Better Know an Energy Play: Utica Shale

To help Foolish Investors better understand the oil and gas boom in the United States, we are putting together a series of articles focusing on the major energy plays in the lower 48. We'll need to rely heavily on these areas to achieve North American energy independence. Today we're going to take a look at the Utica Shale.

Introduction
The Utica Shale is an oil and gas play that's still in its infancy, but it could hold lots of potential energy. The shale is located in the Appalachian Basin, primarily in Pennsylvania, Ohio, New York, Virginia, and West Virginia, and sits under another famous shale play, the Marcellus.

Similar to the Marcellus Shale, the Utica Shale is comprised of rock pores that hold hydrocarbons like oil and gas. One difference between the two, though, is that Utica holds more "wet" natural gas, which consists of ethane, butane, propane, and pentane. Dry gas consists primarily of methane. The Utica Shale is also deeper than Marcellus, ranging from 2,000 feet at the outer fringes of the shale, to over 14,000 feet near the core. Much of the wet gas is found in the outer regions of the shale, usually with depths of about 6,000 feet or less.


Source: US Geological Survey

Utica's oil is primarily located in Ohio, where most of the Utica's drilling takes place, and the upper western part of Pennsylvania. The most recent U.S. Geological Survey of Utica, released in October 2012, estimates the amount of technically recoverable oil and gas reserves at 590 million-1.39 billion barrels of oil, 21 trillion-61 trillion cubic feet (Tcf) of natural gas, and 4 million-16 million barrels of natural gas liquids. This makes the Utica a smaller natural gas play than the Marcellus, but still a significant source of both oil and gas resources.

Who's ubiquitous in Utica?
As with any shale play, one of the primary goals of a company is to buy up the biggest and best areas of land. The top seven Utica land lease owners right now are Chesapeake Energy (NYSE: CHK  ) , Chevron (NYSE: CVX  ) , EnerVest, Anadarko Petroleum (NYSE: APC  ) , Gulfport (NASDAQ: GPOR  ) , MarkWest Energy Partners (NYSE: MWE  ) and ExxonMobil (NYSE: XOM  ) .

Chesapeake dominates land ownership by far, with EnerVest coming in a distant second. It's not unusual for land ownership to change quickly, and companies are continually buying and selling land for a better position in the play.

Production and rig counts
The vast majority of the Utica's production comes out of Ohio. Unfortunately, Ohio's Department of Natural Resources only requires companies to release production information once a year. In 2011, there were about 13,000 barrels of oil per day coming out of Ohio, compared to the Eagle Ford Shale's current rate of 300,000 bpd. But that was over a year ago, and estimates remain uncertain.

A Reuters article described the situation: "More than a year after Chesapeake Energy Corp Chief Executive and top Ohio driller Aubrey McClendon declared the Utica to be 'the biggest thing to hit Ohio since the plow,' investors, landowners and even the federal government are still in the dark over the true pace of oil and natural gas production in the state."

But the state of Ohio has offered up the current rig count and permit numbers. As of December 2012, the Utica Shale has 29 rigs, 193 wells drilled, and 469 permits issued. The state has 45 wells that are currently producing. About 24 of the rigs drill for oil, as opposed to natural gas, and Chesapeake Energy operates about half of all those operational rigs.

Below is a chart of Utica rig counts and resources the rigs are drilling for, as of October 2012.


Source: U.S. Energy Information Administration 


Source: U.S. Energy Information Administration

Drilling economics: think Marcellus... on steroids
In our analysis of the Marcellus Shale play, we highlighted how well completion costs can be as high as $4 million. If only that were the case in Utica as well. Since the Utica formation is below the Marcellus, depths for this formation can be well below 12,000 feet. Based on current drilling technology and fossil fuel prices, it simply isn't worth going after a large part of the Utica play.

This is why we are seeing much of the action in the Utica formation on its fringes in Ohio, West Virginia, Maryland, and Quebec. New York could be in that discussion as well, but the state's current moratorium on drilling has restricted exploration there. In these areas, the Utica can be more shallow and more commercially viable to drill.

