Investing in the Marcellus Shale

by: Harry Chernoff March 17, 2008 | about stocks: ATN / CHK / COG / LINE / RRC / XCO    

Harry Chernoff

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The hottest natural gas play in North America is the Marcellus Shale. The core area runs from southwestern New York through much of western Pennsylvania and parts of West Virginia and Ohio. Industry activity in the Marcellus has been growing rapidly in the past few years but only gained popular attention when a technical paper from Penn State and SUNY-Fredonia, estimating original gas in place at 168-516 Tcf and recoverable reserves of as much as 50 Tcf, got picked up by USA Today.

Of course, Penn State’s announcement was not the first word on the subject. Several of the major independents, including Range Resources (RRC) and Chesapeake Energy (CHK), have large acreage positions and drilling programs. Among the smaller independents, the most relatively outsized acreage positions include those of Atlas Energy Resources (ATN), Cabot Oil & Gas (COG), Linn Energy (LINE), Exco Resources (XCO), and Rex Energy (REXX). Essentially all the participants are reporting good-to-excellent results from increasingly aggressive capex programs, including horizontal drilling.

In very broad terms, recent drilling shows recoverable reserves of about 1 Bcf per vertical well on 40-acre spacing with F&D costs of about $1.00/mcf. Horizontal wells are estimated at about 2.5 Bcf on 80-acre spacing at costs less $1.00/mcf. The shales are easily accessible, susceptible to new techniques in fracing and completing, and cover an area several times the size of the Barnett shale. Meanwhile, the combination of F&D costs well below the North American average and gas realizations well above NYMEX levels (because of proximity to pipelines in the Midwest and Northeast) is making full-cycle economics almost irresistible.

There are three obvious approaches to playing the Marcellus in the stock market. The first approach is to go for size and demonstrated technical capabilities. Range Resources (RRC) began the modern exploration and development of the play in 2004. RRC has 650,000 net acres in the play out of 1.1M acres in the Marcellus trend and estimates its net unrisked reserve potential at 10-15 Tcf. Range is planning 60 wells this year, about 40 being horizontal. The last eight horizontals IP’d at 3.2 to 4.7 mmcf/d.

On the other hand, Range is a large, diversified independent, with an EV exceeding $10B and an estimated 2008 EV / EBITDA multiple exceeding 10x, making the Marcellus a modest percentage of a large company that is highly valued for reasons other than the Marcellus.

Chesapeake Energy (CHK) has 1.0M acres in the play but a much more conservative assessment of the potential: 5.7 Tcfe unrisked and 1.4 Tcfe risked, assuming 1,400 risked, net undrilled locations on 160 acre spacing, and 1.25 Bcfe per $1.6M vertical well.

While Chesapeake has the most Marcellus acreage among the independents, its $36B EV means the Marcellus is a very small percentage of the company.

An entirely different market approach is to look for concentrated and aggressive development off a small-to-moderate base. Atlas Energy Resources (ATN), with an EV of $2.75B and 230,000 net acres, and Linn Energy (LINE), with an EV of $3.8B and 182,000 net acres, are the primary candidates in this group. Forward EV/EBITDA multiples for both companies are about 8x. ATN estimates its Marcellus potential at 4-6 Tcf.

The obvious concern with companies like ATN and LINE is their MLP-like structure. This type of structure is based on high current yields and high payout ratios (typically from exploitation of PDP reserves). It is impossible to simultaneously maintain an MLP-like payout ratio and internally fund the development capex needed to convert resources into PDP reserves.

A third approach is based on the small-cap and mid-cap independents for whom a mid-range combination of cost, performance, internal funding, and valuation combines with an outsized exposure to the Marcellus. Of the numerous companies in this group, Cabot Oil & Gas (COG) and Exco Resources (XCO) are particularly noteworthy.

