Natural Gas Drilling Explosion In Utica Shale Fields Sustain Gas Surplus

by: Tom Dorsey

The Marcellus and Utica oil and gas fields, stretching from Ontario Canada, through New York, Pennsylvania, Ohio, and West Virginia, have seen an increase in the number of gas wells planned, drilled and continued growth in the near future. The companies working in the Utica Shale field are concentrated on targeting natural gas liquids over oil production. Due to the increased production gas prices have lagged. And over the past twelve months, certain components of the natural gas liquids (such as ethane) have had serious price depression as well.

We anticipate the continued suppressed prices in natural gas and stress on the companies to profit through the near term. We believe that the individual companies are looking at the micro-economics for their companies, but fail to see the whole market production increases that will increase the supply faster than the demand will grow.

Current Gas prices

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7 Key Points that will drive the Natural Gas Market

1. There are new proven techniques to extract more natural gas.

2. There are large new found fields, old fields that can increase production and unrealized natural gas fields that companies are just beginning to drill and come on line in the near future.

3. There are many companies, small and large that are buying/leasing new lands and engaged in producing more natural gas.

4. Currently, and for the needs of the future, there is not enough infrastructure to take the natural gas to market.

5. There are not enough markets that can buy the amount of gas that will be produced.

6. There are 3 licensed export terminals to sell the gas overseas, but limited the terminals are not up and running at this point in time. The infrastructure to get gas to the terminals is still being planned and built. The infrastructure will be built over time, but expect 3-5 years for the maturity to develop and start relieving the supply pressure.

7. With the gas glut, the price has been driven down and will remain there for the next several years. Companies will consolidate, some go out of business and others take losses until the supply levels to the demand level. The demand will grow and increase, but expectations in the market are 3-5 years.

Currently, the natural gas power plants use approximately 1/3 of all the natural gas in the United States, and that will grow in the future. There are currently 19 plants with the ability to create over 9.3 gigawatts (GW) From 2011 - 2015 there are 258 new natural gas burning plants being built and planned to come on line by 2015 - 2017 and provide an additional 21 GW of electric power into the grid. The amount of increased usage of natural gas is estimated up to 2.5 billion cubic feet per day. The estimated amount of increased production that the companies can produce is over 4 billion cubic feet per day. Moving this amount of gas to all the power plants from the gas fields is another challenge to be built through a transportation/infrastructure network.

The new techniques of fracking, extracting oil and natural gas from rock structures is an important development, however, the large increases in the number of wells and amount of oil and natural gas will create a glut on the market, driving the prices down, below the breakeven point and forcing companies to consolidate, and/or go out of business. This ability to over produce natural gas will slow down based on the high supply, and will only be relieved, not solved with the increases in infrastructure and increase markets for their product. Between 2017 and 2020 will the market smooth out with a better production to use ratio that will be sustainable to drive a steady market.

One of the drivers is there is not enough infrastructure to move the product from gas fields to the users. Another is the lack of consumers to use all the natural gas here in the U.S. The third is there are insufficient export terminals to handle the large quantities of natural gas and the price in the U.S. will be near record lows and the world price will be much higher, but we cannot reach the foreign markets, especially in Japan and China. The Energy Department has given Cheniere Energy's (NYSEMKT:CQP) Sabine Pass facility in Louisiana the first export license, the Dominion's (NYSE:D) Cove Point in Maryland the second license and just in August 2013 the third license Freeport LNG in Lake Charles, Louisiana. The total export could be as much as 5.6 billion cubic feet of gas per day when they come on line in the near future (2-5 years, based on construction and reconstruction of current facilities).

Over the next three years, the production of natural gas liquids from the Marcellus/Utica could increase 8-fold, to more than 650 million barrels per day (Mb/d). Nothing like this has ever happened in the NGL business before. Last month MarkWest initiated the ethane markets in the Appalachian area. From 5 Mb/d today we could see production levels capable of 200 Mb/d by this 2014. But they won't, because there are not enough markets for the additional ethane to be consumed. Already up to 250 Mb/d of U.S. ethane is being rejected - pushed back into natural gas in the Rockies, Midcontinent, and other regions. That number will continue to grow.

The Ohio Department of Natural Resources reports there are 819 permitted Utica wells in Ohio, 460 wells drilled or drilling, and 119 currently producing. This huge increase in the number of wells is one of the driving factors of the coming glut of natural gas.

Chesapeake (NYSE:CHK) is the largest player in the Utica Shale at the moment. In its 2Q13 results, it gave the following update on the play. It produced 85 MMcfe (millions of cubic feet equivalent) per day of production in 2Q13. The average daily peak production of 42 wells producing in Utica in 2Q13 of ~6.6 MMcfe per day. They have 11 rigs in the Utica, with 10 more by year end 2013. As of June 30, 2013, 321 wells in the Utica, with 106 producing, 93 waiting on pipeline connection, and 122 in various stages of completion. The supply natural gas is fully met at this time and the additional flow from 93 additional wells will push the supply over the top and drive prices south. Chesapeake is not the only company will wells ready to produce, but limited demand for the product.

In 2012, the U.S. Geological Survey released the first study on the Utica Shale estimated it contains about 38 trillion cubic feet of undiscovered, technically recoverable natural gas according to the first assessment of this continuous natural gas accumulation. The Utica Shale has a mean of 940 million barrels of unconventional oil resources and a mean of 208 million barrels of unconventional natural gas liquids. The Utica Shale lies beneath the Marcellus Shale, and both are part of the Appalachian Basin, which is the longest-producing petroleum province in the United States.

