The following is a transcript from a speech I delivered to the Carroll County (OH) Business Development Council during 2012. It was entitled “the Utica Shale – It’s Economic Impact as to Ohio and Carroll County in Particular.”. It is important to recognize that Carroll County was the epicenter for much of the initial Utica exploration, hence its importance regarding establishment of the Utica as a legitimate prospect.  I apologize for its length, but they requested a speech to last a designated time period and that is what I provided. Although somewhat dated, I think you will find it to be quite interesting and that it remains informative. Enjoy.

Good evening. My name is John W. Howard and I am quite honored to be chosen as tonight’s guest speaker. I suspect my good friend and your devoted Auditor LeRoy VanHorne had something to do with this as he holds me in undeserved high regard, but I am most proud to have a man of his stature as a friend. I am equally proud to address tonight’s business forum here, and I want to thank you for extending me the opportunity.

I warned Michael in advance that I had no particular credentials which would make me an attractive candidate to speak, but, as I tell my good friend Tom Mitchell, I do keep my ear to the ground and my finger to the wind. Consequently, I do believe I have a wealth of knowledge to share with you. Much of this was gleaned researching a book I have written and copyrighted and which I continue to update weekly. When I began writing it in 2010, no one had even heard of the Utica Shale. My co-workers all thought we were in pursuit of the Marcellus.

I have had the pleasure to work this play for almost three years now, and was fortunate enough to work here, in Carroll County, at ground zero, for the better part of two years. I have seen a lot of changes in Carroll County over the last few years (as I am sure have all of you) and I hope most of them have been positive. Tonight’s speech will touch on what’s happening in Carroll County, and the resulting impact as it relates to the economy of Ohio and Carroll County in particular.

Carroll County still leads the pack, by far, with regard to drilling activity with 140 horizontal permits and 21 producing wells. Of significance is that this comprises about 35% of the total permits and an incredible 62% of producing wells. Things show no signs of slowing down either, with six new permits pulled for Carroll County in just the past two weeks. Currently, Chesapeake, Rex and Enervest are all actively drilling and/or have recent completions here. We will talk later about their well results and in particular about the financial woes of CHK and what effect it will have upon future operations. For now, let’s talk about the beginnings of the play, how it has progressed, and what the future potentially holds for Carroll County and Ohio in general.

I suspected this was the real deal when CHK reported during their first quarter conference call in 2011 that the Utica was “likely most analogous to, but economically superior to the Eagle Ford shale in South Texas”. For a prospect that had yet to see a single horizontal well permitted, much less completed, this was an incredibly bold statement. With the possible exception of the Bakken in North Dakota and Montana, the Eagle Ford is generally considered to be the premier shale playing in existence today. It features an oil window to the West, a centrally located wet-gas zone, and a dry gas zone to the East. The formation maps between it and the Utica are remarkably similar.

I’m sure most of you know that it is the liquid production here which make Carroll County such an attractive target. They are getting mostly NGL’s here (ethane, butane, propane, and pentene) and a little crude as well. The play has already been derisked with regard to the wet gas zone, but those searching for oil per se (i.e. Devon) have been quite disappointed. Their wells in Ashland, Medina and Knox counties have already been discounted as poor producers, and it is rumored that their Wayne and Holmes County wells are equally disappointing. They continue to move eastward, and will eventually define the Western boundary of the oil window. They have moved into Coshocton and Guernsey counties recently, where Anadarko reportedly has completed several wells with significant oil production. Devon is trying to stimulate some completions by means of pump jacks, but I am not optimistic about the potential results. It is a little-known fact that a mix of dry gas (as much as 1/3) stimulates production of heavier hydrocarbons by helping bring them to the surface. The Carroll County wells have typically been 9000’ deep or more, whereas Devon’s wells further West have been less than a mile deep. They are incurring pressure problems, and will have to find those areas with higher permeability which will allow better results.

In September 2011, CHK released their first test results in Ohio’s Utica, reporting on two Carroll County wells and the Buell well in Harrison County. The Carroll County wells both had initial production rates in excess of 1000 BOE (barrels of oil equivalent) which is excellent, but it was the Buell well which was labeled as the “showcase”. Until Gulfport’s recent completion in Belmont County, its initial production of 3010 BOE has been the proud standard by which all others are measured.