In February, Cabot called the Marcellus the most exciting new play in the U.S. and a large part of the biggest program the company has ever planned. Exactly how exposed COG is to the Marcellus is impossible to say. In some reports COG says it has “well over” 100,000 net acres in the play but also says the Marcellus is productive under at least 200,000 of its 1M acres in West Virginia. Meanwhile, its 20-well development program for 2008 is in Pennsylvania. Cabot’s most recent vertical wells, in West Virginia, IP’d at 1.2 to 1.8 mmcf/d, with horizontal drilling on tap across the play, starting in Pennsylvania. COG has also stressed that much of its Marcellus acreage underlies existing production and facilities in other zones so the incremental cost of deepening into the Marcellus and connecting to pipelines is very low (see conference call transcript).

All of these factors have helped put a Marcellus-related bid into the price of COG. It gained more than 15% in the two weeks after highlighting its Marcellus potential. With a valuation of 8x 2008 EBITDA, however, it trades well above the industry average. EV is $5.1B. In February, Exco reported over 191,000 net acres in the overpressured, thicker Marcellus fairway and more than 350,000 acres in the broader play. XCO also announced plans for a modest Marcellus capex program, including at least 10 vertical wells and 4 horizontal wells, out of a then-announced $625M capex budget. XCO also said it was evaluating the potential for a $50-100M Marcellus capex expansion this year (see conference call transcript).

March 13, XCO increased its capex program by $175M, including $150M for the Marcellus, all of it internally-funded. Exco now estimates an unbooked reserve potential of 6 Tcfe on its more than 368,000 net acres in the Marcellus, including more than 198,000 acres in the overpressured fairway. This reserve potential compares to current reserves of 2.1 Tcfe (1P) and 4.5 Tcfe (3P). Exco’s announcement expands its Marcellus program by about a factor of ten compared to the level in the earlier budget. It easily vaults XCO to the front of the overall E&P sector in terms of Marcellus capex relative to the size of the company ($3.8B EV). It also positions XCO for a big increase 1P/2P/3P reserves should the drill bit activities match those of its peers in the play. Strictly from a Marcellus perspective, XCO looks to be the play on several metrics, both long-term and short-term. The knock on XCO has been its poor profitability until very recently.

That, however, is changing as A&D activities over the past few years are finally converted into solid drilling results, production, cost control, and EBITDA. Most valuation metrics are about average but include nothing for the Marcellus. 2008 EV/EBITDA is estimated at about 6x. Overall, XCO offers the most aggressive Marcellus program off a reasonably valued base. The prices of stocks like COG and ATN significantly outperformed their peer averages immediately following similarly aggressive comments on their Marcellus potential and capex. The same thing is likely to happen to XCO in the immediate future. Notes:All EV/EBITDA multiples are 2008 estimates based on First Call EBITDA estimates, excluding non-E&P segments, as reported by SunTrust Robinson Humphrey, March 7, 2008.

Disclosure: Author holds a long position in XCO

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This article has 29 comments:

  •  
    Mar 17 06:36 PM
    Thank You for sharing some incredible, valuable info.
    After doing all the reading I possibly can, I am often frustrated by the superficial intelligence displayed. Maybe I'm tapping the wrong channels. Also I can not get enthused about alternative energy at this point. (example:Europe is destroying it's natural beauty by placing millions of huge windmills all over the landscape.) Looking forward to your future posts.
    Reply | Link to Comment
  •  
    Mar 17 06:53 PM
    Without question the Marcellus Shale play is the most exciting topic in the US natural gas world today. However, in this “do-it-myself” research age, errors can be made.
    # 1. I suggest researching what % of Range assets exist in Appalachia and what % Marcellus may represent of their output in 2-3 yrs.
    2. Next expertise varies widely, fracing skill/experience can make the difference between a great well and a dud.

    3. Linn. Linn doesn’t do exploratory drilling, does the author know that? They buy shallow sands developmental property and take the gas out. Do there even have a well drilled to the Marcellus formation? I don’t think so. Do they own deep rights below their shallow production? Or does someone else own that? Shallow well drilling is akin to glorified water well drilling.
    E&P shale takes huge capital and it has to be risked. LPs paying out cash flow can’t compete. I know no one who calls Linn a Marcellus play.

