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November 8, 2011






Brace yourself on the mighty Utica.

When the Ohio Department of Natural Resources (DNR) issued its weekly update of oil and gas activity in early November, the spreadsheet revealed some surprising numbers.

First, there were a grand total of nine rigs at work in the Ohio portion of the Utica Shale, including four drilling horizontal wells. Secondly, oil and gas operators had completed just 12 horizontal wells on 53 horizontal Utica permits through October 23rd.

So it's a good thing British prime minister Winston Churchill was not an oil and gas market analyst. Imagine a deep-voiced British accent intoning: "Never in the history of oil and gas has so much excitement been owed to so few wells."

Of course that was before Chesapeake Energy Corporation announced a blockbuster $2.14 billion joint venture agreement with an undisclosed international major for a 25% interest in 650,000 net acres straddling 10 counties in the wet gas portion of Ohio's Utica shale.

Briefly, the transaction is a multi-part deal involving acreage held by Chesapeake Energy Corp., EV Energy Partners and Enervest Ltd. Of the 650,000 net acres in the joint venture Chesapeake holds a 570,000-acre parcel while Enervest Ltd. holds the remaining 80,000 acres. Chesapeake will realize $2.14 billion from the joint venture, including $640 million in cash and another $1.5 billion as a drilling and completion cost carry through year-end 2014. Enervest receives $300 million in combined cash and drilling carry. Chesapeake valued the deal at $15,000 per acre.

The joint venture suggests the Utica shale is the next big thing in oil and gas. But despite the Chesapeake JV, feverish discussion on Utica shale potential has been far more advanced than actual development.

The truth is that the main players in the Ohio Utica generally earned their stellar acreage positions the old-fashioned way: they acquired properties that became prospective for Utica at a later date. For example, Chesapeake Energy Corp. bought the Appalachian acreage of Anschutz Exploration ($850 million, 500,000 acres) in November 2010 and subsequently partnered with EV Energy Partners LP, who, with its corporate cousin, Enervest, had purchased legacy Ohio acreage from Range Resources Corp. for $330 million in March 2010.

The actual inflection point may well have occurred in September 2011 when Hess Corporation bought Marquette Exploration ($750 million, 85,000 acres) and partnered up in a $593 million joint venture with CONSOL Energy Inc. just weeks after Chesapeake Energy announced a major discovery in the liquids rich Utica.

Anschutz, Marquette, and CONSOL subsidiary CNX had one thing in common: they had permitted a grand total of five Ohio Utica shale wells in 2010, which was the sum of all Utica horizontal activity in the state up to that time.

From such inauspicious beginnings, all hell has broken loose. News reports outline how Chesapeake spent a billion bucks on 1.25 million acres in leases by March 2011 (though that number included the Anschutz acquisition).

More recently Devon Energy Corp. surprised listeners to its third quarter 2011 earnings call when information surfaced that it was seeking a North American joint venture partner to develop five plays--including 110,000 acres in the Ohio Utica--in a multi-decade arrangement no doubt wisely designed to outdistance the 72-day Kim Kardashian nuptials.

Meanwhile, Rex Energy touted a 9.5 MMcfed IP gas well on its Utica test in Butler County, Pennsylvania during its third quarter earnings call.

Interest in the Ohio Utica had already taken a hockey-stick turn skyward in late September when Chesapeake released results from four of its 12 completed wells. The horizontal results suggest the Utica shale is an Eagle Ford analog with a shallow, oilier portion in central Ohio, which grades into a narrow wet gas window along the Ohio, West Virginia, and Pennsylvanian borders before dipping into a dry gas deep basin in southwestern Pennsylvania.

The last 90 days has produced Utica shale news on the level of a wintertime nor'easter. But getting from the phase of the story that estimates economic potential on the back of a cocktail napkin to the phase of story that outlines what is actually viable in the Utica is going to take a little time. And that was the ultimate message in those Ohio Department of Natural Resources numbers.

The main takeaway on the Ohio Utica shale is that the play is just a year into the land grab—and still a year away from broad-based drilling although the Chesapeake transaction will play a major role in accelerating Utica development.

The Known Knowns of the Utica

The Utica shale underlies a 170,000-square mile area from central Ohio to eastern Canada, including large sections of Pennsylvania and frac-phobic New York.

Interest at the moment is greatest in the wet gas window where the Utica is associated with an underlying formation known as the Point Pleasant shale. No Point Pleasant, no wet gas--at least that's the early indication. And make no mistake: wet gas is going to be the name of the game in Appalachia as the midstream sector adds liquids processing capacity over the next half decade in a larger global gambit to wrest the feedstock portion of the ethylene market from the naptha producing Middle East.

According to the Ohio DNR, there are 28 wells producing oil or gas from the Utica shale with most drilled vertically in prior years. However the Utica is a play with a history and not all of it is tied to the U.S. Farther north, Canada's Questerre Energy Corp. completed a 12 MMcfed Utica shale well underneath farmland 40 minutes south of Quebec City in January 2010. (Noted shale player Talisman Energy is a 75% partner with Questerre in the venture.) However the province of Quebec has been grappling with how to regulate natural gas development after operators filed more than 600 drilling permits in 2010 seeking access to an estimated 50 Tcf in natural gas reserves in the wake of the Utica discovery, prompting the ire of Quebecois citizens.

