwater plays and regions fraught with political risk, but the experience and knowledge gained in US shale oil fields can also be applied to similar formations located around the world.

Many industry observers expected the next big deal to involve an operator in North Dakota’s Bakken Shale or south Texas’ Eagle Ford Shale, two unconventional plays where drilling activity and production have increased dramatically over the past few years. We wrote about the frenzied development of these plays at length in a number of articles, including Drilling for Profits: The Bakken Shale and Why Some Natural Gas is Worth $7.28. Sometimes a picture–or, in this case, an animation–is worth a thousand words. For word-weary investors, the US Energy Information Administration has put together impressive animations that track the development of the Bakken Shale and the Eagle Ford Shale.

Despite the market’s tendency to expect copycat transactions, dealmaking has been brisk in the Ohio portion of the Utica Shale, an emerging unconventional play that lies beneath the Marcellus Shale and is in the early stages of exploration and development.

Thus far, much of the information available on the field comes from Chesapeake Energy Corp (NYSE: CHK), which quietly began building a position in the play about a year and a half ago and had amassed about 1.36 million net acres at the end of the third quarter. The independent producer tipped its hand slightly in early November 2010, when the firm announced it had acquired 500,000 acres in the Appalachian Basin from the privately held Anschutz Corp for $850 million.

Since Chesapeake Energy’s July 29, 2011, conference call to discuss second-quarter earnings, the company has revealed that the Utica Shale consists of three zones: a dry-gas window that abuts Ohio’s eastern border with Pennsylvania; a wet-gas segment that includes substantial amounts of natural gas liquids (NGL); and an oil-laden portion to the west of the wet-gas segment.


Source: Chesapeake Energy Corp

During the conference call, Chesapeake Energy’s outspoken CEO Aubrey McClendon asserted that the emerging field could generate better returns than the red-hot Eagle Ford: “[W]e believe the Utica will be economically superior to the Eagle Ford because of the quality of the rock and location of the asset.” A Sept. 28 press release disclosed peak flow rates from three horizontal wells in the wet-gas phase of the Utica Shale:

  • Buell 10-11-5 8H in Harrison County, Ohio, (6,148-foot lateral) yielded 9.5 million cubic feet (mcf) per day of natural gas and 1,425 barrels per day of NGLs and oil;
  • Mangun 22-15-5 8H in Carroll County, Ohio, (6,231-foot lateral) flowed 3.1 mcf per day of natural gas and 1,015 barrels per day of liquids; and
  • Neider 10-14-5 3H in Carroll County, Ohio, (4,152-foot lateral) peaked at 3.8 mcf per day of natural gas and 980 barrels per day of liquids.

These announcements touched off a wave of transactions in the Ohio portion of the Utica Sale and sent lease prices soaring. In fact, McClendon told listeners during a conference call to discuss Chesapeake Energy’s third-quarter results, “We continue to be very pleased with our Utica well results to date, but are not releasing any additional well results this quarter because last time we did it, leasehold prices doubled in the field within weeks.”

Integrated oil company Hess Corp (NYSE: HES) on Sept. 7 announced a $593 million deal to acquire a 50 percent interest in 200,000 net acres of coal producer CONSOL Energy’s (NYSE: CNX) leasehold in the Utica Shale. A day after unveiling this joint venture, Hess acquired Marquette Exploration and other leases in Ohio’s Utica Shale–roughly 85,000 acres–for about $750 million. Management indicated that the company will begin drilling its first appraisal well in the fourth quarter and plans to run three rigs in the Utica in 2012.

Meanwhile, Denver-based Petroleum Development Corp’s (NSDQ: PETD) acquired the rights to 30,000 acres in southeastern Ohio for $50,000, while Marcellus Shale Operator Rexx Energy Corp (NYSE: REXX) leased almost 11,000 net acres in Carroll County, Ohio, for a total consideration of $40 million.

Although Chesapeake Energy CEO Aubrey McClendon complained that this land rush had elevated leasehold costs in the Utica Shale–the firm continues to acquire almost 1,000 net acres per day–the frenzy enabled the firm to ink an impressive joint venture of its own. The firm on Nov. 3 disclosed that it had signed a letter of intent with an unnamed “international energy company” that will grant the partner a 25 percent interest in 570,000 net acres of leasehold in the wet-gas portion of the Utica.

The transaction values the leasehold at roughly $15,000 per acre. Chesapeake Energy will receive $640 million when the deal closes and about $1.5 billion in drilling and completion cost carry. With five rigs currently operating in the Utica and a plan to expand to 20 rigs in 2012 and 30 rigs in 2013, Chesapeake Energy expects to receive the majority of the $1.5 billion to fund drilling and completion costs by 2014.

This deal has a number of important ramifications. That the unnamed international oil company was willing to pursue this transaction at such an early stage in the field’s development underscores the appeal of North American shale oil and gas assets. That the Ohio portion of the Utica Shale has been billed as one of the last major unconventional discoveries–a field that can compete with the Eagle Ford on profitability–has likewise given latecomers a sense of urgency.

In the wake of this transaction, Utica leaseholders Petroleum Development Corp, Rexx Energy and Gulfport Energy Corp (NSDQ: GPOR) all indicated that they, too, would seek joint partners to help fund additional acreage purchases and drilling activity. NiSource (NYSE: NI), a utility that also owns midstream energy infrastructure, is also exploring potential joint ventures to cash in on roughly 100,000 to 200,000 acres secured by its natural-gas storage facilities.

But the letter of intent Chesapeake Energy signed with the international energy company also reminds investors of the unique challenges posed by the company’s strategy of investing massive sums to acquire huge swaths of leasehold. The recently announced joint venture hardly came as a shock; Chesapeake Energy had inked six similar agreements since 2008 in an effort to fund development and production from cash flow–an uphill battle.

That being said, the deal involved less acreage, and presumably less money, than management’s stated goal of monetizing 30 percent of the firm’s then leasehold of 1.25 million acres. From our standpoint, this underscores the potential risks associated with a play in such an early stage of development.

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