    4. Next, shale varies across the geographic spectrum. Lycoming County PA acreage may have 2Xs the output potential of SW PA.

    Some NY hedge fund thinks, New Fuel Gas acreage in NW PA has value. Well, ask a company who has drilled it., the shale is immature there.
    It has zero in common with Range acreage. All of CHK’s acreage isn’t IN prime Marcellus fairway.

    Exco ? If they are paying 750$ to lease south of the Allegheny Front, are they planning blue stone operations? Because there isn’t any gas there.
    I don’t mean to be so adamant but this isn’t homogenous at all.

    Mr Vitrinite
    Reply | Link to Comment
  •  
    Mar 18 08:28 PM
    How can anyone legitimately claim finding and development costs of <$1/Mcfg when a consortium of major U.S. gas producers (including Anadarko, Apache, Chesapeake, Devon, EOG, Newfield, Nobel, Plains, and XTO; see: www.eogresources.com/m...) have an average cost of $4.35/Mcf?

    Even excluding DD&A and interest costs, lease operating cost (LOE) and overhead cost (G&A) for these operators average $1.25/Mcf.

    I think that your claims of absurdly low F&D costs explain the giddy enthusiasm for shale plays that consume huge amounts of capital with miserable full-cycle economic results. The Barnett Shale is the model and only about 28% of wells will break even.
    Reply | Link to Comment
  •  
    Mar 18 10:16 PM
    Hi.

    Anyone have some news about Nornew?

    Operating in the Marcellus play near Hamilton.

    Norway
    Reply | Link to Comment
  •  
    Mar 19 09:04 AM
    How many idiots other than me had to look up the meaning of capex?
    Reply | Link to Comment
  •  
    Mar 20 09:56 PM
    My idea is short the weaker ones (xco, ATN)that are up on general Marcellus hype. And stay long the ones with quality leashold positions (RRC, COG, CNX ) in the fairway of the play.

    v
    Reply | Link to Comment
  •  
    Apr 01 02:30 AM
    Norway .... they sold their US assets, probably toinvest in Brasil

    www.rigzone.com/news/a...
    Reply | Link to Comment
  •  
    Apr 07 02:17 AM
    Hi All

    Norse Energy(Nornew) is the Third Largest in Marcellus shale with 150-200.000 acres. They operate in Hamilton,Smyrna,Lebano... and Albany.

    This Stock i must tell is really for free: tikker NEC

    I Will Compeare it with Atlas Energy...Whnw it comse to The Marcellus Play.

    If anyone have some updates, ill be thankfull.

    Norway




    On Apr 01 02:30 AM #8 wrote:

    > Norway .... they sold their US assets, probably toinvest in Brasil
    >
    >
    > <A href="www.rigzone.com/news/a...; rel=nofollow>rigzone.com/news/artic...
    > </A>
    Reply | Link to Comment
  •  
    Apr 09 02:02 PM
    Norway & #8.....I too am interested in any info on Nornew, and Atlas drilling as both companies have approached several landowners in Northwestern PA for drilling leases. It was our understanding that Nornew was to drill deep wells, Atlas shallow. Wondering now, who has Nornews leases? any info would be appreciated.
    Reply | Link to Comment
  •  
    Apr 10 07:53 PM
    Hi

    Nornew is 100 % owned by Norse Energy corp. (NEC )Only on norwegian stockmarket.Operates in USA and BRASIL, both strong companymakers


    Homesite: www.norseenergy.com/

    Visit latest pressrelease!

    Nornew have 165.000 acers in NY(PA)

    Landprices have gone from $300-$2400 in only one month, most of Nornews Land has been leased from back in 2004-2008($5-$25 pr.acre)

    The stock i think is a VERY good case, because marcellus play is not shown in the Stockprice.