With a cost to drill between $6.5M and $7M, they must really like what they are seeing. At least 19 E&P companies currently hold permits to explore the Utica here in Ohio, including seven of the nine largest majors in existence. There are currently 405 horizontal permits pending to explore the Utica and see how it responds to various fracking techniques. CHK holds 281 permits alone, and recently increased their 2012 budget by a half billion dollars, specifically citing increased drilling in Ohio. They currently have eleven drilling rigs operating here, expect to have eighteen by year’s end, and at least twenty-two rigs throughout the course of the next year. RigZone reports CHK to be committed to drill a minimum of fifty wells per year between now and 2016, and as many as 12,500 total.

CHK has made a lot of headlines recently, mostly for all the wrong reasons. Many energy stock pundits have predicted a buy-out, speculating that Exxon, Chevron and Shell are all expressing interest. There is little doubt that the CHK asset portfolio is unparalleled on-shore in America.

Exxon, despite being the world’s largest energy company (with a market value of $373B) has seen their oil and gas production decline steadily for the last three quarters. Bloomberg says they “desperately need” to boost production and may well to look to acquire CHK as a quick fix. Chesapeake’s incredible debt is of little concern to them considering they are sitting on at least $19B in cash right now. They can easily buy in without incurring any damage to their corporate credit rating.

Speculation regarding Chevron is similarly grounded. Their year-over-year production numbers have fallen for five straight quarters, but they are sitting on a pile of cash similar to Exxon’s. “For somebody like Chevron”, says Suntrust analyst Neil Dingman, “they just don’t have much in the way of production growth right now, and the easiest way to get that is to go out and acquire it”. Exxon’s cash holdings make CHK an extremely attractive acquisition target despite its unattractive balance sheet.

Shell may be interested for entirely different reasons. Despite being Europe’s biggest oil company, they have a high exposure in regions with great political risk. About a third of their production originates in Africa and Asia. Huntington’s Paul Sorrentino summed it up quite nicely saying “If you want to try to clean up and eliminate some of your political and geographic risk, these (CHK’s) assets would be quite attractive. CHK has quite a bit of drama surrounding it, but that doesn’t change the fact that these are very desirable assets.” Both Shell and Exxon have recently been reported as having purchased significant CHK holdings in the Permian Basin of West Texas and New Mexico.

What exactly is going wrong at Chesapeake? They have a problem similar to our federal government. Too damn much debt. $13.1B in debt to be exact, as per their second quarter earnings call. Things are further complicated by the incredibly intricate joint ventures which they have entered into in an attempt to stay liquid. In Ohio, they have partnered with France’s Total SA, who announced in November of last year that they had agreed to pony up $2.14B to play ball here. CHK got an immediate $650M (in return for a 25% interest covering 650,000 acres) and will receive an additional $1.5B toward drilling costs. Their partner, ENV, received $90M in cash and will get an additional $210M with which to fund drilling. They recently announced that they have been able to sell assets totaling $6.9B in 2012 thus far, but they obviously still have a way to go.

CHK’s founder, Aubrey McClendon has been assailed from a number of very uncomfortable angles recently, including the IRS, the SEC, and others. He was sitting pretty, poised to become the world’s wealthiest man within five years by virtue of the Founders Well Participation Program, which he had convinced Board Members to approve several years ago. This allowed him to cherry-pick investments in only the very best wells, acquiring a 2.5% stake in any CHK well of his choosing. Through mutual agreement (with Aubrey reluctantly agreeing for sure), it was decided that the program would cease in June 2014 and that McClendon would immediately step down as Chairman of the Board, retaining his precarious seat as CEO. With billionaire Carl Icahn recently buying in, and partnering with other stockholders, his days as CEO may also well be numbered.

Stockholders are not only concerned about the debt, but also with the manner in which Aubrey has chosen to finance both his and the company’s investments. Their use of VPP’s (Volumetric Production Payments) unnerves many stockholders. These are complicated financial transactions, previously unknown to the industry, which allows CHK (or Aubrey) to sell future rights to production from existing wells. It allows them to function similarly to a hedge fund, using borrowed money to make big financial bets. What was once considered an innovative way to raise capital has now begun to be categorized as simply a way to tread water. They are expanding so fast that they take in much less revenue from production than they spend, leaving them stretched. Hence, its business depends on deal making: raising money from investors to acquire land and drill wells; selling the rights to the production from the wells; plow that money into new land and wells; and repeat the cycle all over again. Some feel this is a vicious cycle from which they cannot emerge. Time will tell.

