Marcellus shale gas play entry opportunities abound

Feb. 1, 2010
The US shale business has been one of the hottest E&P topics the past few years, with the Marcellus capturing most recent attention.

The US shale business has been one of the hottest E&P topics the past few years, with the Marcellus capturing most recent attention.

Many have expressed concern that they are either too late or too slow to enter the Marcellus and fear that the best opportunities have passed. However, deal flow in the Marcellus since 2008 has actually increased, while entry opportunities are still numerous and may be strategically matched through a variety of business models from existing and new players.

The main reason is that the US unconventional gas market remains distinctly unconsolidated. The sheer breadth of entry choices can be executed and measured in a number of ways from bigger corporate deals to small focused land acquisitions.

In this article, the author suggests a framework for explaining Marcellus deal activity through the concept of development phases, namely where in the operational development cycle the play is currently and where it is going.

Recent Marcellus transactions

Despite the economic slowdown and weaker gas prices, the number and variety of entry deals in US shale plays has increased considerably.

In 2009 alone, Marcellus-related deals increased by 60% vs. 2008. Strategic entry choices companies can make to gain shale gas exposure are wide, including joint ventures, alliances, financial investments, private equity participation, land acquisitions, and all-out corporate deals.

The lack of consolidation in the US shale gas sector can be explained by low entry and exit barriers and the rapid application of transferable drilling and completion technologies.

A short history of the past 5 years' deal flow shows a variety of deals with very different strategic drivers (Table 1).

The most significant early deal in the Marcellus was in 2005, with Chesapeake Energy Corp.'s acquisition of Columbia Natural Resources Inc. for $2.95 billion. Through this acquisition, coupled with engaging a "land army" of brokers, Chesapeake built the largest acreage position in the Marcellus fairway.

Three years later, in 2008, Statoil entered into a strategic alliance with Chesapeake, acquiring 32.5% of Chesapeake's 1.8 million Marcellus acres.

Most recently, in what is the largest multiplay unconventional gas deal so far, ExxonMobil Corp. is expected to acquire XTO Energy Inc. for $41 billion in 2010. Then Chesapeake announced its fourth major JV, with Total in the Texas Barnett shale.

Private equity investments in the Marcellus have also captured headlines in the business press, including deals involving Morgan Stanley Capital Partners and KKR. Midstream deals are also apparent including Williams, MarkWest, and NGP Midstream Resources.

And most recently, large land acquisitions, including deals from Ultra Petroleum, Hess Corp., and Seneca Resources, have raised the land stakes further as companies vie for leases to build contiguous acreage and drillsites.

These reported deals fail to reflect the real underlying activity, including the under-the-radar deals covering all types of swaps, acquisitions, and divestments. Newer deals covering all these entry choices are likely to continue in 2010.

Understanding deals

To make sense of deal activity, the competitive landscape and entry choices into the Marcellus, a framework is presented in Fig. 1.

When companies want to enter US shale plays, they typically assess the relationship between the industry strategic drivers and the stage of development of the particular play. By making sense of this interaction, it helps in asking the fundamental question: In which part of the development phase can you create value and how can success be measured?

The development phase for most shale plays can be roughly broken down into four key stages: early moves and land grabs; experimentation and growth; core development; and, exploitation and optimization.

Early moves and land grabs: This can be from an existing player already exposed to the play (vertical wells or CBM); from applying technology from one shale play to another (Barnett as a laboratory); or by simply making early bets (using land as a commodity). For the Marcellus, this started with Range's first Marcellus well in 2003.

Experimentation and growth: Shale gas production growth kicked off in 2005 and within 3 years became a game changer for the US gas market. What defines this phase is the rise of US independent E&P companies, phenomenal increases in bonus payments, and the entry of the majors. The Marcellus is still in this period.

Core development: This is all about positioning and the core. Not all shales are created equal. Where drilling and completion experimentation aligns with subsurface understanding, the difference in value between core and noncore is great. Much of this is occurring in the Marcellus, but the play is too large and untested to draw conclusions on the subsurface.

Exploitation and optimization: This stage is what some consultants call factory drilling or the flexible factory. What defines this phase, which we are witnessing in the Barnett, is how to efficiently organize around the parameters of a margin business and how to squeeze the most out of existing acreage in a volatile gas price environment. The Marcellus is not at this stage yet.

Given that development phases and strategic drivers are never static entities, external drivers including changes in the competitive environment, gas price volatility, technological developments, legislation, and regulation all will influence companies' entry strategies. Using the entry choice framework a discussion of past entry deals, principally in the Marcellus, is analyzed below.

Early moves and land grabs

While some companies possess what may be called legacy positions in the Marcellus, including Range Resources, Atlas, and EQT, established Appalachian producers, it was Chesapeake that made the boldest move into the play through the acquisition of Columbia Natural Resources in 2005.

In the Barnett, Devon Energy employed the early move and land grab strategy through the $3.5 billion acquisition of Mitchell Energy in 2001. XTO Energy acquired much of its 280,000 acres Marcellus position from Linn Energy and private sellers in 2008. In the same year, ExxonMobil made a $22.4 million land acquisition in Pennsylvania that at the time received little attention.