    U can by it for 4.59 NOK(A bit under $1)

    Ill say its very BULL and a winner in 2008

    If anyone can help with updates on this stock ill be thankfull, because not much have been publiched from them when it comse to The Greate Marcellus Play

    I will answer all questions as good as i can:)

    PS. Director/Owner of company Øivind Risberg is loaded with stocks

    Norway
    Reply | Link to Comment
  •  
    Apr 11 02:42 AM
    # 8

    Norse, who is the owner of Nornew have sold some parts of there US assets - to build up there ownership in Marcellus Shale.
    Reply | Link to Comment
  •  
    Apr 11 02:58 AM
    We would like to gett some information about a well named Theresa.

    Nornew(Norse Energy) have 20 % interest in this well.

    This well we have been told was a Winner!


    Norway
    Reply | Link to Comment
  •  
    Apr 11 03:08 AM


    Nornew the cheapest energy company active in Appalachian basin?

    Nornew a small company 100% owned by norwegian OSE listed Norseenergy ticker NEC must be the cheapest way too get access to Marcellus acreage. Nornew leases 165 000 acre land in New York state where Marcellus is thickest.
    NorseEnergy also has a huge upside in it Brasil assets. The total production today is approximately 5000 BOED The marketcap is 1,7 billion NOK

    Norway
    Reply | Link to Comment
  •  
    Apr 11 03:19 AM
    NorseEnergy (norseenergy.com) marketcap 0,34 bil USD



    Norway
    Reply | Link to Comment
  •  
    Apr 11 04:01 AM
    Last update on Norse Energy(Nornew)


    www.norseenergy.com/in...

    How can we get Mad Cramer to take a look at this Stock?

    Norway
    Reply | Link to Comment
  •  
    Apr 11 03:09 PM
    To All

    Read this:

    murphies.blogspot.com/...


    Norway
    Reply | Link to Comment
  •  
    Apr 12 03:19 PM
    Norse Energy Corp a company holding more than 165,000 acres in prime Marcellus area. Since the company seem to be unknown among investors both in US and Norway I would like to give some key information about the company.

    Norse Energy is engaged in oil and gas exploration and production with operations in the US and Brazil. In addition to its E&P activities, Norse Energy Corp also owns and operates pipeline systems in the US for gathering and transmission of natural gas. The company is the result of a merger of NaturGass (USA) AS, a Norwegian private company and Northern Oil ASA, a Norwegian publicly traded entity, whose shares were listed on the Oslo Stock Exchange. Norse Energy Corp was listed on the OSE on July 13, 2005. ( Ticker: NEC)

    The leasing value of 165000 acers is today about 2000 $ an acre, total leasing value approximately the same as the Market Cap of the Company.( Fridays value was NOK 4, 80 a share which is less than $ 1 - Number of shares are 352 000 000).

    Norse Energy has through is subsidiary company Nornew been operating in the Appalachian area for about 10 years and knows the area better than many of its competitors.

    Norse Energy is also a major distributor of gas in the New York area through It`s subsidiary Company Norse Pipeline.

    As an investor in Norse Energy I am a bit frustrated by the information strategy of the Company. On the other hand, that may be the reason why they have got hold of more than 165 000 acres of land in the prime Marcellus shale area at a very low price

    Norse Energy is also about to become a big player i Brazil.


    For futher information: www.norseenergy.com/
    Reply | Link to Comment
  •  
    May 07 09:21 PM
    I would direct you to ATN's most recent conference call. ATN's MLP structure allows them to retain 35% of gas produced while farming out the cap cost of each well to limited partnerships. They are actually issuing a new offering for their next round of Marcellus wells and they are upping the % they will keep, ATN makes money drilling the well, managing the well, and they get their % of gas produced. That is for the verticals only. Their first horizontal was such a success (no results released yet but listen to cc and you will know why) they are tripling their horizontal program this year. They will drill 150 verticals and 12 horizontals in the next 12 months. Beyond that, they have the MOST pipeline infrastructure available through their relationship with Atlas Pipeline holdings (which by the way is doubling capacity this year, and doubling again next year) The big boys from Texas will have to either buy or build out their pipeline and gathering infrastructure, so ATN has a big advantage in this as well. They are drilling right now in SW penn and have 250,000+ acres in that area, which they translate into 4-6000 wells and 4-6tcf of recoverable gas. Their capital structure is far superior for a smaller company to move quickly to explout Marcellus. Do your own DD, but I have and bought heavily. 6% divi is just a bonus.