In presiding over his last shareholder’s meeting as Chairman, Aubrey promoted what he called the fourth phase of asset harvest, saying the firm will focus exclusively on ten domestic oil and gas formations. He was referring to his philosophy of being the first to stake a claim in a new shale play, buying up as many acres as possible and then parceling off the assets for cash and a stake in production. Of interest is the fact that they recently offered almost a half million acres here in Ohio, hoping to receive $15K per acre, without any takers. They did announce a deal in September for $600M, but without disclosing the buyer or the acreage. This is obviously either a small part of what they had hoped to sell, or else they were forced to sell at a huge discount - likely the former.

Their presentation to investors that same day gave the Utica Shale the star treatment. It was not only described as being the primary savior for CHK itself, but went on to label it as being “one of the most important discoveries in the history of the business”. It was recognized by Oil & Investor Magazine as being their Best Discovery Award recipient for 2011. I said it before and I’ll say it again – CHK is all in with regard to Ohio. The Utica Shale is going to give them the chance to flip or fly, and it certainly has the opportunity to do either.

Reaction to CHK’s initial release of production numbers was mixed. “Disappointing” is the phrase used by the Energy Policy Forum. “Underwhelming” was the expression preferred by The Street. Bernstein analysts said it “has the potential to disappoint”. Why the initial negatively if production is reported in excess of 1000 BOE daily?

What the numbers did not disclose is the BTU content of the gas, meaning the percentage and type of natural gas liquids within the production. Without knowing BTU equivalence, or knowing how much or what type NGL’s are being produced, it is impossible to truly rate things. Because NGL’s trade at a huge premium to dry gas, an even split three ways between wet and dry gas (and oil) would make the numbers much more attractive. An even split three ways between NGL’s, dry gas, and oil would put it on par with the Eagle Ford , among the most economic plays in existence today. More recent disclosures have included BTU equivalency, and have provided rough percentages as to the amount of liquid production. Many, including the Buell well, are purported to have as much as 50% liquid production, noteworthy considering its prolific production rate. There are many ways in which one can rate production volumes. For simplicity, I prefer to look at the projected BOE for each, which factors in conversion of dry to wet gas and appropriate shrinkage factors associated with such. The Buell well was described as being “one of the best wells ever seen in the US – period”. If true, Gulfport’s recent completion in Belmont County may be among the best in US history, producing an incredible 4913 BOE daily. I know I have never heard of an on-shore well in America producing anything close to this, and I have been in the business for almost twenty-five years.

I am also of the opinion that many, if not all of these wells are being choked back. Producing a new completion at anything near capacity has the likelihood of causing permanent damage. During completion of their Buell well in Harrison County, CHK incurred a minor problem which delayed completion of the well. The unintended resting period allowed much of the water and frack flued to dissipate prior to completion. It has been confirmed that a resting period of 30-60 days in the NGL window and 60-90 days in the oil window significantly increased production. This has now become an industry standard mimicked by all Utica competitors. I found it interesting also that they described their first three completions in Carroll County as being inadvertently “damaged”, consequently producing at less-than-optimal capacity.

Although Ohio is blessed with an incredible amount of infrastructure to service these wells and bring product to market (meaning a ton of pipeline capacity as well as five existing refineries) midstream activity is quite brisk. As we speak, Dominion, MarkWest Energy Partners LP, and Caiman Energy, LLC, among others, have significant pipeline or processing projects underway. Kinder Morgan grabbed headlines by initiating the largest ever takeover in the pipeline industry by completing the acquisition of El Paso for $21.1B. The sector incurred further consolidation when US pipeline owner Energy Transfer bid over $5B to acquire Southern Union, specifically to gain access to the Midwest, meaning the Utica. It is no coincidence that this deal was announced shortly after CHK released test results reporting “phenomenal” liquid production from its Carroll and Harrison County wells.

Success here has brough good new to Carroll County. It was announced 3/14 by CBS News and others that CHK had, along with Enervest, committed to build a gas-generating facility running the entire length of Carroll County, linking a facility to be built in Columbiana County with one proposed for Harrison County. The Columbiana County facility will process natural gas extracted by various companies and will have an initial capacity of 600M cubic feet of gas per day. The Harrison County complex will process propane, butane and other NGL’s extracted during the drilling process. It will have a capacity to store 870K 42 gallon bbls and process 80K bbls daily. They are committing damn near a billion dollars to this one project alone. Construction on the Columbiana County facility is already underway.