Farther south, Range Resources drilled the first horizontal Utica well in Pennsylvania. The 12,000 foot well tested out at 4.4 MMcfed of dry gas but is remote from infrastructure and has been shut in as Range focuses on developing its wet gas Marcellus holdings in southwest Pennsylvania. Range has legacy acreage in northwest Pennsylvania that may be prospective for Utica wet gas though it appears the company divested prospective Utica acres when it sold its Ohio legacy holdings to the EV Energy Partners/Enervest group in March 2010.

Back in Ohio evidence of rising interest in the play can be seen in how operators are valuing acreage. Lease values traditionally were as low as $8 per acre in Ohio--enough to pay a farmer's property taxes. However recent acquisitions approached $8,800 an acre (based on the Hess/Marquette deal). The Chesapeake joint venture brings $15,000 on a per acre basis for the wet gas portion of its Utica holdings.

The Chesapeake JV notwithstanding, how early is it in the Ohio Utica? One hint can be found in the varied estimates of Utica yield, which range from 9 to 49 Tcfe on a one to five percent recovery of original resource in place. It is still early for economics, but PDC Energy is targeting approximately 500 Mbo in Utica EURs on 5,000-foot laterals and 12 fracture stages on 8,000-foot vertical wellbores at a cost of $6 million per well.

One intriguing question is whether operators will be able to leverage unconventional techniques such as horizontal drilling and multi-stage completions to coax oil out of the shallower Utica in central Ohio. Farther east, the dry gas potential for the Pennsylvanian Utica is less impressive in an oversupplied gas market, particularly since the production is deeper--and more expensive--than the shallower overlying Marcellus shale.

Still, look for Utica development to accelerate. Ohio has 168 brine disposal wells, which can take produced water from well stimulation, eliminating one of the restrictions slowing the pace of Marcellus shale development in Pennsylvania.

To date, the Ohio DNR shows 71 total Utica permits. Of these Chesapeake holds 54, Anadarko holds seven, while Enervest and CNX hold 5 and 3 respectively. Carroll County Ohio is site for 16 of the 53 outstanding horizontal permits followed by Jefferson County (9), Colombiana County (5), and Guernsey, Mahoning, and Portage counties with four each.

Operators Line Out 2012 Utica Programs

So what's on tap for the Utica outside of Chesapeake? Hess Corporation plans a three-rig Utica program in 2012. Gulfport Energy Corp. plans to run two rigs in the Utica in 2012 and drill 20 wells on its 62,500 net acres position.

Carrizo Oil & Gas Inc. and Avista Capital Partners entered a $130 million JV in September 2011 for 15,000 acres prospective for Utica shale in Mercer and Trumbull counties Ohio with initial development slated for 2012.

PDC Energy plans a one-rig program in late 2011 on 40,000 net acres in Monroe, Washington, Morgan and Guernsey counties, Ohio and will grow its leasehold to 80,000 net acres by year-end 2012 before seeking a joint venture partner to develop the properties.

Anadarko Petroleum Corp. has assembled 300,000 net acres in the Ohio Utica and filed for permits for six horizontal wells to date.

Of course it's not just the big independents. Chevron holds 600,000 net acres prospective for Utica shale and news reports also hint that the ever-secretive ExxonMobil has added Utica leases totaling 75,000 acres in Monroe and Belmont counties Ohio, though most acreage for the two major oil companies may reside in southwest Pennsylvania where it originated from recent acquisitions.

That Dog Will Hunt

But Chesapeake Energy Corp. remains the big dog on the Ohio Utica shale porch. The company has 1.5 million net acres, or 40% of the potentially drillable acres in the Ohio Utica, according to its investor presentation, and plans to exit 2011 with 10 rigs active in the Utica before adding roughly 10 rigs per year, eventually peaking out at 40 units in 2014.

In addition to the joint venture, Chesapeake also announced a proposed $1.25 billion preferred stock subsidiary to accelerate further Utica drilling. EIG Global Energy Partners will contribute $500 million in cash for a share in CHK Utica LLC, a drop down entity from the parent corporation that will hold 700,000 net leasehold acres in 13 Ohio counties prospective for the Utica. Chesapeake anticipates selling another $750 million in shares of the subsidiary by November 30. Investors will receive an annual distribution of 7% payable quarterly. The subsidiary essentially provides investors in the CHK Utica entity a 3% overriding royalty interest in the first 1,500 wells drilled on Utica leasehold. Chesapeake will run a 10-rig program to drill a minimum 50 net wells per year through 2016 up to a total 250 net wells for the CHK Utica drilling subsidiary.

The larger picture is this: substantial dollars will be flowing into the Utica shale over the net four years. Utica joint ventures, including Chesapeake's preferred stock dropdown, have reached $3.9 billion in announced value over the last 60 days. Overall, Appalachian joint ventures are approaching $16.3 billion in announced value, which is 48% of the U.S. onshore JV total since 2006.

Furthermore, the drilling carry portion represents 70% of total value for announced Appalachian joint ventures, or nearly $11 billion spread from 2008 to 2014. At $5.5 million per well, which is conservative, those drilling carries represent 2,000 wells (including 700 in the Utica) with a majority of those wells to take place after 2012. In other words, the industry will witness $1.8 billion in drilling expenditures from joint ventures over the six-year period ending in 2014, though the value will easily exceed $2 billion annually after 2012. Absent all other investment, joint venture drilling carries would generate nearly a well per day after the region ramps up to full-scale development after 2012.