The Newest Entrant in the Marcellus Shale

Gastar Exploration (AMEX: GST  ) is one of the latest energy companies looking to cash in on the Marcellus Shale natural gas play. The company got its first two horizontal wells up and running at the end of July, and some analysts think that despite a flagging operation in East Texas, the oil and gas outfit may be an unsung hero.

Commodity metaphors
Gastar is definitely drilling in the right place: Marcellus is a kingmaker. Of all the shale plays in the U.S. right now, it's the hottest. There is a bit of controversy about exactly how much gas is trapped in the Marcellus Shale, but even conservative estimates are huge, producing anywhere from 12 billion to 17 billion cubic feet per day by the end of the next five to 10 years.

Gastar's production capability
The first step to understanding Gastar is to evaluate how it fits into the Marcellus production story:  

 

Company

 

Marcellus Net Acreage

 

Production Q2 2011
(mmcf)

Gastar

80,000

15.5

Chesapeake (NYSE: CHK  )

1,750,000

320

Range Resources (NYSE: RRC  )

900,000

350

Cabot Oil & Gas (NYSE: COG  )

200,000

425

Anadarko (NYSE: APC  )

260,000

119

Source: Company press releases.

Right now, operating only two brand-new wells means that Gastar's daily production is low. Though the company anticipates ramping up to 40 mmcf a day by the end of the year, that number still pales in comparison with the second-quarter numbers of the region's other major players.

Risk factors
There are at least two things that may doom Gastar's fledgling operation in the Marcellus -- falling natural gas prices among them.

Natural gas is now selling at half the 2008 average price -- the more players in the game and the more gas that's produced, the harder it is for companies like Gastar to make money and create value for investors. So, even though Gastar is setting up shop in the best possible shale play, it might not do it any good.

That being said, any change that makes natural gas more expensive to produce (government regulation) or increases demand (government-backed incentives) could help push up prices.

Foolish takeaway
Gastar is an intriguing opportunity simply because so much is unknown right now. Interested investors should keep an eye on production numbers in the Marcellus. If output ramps up, it would be worth considering Gastar as a potential buyout, as mergers and acquisitions boom in the industry.

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Fool contributor Aimee Duffy doesn't own shares of the companies mentioned in this article. If you have the energy, check out what she's keeping an eye on by following her on Twitter @TMFDuffy.

The Motley Fool owns shares of Range Resources. Motley Fool newsletter services have recommended buying shares of Range Resources and Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (8)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 09, 2011, at 3:41 PM, Pennyperson wrote:

    Gastar will rise to the occasion. What you failed to mention was their move last year into oil which gives them more diversity, so this is just not a natty gas play.

    And they have 87,600 acres in the Marcellus, not 80.000. It controls approximately 33,400 gross acres in the Hilltop area, located midway between Dallas and Houston in Leon and Robertson counties in East Texas. It also has interests in approximately 55,000 gross acres in Wyoming's Powder River Basin, one of the most active coalbed methane plays in the U.S.

    Out of the many small E&P’s T-Boone Pickens holds a position in this company and as you can tell I’m Gastar fan.

    Its movement has been little during the wild swings of the market during August until “today”….This little jewel is holding its ground.

  • Report this Comment On September 09, 2011, at 8:39 PM, XMFAimeeD wrote:

    Love the enthusiasm, @pennyperson!

    btw, I was quoting the net acreage Gastar lists here:

    http://www.gastar.com/globaloperations.cfm?pagesect=Appalach...

    Fool on,

    Aimee

  • Report this Comment On September 10, 2011, at 3:27 PM, Pennyperson wrote:

    Then show a little enthusiasm and give it a pick in Caps, I mean AOL over GST?

    But, hey!! I like the Beach Boys and Ford, LoL

    Gastar is a very solid spec play and are drilling the shales next (door) to their larger cap peers. I expect this one to be double in digits by Q3 of 2012 if (all) goes as planned.

    Of course to others that might read this (always) complete your own D&D.

  • Report this Comment On September 10, 2011, at 3:41 PM, Pennyperson wrote:

    Let’s give some folks more info from Portfolio Manager and Founder Josh Young of Young Capital Management

  • Report this Comment On September 10, 2011, at 3:43 PM, Pennyperson wrote:
  • Report this Comment On September 10, 2011, at 3:45 PM, Pennyperson wrote:

    The jest of it, he pretty sums up how I'm looking at GST...of course and again...always complete your own D&D

    TER: Where can value be found?

    JY: I'm interested in finding really significant mispricings. And in the smaller cap O&G space, there are some great value opportunities - particularly in companies going through transition processes. One example is a company I'm investing in that's in this process of transition. In fact, it's practically a textbook case for transition. Most investors who have heard of it haven't looked at it in a few years because it was a mess - it was overlevered and was forced to sell one of its core assets to pay down that debt. It was asset rich but did not have a lot of production, and it was forced to take meaningful write-downs on the book value of those assets. And it was producing 100% natural gas in a rising-oil-price/falling-gas-price environment.

    Today, the story is different and the market is just beginning to recognize that. The company sold an asset and, virtually, has no debt. It joint ventured (JV'd) an asset and is in the process of ramping-up production. It has major liquids discoveries in both of its core assets and will be increasing the percent of its production coming from liquids and oil substantially and is the most levered company on an acreage versus enterprise value (EV) basis to the Marcellus Shale. The company is trading for a fraction of the valuation of other Marcellus companies and the market misunderstood its recent oil discovery, which could move the needle significantly.

    The company, Gastar Exploration Ltd. (GST), also has 17,000 acres of the lowest-cost onshore dry gas play in the U.S. - 80,000 net acres in the Marcellus and a JV that will be funding the majority of the 8–10 net wells it is drilling primarily in the liquids-rich area of the play in 2011. Gastar has an oil discovery in East Texas with 30 locations and substantial potential value from the development of that play, which the market does not seem to understand and has yet to price in. And it has 17,000 net acres prospective for oily Eagle Ford and Deep Bossier gas, which is widely recognized as one of the lowest-cost natural gas plays in the U.S.

    Gastar trades at a big discount to its Marcellus-levered peers, such as Cabot, EQT, Range Resources, EXCO Resources Inc. (EXCOF.PK), etc. In fact, it trades at almost one-quarter the price per acre, despite having similarly prospective acreage. This value gap should close as the company drills numerous wells this year, most of which will be funded by a JV agreement it entered into last year, and ramp-up its production and cash flow.

    That doesn't even consider Gastar's recent oil discovery in East Texas, which could contribute substantial additional value. The company recently announced a Glen Rose well producing 250 barrels of oil per day (bpd) and 1,300 barrels of completion fluid, with inclining oil production. Generally, as a well produces, the amount of completion-fluid production declines and the oil production inclines. From some of the wells I've seen, the initial production (IP) rate on this well could be over 500 bpd with an implied EUR (estimated ultimate recovery) of more than 250,000 barrels of oil. For a $4 million per-well cost on the 30 remaining locations, this could significantly shift Gastar's production toward oil and lead to a substantial revaluation of the company after the official initial production rate of this well is announced.

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