Even as many energy producers continue to focus primarily on oil, some are aggressively ramping up gas-drilling activity. Range Resources (NYSE:RRC), for instance, plans to boost its capital budget for the year by $220 million to $1.52 million, as the Fort Worth, Texas-based gas producer seeks to capitalize on high gas prices and its massive inventory of high-margin drilling opportunities in the Marcellus shale. Let's take a closer look at whether or not it's a smart move.

M Shale Rig Nicholasatonelli

A gas drilling site in the Marcellus shale. Photo credit: Flickr/Nicholas A. Tonelli 

An exceptional Marcellus operator
Given Range's industry-leading cost structure in the Marcellus, strong recent performance, and expectations for gas prices to remain in the $4-$5 per MMBtu range over the near term, it makes good sense for the company to ramp up drilling activity in the play, which will account for 87% of its 2014 capital spending program after the announced increase in spending.

Range's recent results in the Marcellus have been nothing short of impressive. First-quarter production volumes surged to a record high, averaging 1,056 Mmcfe per day, up 21% from the year-earlier quarter, which fueled adjusted cash flow growth of 20% year over year to $262 million. The company also drilled one of its highest rate Marcellus wells ever during the quarter, while further improving its cost structure.

The company's unit costs have declined 34% over the past six years, falling from $4.30 per Mcfe in 2008 to just $2.84 per Mcfe in 2013. In the first quarter, they declined by an additional 6% over the previous year's quarter. As a result, Range enjoys one of the lowest cost structures in the industry, earning triple-digit rates of return with a wellhead gas price of $4.00 per Mcf.

Doubling down on gas
With these kinds of returns, its no wonder that Range is focusing so heavily on natural gas, even as peers such as Devon Energy (NYSE:DVN) and Chesapeake Energy (NYSE:CHK) focus overwhelmingly on growing oil and gas liquids production. Devon has completely curtailed dry gas drilling and is focusing the largest portion of its capital budget on the oil-rich Permian Basin and Eagle Ford shale, while Chesapeake is concentrating on the Eagle Ford and liquids-rich Utica shale.

Range, meanwhile, recently exited the Permian Basin as part of an asset-exchange agreement with EQT Corp (NYSE:EQT). Under the terms of the deal, Range will give EQT about 73,000 net acres in the Permian, where current production is mostly oil and gas liquids, in exchange for EQT's interest in 138,000 net acres in Virginia's Nora Field, a supporting gas-gathering system, and $145 million in cash. The Nora Field properties are currently producing 41 MMcfe per day of primarily coalbed methane.

But even as Range is focusing heavily on natural gas, it's mitigating its risk through a highly conservative hedging program. The company typically hedges a significant portion of its upcoming annual production through derivatives contracts, which makes its cash flows more predictable. For 2014, more than 80% of the company's expected output is hedged, while over 30% of projected 2015 output is hedged.

Further, Range also has a major infrastructure advantage that should allow it to comfortably grow its gas production at double-digit rates over the next several years. The company has contracted capacity on three major projects -- Mariner East, Mariner West, and ATEX pipelines – that allow it to market its gas to both domestic and international markets at relatively low cost.

Investor takeaway
Given Range's vast, high-quality acreage position in the Marcellus and industry-leading economics, especially at the current Henry Hub gas price north of $4.50 per Mcf, it makes perfect sense for the company to ramp up drilling activity. With well over a decade worth of drilling inventory in the play and plenty of low-cost options to market its production, Range should have no problem growing its Marcellus production at an annual rate of 20%-25% for many years to come, which should fuel strong growth in earnings and cash flows.

But the only thing I don't like about Range is its valuation, which appears lofty compared to its peers. Shares currently trade at 31x forward earnings, which is nearly twice the multiple competitors Southwestern Energy and Cabot Oil & Gas command. With that said, I think a meaningful pullback in its share price would make Range a compelling opportunity.

Will this stock be your next multi-bagger?

While Range Resources is poised for peer-leading growth, there's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Arjun Sreekumar owns shares of Chesapeake Energy and Devon Energy. The Motley Fool recommends Range Resources. The Motley Fool owns shares of Devon 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.

Compare Brokers