Thanks to relaxed reporting standards in Ohio, it is more difficult for investors to find drilling data than in several other shale plays in the U.S. To give a rough idea of well completion costs, EQT Resources (NYSE: EQT  ) said it plans to spend $40 million on eight wells in Ohio next year, according to its most recent operational forecast. This averages out to about $5 million per well. A report from Citi Investment Research & Analysis places the costs of a Utica well in the $5 million-$10 million range. This puts Utica well costs on the high side in comparison to the Marcellus, and more in line with costs for the Bakken and Eagle Ford.

Also, since the play is so young, and several companies are keeping well production rates quiet, it is hard to get a gauge on production and decline rates for this region. To date, EV Energy Partners (NASDAQ: EVEP  ) has announced the results at only one of its wells. At this well, drilled to a depth of over 12,000 feet, the 24-hour test rate was 1,690 barrels of oil equivalent per day (boe/d). Chesapeake has also published the results for three of its wells in the region. These wells have a 24-hour peak capacity in the range from 800-1,700 boe/d. Since these wells are still young, their decline rates have yet to be published.

With so little actual information coming out, let's take a look at some other sources. The Citi Investment report gives an estimated ultimate recovery range for the Utica between 450 million and 900 million barrels of oil equivalent, and an initial production range from 1,000-1,400 boe/d.

Another possible mirror for the Ohio section of the Utica can be found in the current drilling reports from the play's Quebec region. Drilling info from Talisman Energy (NYSE: TLM  ) back in 2010 measured initial production of dry gas at 5.3 million cubic feet per day (MMcf/d) for the first 30 days, but then dropped off to 1.4 MMcf/d after five months of operation. This is one of the steepest decline rates for any major oil and gas play in North America. A 5.3 MMcf/d well in the Marcellus should expect a production rate of 2.5 MMcf/d after five months. 

Let's keep in mind that these numbers represent a dry gas play hundreds of miles away from Ohio. It is possible that the Ohio section of the Utica could produce very different results. Until those results are produced, though, the Quebec data is the only limited lens we can use to look at what's going on in the region.

Most companies are not going to rush to build out production in this region as fast as they did in other areas like the Marcellus, mostly because several exploration and production companies have been burned by the Utica area's very low prices. The chart below highlights how spot prices for natural gas, in the Northeast and nationally, diverged as oversupply in the region took hold. This chart shows Marcellus prices, but with the two plays so close, Utica's prices are very similar.

Source: U.S. Energy Information Administration

The one distinction between the Marcellus and Utica is the oil and liquid gas in the Utica. The Utica is the only onshore oil play east of the Mississippi. For companies that have major refineries on the East Coast, like Phillips 66 (NYSE: PSX  ) and Marathon Petroleum (NYSE: MPC  ) , this could be a major opportunity to source domestically. Since the prices for oil and liquid gas have not seen as sharp a decline as dry gas, some of the major players in the Marcellus aim to shift their drilling rigs to the Utica in pursuit of a more profitable product.

The only thing more incomplete than drilling reports for the region is the infrastructure to transport the new finds in the region. Since much of the region is new to fossil fuel exploration, it needs lots of work to bring the pipeline and rail infrastructure up to snuff.

The biggest efforts to date for Ohio pipelines come from a Spectra Energy (NYSE: SE  ) / Enbridge (NYSE: EEP  ) joint venture to build a $1.5 billion pipeline between Eastern Ohio and existing pipelines near the border between Michigan and Canada. Sunoco Logistics (NYSE: SXL  ) also plans to build an 110,000-barrel-per-day pipeline through Eastern Ohio and Western Pennsylvania. Until these pipeline networks are built out, expect production to be limited and a heavy reliance on rail to move liquid products.

So you want to buy Utica?
With so many companies keeping hush about production, it is difficult to understand what a fair price should be for acreage. EV Energy announced a couple of months ago that it hopes to sell 539,000 acres in the Utica for about $6 billion, which averages out to $11,000 an acre. This per-acreage price tag is more than double what CONSOL Energy got when it sold more than 660,000 acres in the Marcellus last year. Clearly, EV believes the liquid assets in the region can justify such a large price swing.

What these Fools believe
So far, Utica hasn't quite lived up to its hype. There's still a lot of activity in Utica, and many companies believe there's good money to be made from the play, but we're still a few years away from seeing how production from this shale will really play out. Well costs are high in Utica, and gas prices in the Northeast have dropped, so the incentive for companies to ramp up Utica exploration and production is low. As Fools, we think Utica could still have a lot of potential, but it's too early to know whether this shale is a boom or bust.