Carroll County Commissioner Doyle Hawk is one of the many landowners dealing with construction of pipelines across his property. He stands to make in excess of $150,000 as a one-time-payment for allowing such. He estimates there are already at least 35 miles of new pipelines in Carroll County alone and expects as much as 200 miles of new pipelines to be laid over the next two years. He is one of many landowners getting a “consolation prize” via pipeline ROW negotiations. He leased early and cheap, but he is not crying. He knows the real money is in royalty payments, not bonus. “They have already fracked three wells around me”, he explains, knowing full well the chances are quite good that at least part of his 600 acres will be unitized and soon.

Existing pipelines and facilities were put in place years ago to facilitate Clinton production. The Clinton formation has long been the most prolific producing formation in Ohio, with production as far back as 1887. Over 100K Clinton wells have been drilled in Ohio. It experienced a renaissance in the 1950’s with the introduction of hydraulic fracturing (vertically). During the peak year of 1981, there were 6085 wells drilled in Ohio, of which 76% were Clinton completions. Because it is a sandstone interbedden with shale, it responds well to artificial stimulation. The Clinton formation is well known in Ohio and for good reason.

Despite its prolific reputation, the Clinton has been proven to hold only those hydrocarbons which escaped through permeable sections of the Utica. In fact, of the 75B bbls of oil generated by lower source rocks, only 400M bbls of in-place oil can be accounted for, including all Clinton production going back 125 years and encompassing over 273K wells. The ABC’s of shale geology in Ohio are such: The Trenton Limestone and Black River Rocks are considered as the source rock for almost all shale plays in Appalachia. Generally speaking, the Trenton Limestone serves as a cap rock for the underlying Black River source rocks. Because it is not as thick here in Ohio, it has allowed petrocarbons formed by the Black River group to migrate naturally into the Utica. To the East, in WV and PA, oil and NGL’s may be trapped deeper, or their thermal maturity may have been negatively impacted by the thicker Trenton, preventing occurrence of such desirable migration into our porous Utica.

Petrocarbons formed here are lighter than water, and naturally migrate toward the surface, impacted by the porosity and permeability of the formations that they encounter. Where significant porosity exists, the structure will absorb and contain them in either a conventional or non-conventional reservoir (shale). Where permeability allows, the oil or gas will continue to rise toward the surface, passing through one formation and continuing to move upward. Shale is typically low in permeability (the Utica is especially impermeable) and serves as a containment source that stops migration and creates a reservoir. Because it is high in porosity, the Utica is particularly adept at serving as a reservoir because it stops the materials from continuing to migrate and absorbs and holds them in containment.

It has been described as being the “Swiss cheese of shale”, noteworthy in that it is both porous, allowing for containment of vast resources, and brittle, meaning it is a perfect candidate to split wide open with a good frack job. Another factor causing the Utica to receive praise is its high carbonate content. It has less clay and more limestone, increasing its propensity to respond well to artificial stimulation. A recent USGS study dated 10/9/12 purports the Utica to hold in excess of 38T cubic feet of natural gas and over 8B bbls of undiscovered oil. As per Keith Kohl, chief pundit for Energy and Capital, “this figure is likely low-balling the true amount of potential bbls in the play”.

Ohio appears to be ideally located to take advantage of development and commercial networks in both the Midwest and on a national scale. Ohio is within 600 miles of 60% of the US population and more than half of the Canadian population. It has much of the necessary infrastructure and one of the most favorable tax/business climates in America. Ohio has zero tax on inventory or corporate income, no tax on investments for inventory or equipment, no tax on products sold to customers out of state, and an ambitious entrepreneurship reward system that allows companies to take the first $1M in profits absolutely tax free.

Larry Wickstrom with ODNR (recently fired/demoted) predicts that the Utica shale will “take off more rapidly” than competitors because rigs capable of drilling horizontal wells, frack crews, production infrastructure and other support services are already in place. Access to the Ohio river is a big plus too, as both a source of frack water and as a means to transport product and supplies. “The Utica is our opportunity for economic recovery,” Wickstrom says, adding that “This is our chance to bring significant investment and job creation to Ohio to drive meaningful long-term growth. It is already happening.”

Is it now? Let us investigate some economics regarding such – prognostications as well as actualities.