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The Utica Shale is an emerging play located primarily in eastern Ohio and western Pennsylvania. The play gained publicity in late 2011, as Chesapeake Energy revealed that it had been purchasing acreage rights in the area. Aubrey McClendon was the former CEO of Chesapeake, but he recently left the company because investors were unhappy with his management. Since his departure, the former CHK head has lined up ~$1.2 billion in financing for investment in Ohio, according to an article in the Wall Street Journal. McClendon now heads a new company, American Energy Partners, which has acquired Ohio assets from EnerVest Ltd. and affiliate EV Energy Partners LP (NASDAQ:EVEP) as well as Royal Dutch Shell (NYSE:RDS.A) (RDS.B).

The fact that McClendon is investing such huge sums of money in the area shows the potential of the play. McClendon has had extensive experience in the upstream oil and gas industry, having built Chesapeake from the beginning until his ouster into one of the largest independent energy companies in the United States. Plus, because CHK is one of the most active players in the Utica Shale, McClendon would have been privy to much information about the potential of the play. As he's trying to build a new company, the ex-Chesapeake head could have chosen any area to operate in, but it looks as if he's making a large, fundamentally unilateral bet on the Utica Shale. This should be a strong signal to the market and other energy players as to the potential of the Utica Shale.

Both EnerVest (private) and EVEP (public) hold assets in the Utica Shale. Combined, EVEP and EnerVest have more than 900,000 acres in Ohio (not all of which is prospective for the Utica Shale). EVEP has 177,000 net working interest acres. As of June 20, 2013, overall Utica activity included 747 wells permitted, 359 wells drilled, and 102 wells producing. Chesapeake Energy, EnerVest, and Total are also working together in a joint venture in the Utica, which is currently running 12 to 16 rigs. In June, the joint venture had 65 producing wells, 54 wells waiting on pipeline capacity, and 540 planned total wells to be drilled through 2014. The number of wells drill that are not producing (257) and the 54 wells waiting the pipeline and 540 more wells planned will again increase the supply, with limited infrastructure and no additional markets.

EV Energy Partners owns about 54,000 acres in what is currently defined as wet gas window. Wet gas is defined to have additional gases, like ethane, and methane which can be separated out and sold for additional income. One problem with this is getting the product to a market with a demand will prove to be more difficult.

Many other small companies are investing heavily in the Utica Gas fields. Here are a few:

Antero Resources (AR) (currently private, but has recently filed for an initial public offering) Antero Resources has 101,000 net acres in eastern Ohio's Utica Shale. The company has drilled and completed 11 horizontal Utica Shale wells, with three online and eight awaiting start-up. The three wells online have estimated net production of 25 MMcfe (millions of cubic feet equivalent) per day, including 1,500 barrels per day of liquids. As of June 30, 2013, the company had 279 billion cubic feet equivalent of reserves in the play.

In Anadarko's (NYSE:APC) 2013 10-K, it disclosed that in 2012, it had drilled five exploration wells in its 411,000 gross acre position. It completed seven wells that are currently in the production testing and evaluation phase. The company has said little about the Utica Shale through 2013.

CONSOL Resources (NYSE:CNX) and Hess Corp. (HES) operate a joint venture in the Utica Shale. In total, the joint venture covers 70,000 acres in the core area (50/50%). In non-core areas, the joint venture covers 90,000 acres (50/50%). For 2013, between the two parties, 27 gross wells are planned, with 11 to be drilled by CONSOL and 16 to be drilled by Hess.

Halcon Resources (NYSE:HK) has ~140,000 net acres in the Utica Shale. It expects to spend ~$200 million in the play in 2013, and to build 20 to 25 gross operated wells.

Gulfport Energy (NASDAQ:GPOR) has 136,000 net acres in the Utica Shale and 6.59 net MMboe (million barrels of oil equivalent) of proved reserves. GPOR produced 3,524 barrels of oil equivalent per day during 2Q13 in the play. For 2013, the company plans to invest ~$499 million of capital expenditures in the area and is currently running seven rigs there, with a plan to drill ~55 to 60 gross wells. During 2Q13, the company spud 16 wells. Average production in 2Q13 was 3,524 barrels of oil equivalent per day, and the quarter exited at 6,993 barrels of oil equivalent per day.

Magnum Hunter (MHR) has ~80,000 net acres prospective for the Utica Shale. On August 12, 2013, a wholly owned subsidiary of Magnum Hunter agreed to acquire rights to up to 32,000 net acres over a ten-month period, for a total maximum purchase price of $142 million. The company started its first horizontal well in the Utica Shale in April 2013.

PDC Energy (NASDAQ:PDCE) has ~46,000 net acres in the Utica Shale. The company plans to spend $96 million there in 2013, with one operated horizontal rig and 11 planned new wells. It expects 2013 production from the play to be ~1,074 barrels of oil equivalent per day.

Rex Energy (NASDAQ:REXX) had 80,200 net acres in the Utica Shale as of year end 2012. For 2013, the company plans to drill 9 wells in the area.

As production accelerates, it is expected to grow faster than midstream capacity can be constructed; it hampers producers' ability to get to market. Already, bottlenecks in infrastructure have had an effect on Utica production, though comments from several companies on 2Q13 calls have stated that as midstream capacity begins to come online, bottlenecks are resolving. However, the continued increase in production and limited markets will hamper companies from maximizing production for increased results on the bottom line.

Utica is shaping up to be an over-play and expect to depress prices in the near term, as well as the long. Only when some companies leave the production fields, some consolidation of companies and the infrastructure matures will the prices steady for the available markets. Users of natural gas products will reap the benefits of lower prices over the next 5 years.

Due to the increased production of the gas in the Utica and Marcellus Shale fields the companies will struggle with low income for product and this will affect their bottom line. Chesapeake looks to be the largest player in the play and should be productive throughout the next 5 years. Many of the other companies will not be as successful, and have to run a tight budget.

Disclosure: I am long CHK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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