That's not to say that a few companies don't already have a competitive advantage in Utica, though. With the largest acreage in the entire play, Chesapeake Energy will be the driving force in the Utica Shale. As the second-largest natural gas producer in the United States, so much of the company's success has been dependent on natural gas. In our recent premium report on Chesapeake, we examine how the company has shifted its business strategy and what it means for investors. You can get your own copy of this report by clicking here!


Read/Post Comments (2) | Recommend This Article (5)

Comments from our Foolish Readers

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  • Report this Comment On December 26, 2012, at 3:25 AM, shalebaby wrote:

    I don't own stocks but I am very familiar with this play and in IMHO, this article is pretty far off point once you get down to any level of specificity. For starters, if we are focusing on Ohio, *vertical* drilling depths are in the 6,000 to 8,500 ft. range. When you say EVEP drilled a well to 12,000 ft depth, you're likely repeating a number that includes the length of the horizontal, which for EVEP is probably in the 5,000 ft range. Clearly, drilling horizontally costs money, but you'd much rather be drilling *through* the pay zone than drilling to simply access it. If your estimation of vertical depth is literally off by mile, it changes the economics significantly.

    Second, your characterization of the mosaic of data as it relates to initial production (IP) rates is either outdated or narrowly based on official reports to state regulators. This makes little sense as Ohio does not have robust reporting requirements anyway; many things that can be 'massaged' in a public statement can and will be massaged in the final data provided to the state. There is not going to many 'ah-ha' moments on IP rates come April.

    Notably, you'll find extensive Gulfport press releases on no less than *seven* horizontal wells the company completed and fracked over the course of 2012. These seven wells cover three key counties and - if anything - the IP reports have outstripped expectations set by Chesapeake's first well in the play (the Buell 8H, drilled in 2011). We're talking average IPs of 3,500 boe/d with 60 percent coming from liquids, including a lot of low API condensate which turns to oil further west. Each well has a different mix, but that's Gulfport's Utica average.

    Now, decline rate: according to Chesapeake's public statements, production from the Buell well declined 66 percent over the first 10 months. I think you need to put *at least* as much stock in that as a far uglier 75 percent 5 month decline rate hundreds of miles away - don't you? The April data from the state at least has the potential for a few surprises on longitudinal production, but they are likely to be minor surprises, not major ones, and while geology knows no boarders, Quebec is much too far away to assume the mineralogy is substantially similar. (e.g., is the Point Pleasant member of the Utica present in Quebec, and if so, how thick is it?)

    As for comparing acreage prices: this can be tricky, because these deals are something of a black box. But if one wants to play the game, $11,000/acre for EVEP's holdings seems very reasonable compared to the $15,000/acre Chesapeake got from Total in late 2011, especially if EVEP's holdings are free of the title issues that have plagued some of Chesapeake's most favorably positioned holdings.

    Finally, while Appalachian gas may be discounted in recent months, Appalachian oil will likely recieve a premium as it will be competing with Brent as much as any other source. Don't you think? And the Ohio Utica's bread will be buttered (or not) by liquids pricing.

    One always wants more data, better data - but all the signs so far have been extremely positive. I don't think you can credibly argue, as this article states, that the Utica has "not quite lived up to expectations". A more resourceful look compels the conclusion that Utica has matched or even exceeded expectations that were already very high. It's true that Midstream infrastructure doesn't get built over night, but the industry has committed at least $7 billion to build-out in eastern Ohio through the end of next year. Upstream bit hard, now midstream is following suit, and there's every reason to trust that downstream will be next.

    Simply put, in an unpredictable business, Utica is looking more and more like a sure thing for a diverse set of companies.

  • Report this Comment On February 06, 2013, at 3:40 PM, TMFPennyWise wrote:

    Chris and Tyler, Thanks for the Utica Shale 101 article. I am wondering how big a play this will be for Marathon Petroleum and the new MLP they just spun off? Any thoughts on that?

    Also, shalebaby, I appreciate your point of view as well. I hope you keep contributing to TMF as this drilling plays out.

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