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As a recent report by ratings agency Moody's highlighted, natural gas producers operating in Pennsylvania's Marcellus shale enjoy a major competitive advantage over peers drilling elsewhere in the U.S. thanks to the play's exceptional economics and close geographical proximity to high-demand markets.
While there are plenty of world-class operators in the Marcellus, let's take a closer look at one in particular -- Range Resources (NYSE: RRC ) -- and three factors that could set it apart from peers.
Exceptional position in the Marcellus shale
Range's most prized asset is the Marcellus shale, where it commands nearly 1 million net acres. Crucially, more than half of the company's Marcellus acreage is located in the southwestern part of the play, which features stronger economics due to higher concentrations of more profitable hydrocarbons such as wet gas and condensates.
With well costs in this region ranging from $6.1 million-$6.8 million per well, Range earns an internal rate of return of roughly 105% at a wellhead gas price of $4 per MMBtu -- representing some of the strongest economics in the entire play. By comparison, peer Ultra Petroleum (NYSE: UPL ) only generates a rate of return of 25%-50% in the Marcellus, which is why the company has decided to reduce capital spending in the shale this year and concentrate on more profitable opportunities in Wyoming's Jonah and Pinedale fields and Utah's oil-rich Uinta Basin.
Two of the only companies that I have come across that are seeing stronger returns than Range in the Marcellus are Cabot Oil & Gas (NYSE: COG ) and Chesapeake Energy (NYSE: CHK ) . Cabot's pretax returns in the play are now in excess of 100% at a wellhead gas price of just $3 per MMBtu, thanks to a sharp improvement in EURs and a major decline in cash unit costs, while Chesapeake's northern Marcellus wells can generate a 117% rate of return at a gas price of $4 per MMBtu.
Strong, consistent track record
In addition to the hardy economics of its Marcellus program, Range has also demonstrated extremely strong and highly consistent growth in both production and reserves over the past few years, as well as continued improvement in its cost structure -- three traits every investor likes to see.
Last year, for instance, Range reported 25% year-over-year growth in annual average production, which reached a record of 940 Mmcfe per day; 26% year-over-year growth in total proved reserves, which stood at 8.2 trillion cubic feet equivalent as of year-end 2013; and a $0.33 per mcfe reduction in unit costs compared to 2012.
This exceptional operational performance translated into equally impressive financial performance last year, as Range's net income for 2013 surged to $116 million, up from $13 million in 2012, while cash flow jumped 25% year over year. Over the next few years, Range expects to grow its production at an annual rate of 20%-25%, while cash flow is set to grow at an even faster rate thanks to extremely strong returns in the Marcellus.
Large, growing, and diverse customer base
The third reason to be optimistic about Range is its industry-leading gas marketing team, which has been highly successful in securing additional customers beyond the company's core consumer base in Appalachia and the Northeast. Last year, Range's marketing team added 25 new customers in non-Appalachian markets including the West, Midwest, Mid-Atlantic, South, and Southeast.
In addition to the company's contractual agreements on the Mariner East, Mariner West, and ATEX pipelines, Range now also has the option to export gas liquids from the Marcus Hook harbor in Pennsylvania to international markets, where prices are higher. The company has also secured contracts to export its propane to Central and South America and Europe during the summer.
These contracts are crucial because they will allow the company to ramp up its Marcellus production to as much as 3 Bcfe per day -- roughly triple its current output -- with the confidence that all that gas can be marketed.
Strong prospects might justify high valuation
As you can see, Range's high-quality acreage position in the Marcellus shale's sweet spot, its solid track record of production and reserve growth, and its expanding gas marketing opportunities make it one of the more intriguing investment opportunities in the natural gas exploration and production space. Though the company is currently valued at 31 times forward earnings, almost twice the multiple that competitors Southwestern Energy and Cabot Oil & Gas command, Range's exceptional prospects for production and cash flow growth may be just enough to justify this seemingly lofty valuation.
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