    On Mar 18 08:28 PM AEB wrote:

    > How can anyone legitimately claim finding and development costs of
    > <$1/Mcfg when a consortium of major U.S. gas producers (including
    > Anadarko, Apache, Chesapeake, Devon, EOG, Newfield, Nobel, Plains,
    > and XTO; see: www.eogresources.com/m...)
    > have an average cost of $4.35/Mcf?
    >
    > Even excluding DD&A and interest costs, lease operating cost (LOE)
    > and overhead cost (G&A) for these operators average $1.25/Mcf. <br/>
    >
    > I think that your claims of absurdly low F&D costs explain the giddy
    > enthusiasm for shale plays that consume huge amounts of capital with
    > miserable full-cycle economic results. The Barnett Shale is the model
    > and only about 28% of wells will break even.
    Reply | Link to Comment
  •  
    May 17 02:18 PM
    I think the comment above about on 28% of the Barnett Wells will even pay-out is very ill informed. Nor do I think that a companies acquisition only of acreage in the Marcellus is reason to jump on their bandwagon. We (LLAMA) are actively acquiring acreage in the Marcellus and see the existing problem of pipeline availability in most areas as eventually rsulting in a lot of the acquired leases (especially those purchased very cheaply) eventually expiring and the landowners in the area having very negative feelings towards those companies that they feel took advantage of them. We see vertical wells in this play being used to hold large acreage blocks and doubt their ability to produce the estimates shown. Since my perspective, I could be wrong.
    Reply | Link to Comment
  •  
    Jul 10 09:45 AM
    As a XTO Shareholder, I am glad XTO finally bought Linn Energy....this Marcellus Shale will be a huge natural gas find but will take much longer to extract due to the rough terrain in PA.

    www.oilshalegas.com/ma...
    Reply | Link to Comment
  •  
    Jul 14 02:57 AM
    Line really blew it.
    They did not have the bucks to invest.
    Reply | Link to Comment
  •  
    Jul 14 11:35 AM
    Hey, relating to this Marcellus Shale topic, Range Resources is out with a nice Update today...here is a link to their press release

    www.b2i.us/profiles/in...
    Reply | Link to Comment
  •  
    Sep 06 01:53 PM
    Check out gomarcellusshale.ning....
    Reply | Link to Comment
  •  
    Sep 06 01:53 PM
    checl out gomarcellusshale.ning....
    Reply | Link to Comment
  •  
    Sep 10 04:56 PM
    Anyone know of a company called Lodge Energy? According to the Baltimore Sun, they are leasing 31,000 acres of land in my area. As I mentioned on my website I wanted to find out more information on them.

    dansdeepcreekblog.blog...
    Reply | Link to Comment
  •  
    Sep 11 03:01 PM
    what are peoples thoughts of Ngas? They do not have property in Marcellus Shale to my knowledge. I am considering in a limited partnership and would like advice on which offering is the best.
    Reply | Link to Comment
  •  
    Nov 25 11:36 AM
    We have the most startegically placed pipeline on the Marcellus shale in Pennsylvania. Serious inquiries only to jshainman@verizon.net
    Reply | Link to Comment
  •  
    Dec 10 08:28 PM
    I have 114 acres in Clarion Co. PA is anyone leasing the marcellus in my area. Our small companies are only willing to pay $5 or $10 at the most for shallow. What do I do. Wait for the big wheels to come along or settle for what I can get locally. Im confused and the $ would greatly help.
    Reply | Link to Comment
  •  
    Dec 15 10:41 PM
    Anyone know anything about Gas Star from Texas?
    Reply | Link to Comment
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