The Utica Shale rush is on
The new energy land rush is in full force, creating some smart places to put your money.
By Peter Staas, Investing Daily
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.
So far, much of the information available on the field comes from Chesapeake Energy (CHK), which quietly began building a position in the area about a year and a half ago, and had amassed about 1.36 million net acres by the end of the third quarter of 2011.
The independent producer tipped its hand slightly in early November 2010 when the company 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 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.
During the conference call, Chesapeake Energy's outspoken CEO, Aubrey McClendon, asserted that the emerging field could generate better returns than the Eagle Ford Shale, an oil- and NGL-rich play in south Texas: "[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 ten-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 ten-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.
Integrated oil company Hess (HES) on Sept. 7 announced a $593 million deal to acquire a 50% interest in 200,000 net acres of coal producer CONSOL Energy's (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.
Meanwhile, Denver-based Petroleum Development Corp. (PETD) has acquired the rights to up to 40,000 acres in southeastern Ohio for $70 million (about $1,750 per acre), while Marcellus shale operator Rex Energy (REXX) leased 12,900 net acres in Carroll County, Ohio, for a total consideration of more than $40 million.
Although McClendon complained that this land rush had elevated leasehold costs in the Utica Shale, the frenzy enabled his company to secure an impressive joint venture of its own.
In December 2011, Chesapeake inked a deal with Total (TOT) that gave the France-based energy giant a 25% stake in 542,000 net acres of Chesapeake Energy's leasehold in the wet-gas segment of the Utica Shale. In return, the U.S. independent producer received $610 million in cash and up to $1.42 billion in drilling and completion costs over a seven-year period.
In a follow-up transaction, Devon Energy (DVN) took advantage of the shale mania gripping international oil companies to secure a lucrative joint venture. China National Petrochemical Corp (Sinopec) paid a total of $2.5 billion for a one-third stake in five of the U.S. operator's emerging shale plays: 300,000 net acres in the Niobrara Shale, 210,000 in the Mississippian Shale, 235,000 in the Ohio portion of the Utica Shale, 340,000 in the Michigan Basin, and 265,000 in the Tuscaloosa Marine Shale.
Under the terms of the deal, Devon Energy will receive $900 million in cash and $1.6 billion in the form of a drilling carry that should be realized by the end of 2014.
Not only do these and other blockbuster deals in U.S. shale oil and gas plays provide international oil companies with a source of low-risk production growth relative to deepwater plays and regions fraught with political risk, but the experience and knowledge gained in U.S. shale oil fields can also be applied to similar formations located around the world.
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 these deals, Utica leaseholders Petroleum Development Corp., Rexx Energy, and Gulfport Energy (GPOR) all indicated that they, too, could seek joint partners to help fund additional acreage purchases and drilling activity.
The promise of the Utica Shale has also bolstered investor interest in EV Energy Partners (EVEP), one of the best-performing master limited partnerships (MLP) in 2011. Units of the publicly traded partnership returned 77% last year, while the Alerian MLP Index gained almost 14%.
This outperformance is impressive when you consider that natural gas accounted for about 70% of the company's annual production mix. In the current pricing environment, investors have tended to favor upstream MLPs with more exposure to oil and NGLs.
Much of this strength stems from EV Energy Partners' working interest in about 150,000 net acres in the Ohio portion of the Utica Shale and a 2% average overriding royalty interest in an additional 880,000 acres. The partnership acquired most of this acreage in 2009 and 2010, well before the recent surge in investment in the Utica Shale.
EV Energy Partners sold a 25% stake in 3,750 acres to Total for $4.2 billion in cash and $9.9 billion in drilling carry. Management expects to monetize the remainder of its Utica Shale position in the back half of the year, after other producers' well results in the oil window are available.
By all accounts, midstream operators are moving quickly to expand takeaway capacity in the Utica Shale. MarkWest Energy Partners LP (MWE), a leading provider of midstream solutions in the Marcellus Shale, launched a joint venture with the private investment firm The Energy & Minerals Group to build natural gas gathering, transportation and processing and NGL fractionation, transportation, and marketing infrastructure in the Utica Shale.
This joint venture's initial projects include: an extensive gathering system that's slated to come onstream in 2012; a facility capable of processing 200 million cubic feet of natural gas per day, the first phase of which will be completed in mid-2012; a NGL fractionation, storage, and marketing complex with the capacity to handle 100 barrels per day; and a processing complex in Monroe County that's slated for 2013.
On March 3, 2011, MarkWest Energy Partners announced that the joint venture had signed a letter of intent with GulfPort Energy to provide the producer's operations in the liquids-rich window with takeaway capacity.
Spectra Energy (SE), the general partner of Spectra Energy Partners (SEP) and DCP Midstream Partners (DPM), in December 2011 announced that it had inked a memorandum of understanding with Chesapeake Energy, the leading producer in the Utica Shale, and electric utility American Electric Power (AEP) to develop the Ohio Pipeline Energy Network (OPEN).
This 70-mile pipeline will expand Spectra Energy's Texas Eastern pipeline system and connect the Utica Shale and Marcellus Shale to serve Ohio-based utilities and industrial concerns, many of which will transition to natural gas from coal.
The company also announced an open season for capacity on its proposed Renaissance Gas Transmission Project, a plan that would enable end users in Tennessee, Alabama, and Georgia to access natural gas from multiple supply basins in the north and south, including the Utica Shale.
Exploration and production companies are also taking matters into their own hands. Magnum Hunter Resources (MHR), for example, is entertaining the idea of expanding its Eureka Hunter pipeline system in the West Virginia portion of the Marcellus Shale into Ohio. Another option on the table is to spin off the company's midstream infrastructure as an MLP and using the proceeds to fund its drilling program.
Meanwhile, Chesapeake Energy on March 13 announced a partnership with EV Energy Partners and privately held M3 Midstream LLC to build a $900 million gas-processing and NGL-fractionation complex in Harrison County.
According to the press release, the project will initially include 600 million cubic feet per day of gas-processing capacity, 870,000 barrels of NGL storage and fractionation capacity of 90,000 barrels per day. Chesapeake Energy expects the processing and fractionation capacity to come onstream by the second quarter of 2013.
With shares of EV Energy Partners overbought at current levels and Rhino Resource Partners facing considerable headwinds in its core business lines, midstream developments in the Utica Shale offer the most enticing exposure to the Utica Shale. That being said, general partners won’t necessarily drop down these assets right away to their limited partners.
We will continue to monitor developments in this region.
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