With regard to Ohio, it is estimated that the Utica Shale will provide over 200K jobs averaging almost $80K each. This stuff is front-page news. On Thursday, NBC News and CNBC will be here in Ohio reporting on what they describe as “America’s next big energy boom”. Jim Cramer and Jim LeBeau will both report live from various locations and appear on both “Today” and “the Nightly News”, among others. The story is basically this: a once-prosperous area at the heart of American industry, hit hard even before the recession, has new life and optimism driven by the Utica Shale. They plan to report that the industry has contributed $1.7B in sales for the state and will purport it to be the solution to three of America’s biggest problems, namely unemployment, an addiction to foreign oil, and a faltering economy. The Utica will receive credit for inducing a substantial decline in the state’s unemployment rate as well as for the comeback of Ohio’s auto industry. With the upcoming election focusing generally on the economy, Ohio will be referred to as the reigning bellwether in Presidential politics. LeBeau will speak with small business owners in Youngstown to get their take on how the state’s rebounding economy will impact the election. During 2011, the state went from 48th in job creation to 6th, a remarkably quick transformation that even environmentalists find hard to attribute to anything other than the Utica.

Let us now peruse facts presented by the OOGEEP (Ohio Oil & Gas Energy Education Program) in a late 2011 news release. They begin by quoting David Mustine, GM for energy @JobsOhio. “Pursuing oil and gas exploration in the Utica has the potential to turn Ohio’s economy around. It’s an amazing economic opportunity.” Mustine reported that Ohio added 111,300 new jobs in the past 18 months and 4,666 in the second quarter of 2012. Exactly how much of this is directly related to shale development is unclear, but you can believe it is quite significant.

The study focused on 5 specific economic elements – jobs, personal income, royalties, tax revenues, and gross state product (GSP) – from 2011 to 2015. The study reflects 200K or more new jobs directly related to exploration and claims the state could experience an overall wage and personal-income boost of $12B by 2015 from industry spending. The study also projects royalty payments to landowners, schools, businesses and communities could increase to as much as $1.6B by 2015.

Total tax revenue from oil and gas exploration and development in the Utica Shale from 2011-2015, including severance, commercial activity, ad valorem, federal, state and local taxes is projected to be about $480M. Industry expenditures related to the Utica could generate $12.3B in gross state product and result in a statewide output of sales of more than $23B.

“The data clearly demonstrates the transformative force oil and gas exploration and development could have on the state’s economy,” said Rhonda Reda, Executive Director of OOGEEP. “Ohio has been given great geological gifts and the economic potential is tremendous.”

A recent study reported in the Warrant Tribune Chronicle reports that more than 8000 jobs have already been created in the last year in relation to Utica exploration and production. The shale boom will explode the Ohio economy by adding almost $10B to it by 2014, single-handedly accounting for a 1% increase in the Gross State Product (GSP). “When people say this is a game changer, the numbers seem to support it,” says Lind Woggon, Executive VP of the Ohio Chamber of Commerce. She noted that by 2014, there will be an additional $500M in state and local tax revenue with no increases to taxpayers. The increase in projected state tax collections is staggering. $16M in 2011 will increase almost 5-fold in 2012 to $74M, 17-fold in 2013 and a stunning 27-fold in 2014 to reach almost a half billion dollars. That is not 27%....it’s times 27. A big difference, and one sure to be noticed by Ohio residents.

“2013 is the real year,” according to another Chamber representative. Many companies that make parts or provide services for drilling are wanting to see where the drilling occurs. Those suppliers need to be no more than one to one and a half hours from the sites in order to serve customers. This bodes well for Carroll County in particular.

Now, let’s explore the Utica’s impact as it relates more specifically to what you folks call home – Carroll County. First of all, I want to offer my sincere thanks to LeRoy VanHorne, your auditor, my good friend and an ally of all Carroll County residents. I hope you know he is fighting the good fight to protect your tax revenues and keep them here at home. I would also like to thank Patty Oyer, County Recorder, for her patience, courtesy and help, not only with regard to preparation of this speech, but for tolerating and showing great courtesy to myself and the plethora of other landmen who have taken over the record room for the last several years. I am quite proud that industry revenues have allowed you to renovate your beautiful historic courthouse, and I think it is a wonderful thing to see similar events happen throughout the state.

IN THE INTEREST OF BREVITY, I AM CONDENSING THIS A BIT TO DELETE THE PORTION RELATING EXCLUSIVELY TO CARROLL COUNTY REVENUES BUT YOU CAN REFER TO MY OTHER POST ONSITE HERE ENTITLED “HOW SHALE EXPLORATION SAVED A SLEEPY LITTLE OHIO TOWN” IF YOU HAVE INTEREST IN SUCH.

Thank you for your time gentlemen, and let me conclude by quoting State Spokeswoman Heidi Hetzal-Evans. “Carroll County’s potential yields are staggering numbers. We hope they really come true,” she says adding, “All we can do is wait and see”. I wish you all good fortune and hope that the Utica indeed performs as anticipates with regard to its impact on your community.