Many private investors were fast at making early moves into the Marcellus. Their business model is essentially buying and selling leases as a commodity. During the high lease activity levels in 2008, thousands of leases were signed to companies with no intention of developing the resources, which will open up opportunities as the expiry horizon closes.

The strategic drivers and value propositions behind these deals vary, but the underlying assumption is that first-mover advantage in a new play will offer upsides that outweigh the underlying risk. Just 3 years ago, acreage in what are turning out to be the most prolific counties of the Marcellus went for $25/acre with a 12.5% royalty. Today the same area will bring over $5,750/acre with a 20% royalty (Fig. 2).

Comparing the NPV per well between these figures is significant. Taking a bet on gas prices also helped in this period, as US gas prices trended upwards and spiked to $13/MMbtu in both 2005 and 2008.

Transferring technology to the play was instrumental, too, during this phase, building on experiences from other shale plays.

Range Resources experimentation of drilling and hydraulic fracturing practices used in the Barnett is widely regarded as helping to unlock the Marcellus in 2003-05. The key technical and subsurface drivers during this phase included attempting to identify subsurface core areas using existing well data, identifying the "sweet spot" in the prospective zone, determining best drilling and completion practices to lower finding cost, and maximizing recovery.

In addition, educating government agencies and developing service industry capacity was essential. Smaller companies have generally shown that the advantages of speed of execution and management of risk have proven to be the most successful business model in this part of the development phase.

Measuring success in this phase is relative to the time horizon. Clearly some players are positioning to be acquired by a larger company, while smaller private actors are playing the waiting game to offload leases before expiry. What is important to consider is that as the Marcellus moved out of this phase the breadth of entry choices increased.

Experimentation and growth

The pace of unconventional drilling, the growing scale of activity, and evolving completion technologies have quite possibly created a new paradigm in the US gas market.

Where technology, positive well results, and high gas prices met, shale gas soon became perceived as a game changer in the industry. This new growth wave did not go unnoticed (although it took some time before others saw it!) in the strategy departments of the world's major oil and gas companies.

As US shale players proved up and derisked the subsurface through 3D seismic, improved hole stability, longer laterals, improved completion techniques, and shorter drill times, the attractiveness of shale also increased.

As US gas prices started to free-fall from June 2008, activity levels in the Marcellus actually increased, for both permitting and drilling, due to the superior break-even prices of the play and the fact that many incumbent companies had overstretched their balance sheets during the early move and land grab phase offering further entry opportunities.

Several US independents found themselves with a huge inventory of acreage and lacked the capital and credit rating to develop these, hence enter the majors including Statoil, BP, Eni, BG, and most recently ExxonMobil and Total.

The strategic driver for the majors is that shale gas offers a long-life asset base with global applications at a time when international opportunities continue to look limited. Acquiring this skill set can be through large corporate deals (ExxonMobil's acquisition of XTO), through JVs (including BG-EXCO in the Haynesville and Eni-Quicksilver in the Barnett), or through a mixed cooperation approach as in the Statoil-Chesapeake strategic alliance in 2008.

In this deal Statoil gained 32.5% of Chesapeake's 1.8 million Marcellus acres. In addition both parties formed an international study group to scan shale opportunities outside North America, and within 1 year of the alliance, the first exploration application was submitted in the South African Karoo basin.

Statoil has seconded a large group of technical, drilling, and subsurface personnel working in Chesapeake's Oklahoma campus covering all technical aspects of the shale skill set as well as a dedicated Marcellus asset team based in Statoil's Houston office that cooperates with Chesapeake on a daily basis.

The strategic alliance entry choice, rather than a financial investment or a full corporate deal, was more aligned with the Statoil strategy and its Scandinavian culture of cooperation and partnerships. This approach has been honed since the early days of the Norwegian continental shelf in the 1970s and through the BP-Statoil strategic alliance between 1990 and 1999 that internationalized Statoil.

As a result of the Marcellus entry, Statoil has created a new organizational unit, Global Unconventional Gas (GUG), guided by a new business model approach very different to the company's traditional offshore model.

The key issue with all these deals is that entry to the Marcellus can be executed in a number of ways due to the unconsolidated nature of the play. Measuring success on the other hand requires a longer term time frame, both in terms of return on initial investment but also in transferring the US shale experience into a profitable international business.

As Rex Tillerson stated in the Q&A session on the XTO Energy announcement, "this is not a near-term decision. This is about the next 10 to 20 to 30 years of what we believe has now emerged as a very important part of the global resource portfolio."

The technology drivers of note during this phase include experimentation with drilling and completion techniques including drilling fluid type and compatibility, hole stability due to geological complexity, risk assessment of drilling in complex areas, faulting, proppant type, number of frac stages, cluster spacing, and longer lateral lengths. Aligning subsurface understanding with optimal drilling and completion techniques leads to the next development phase.

Core development

Defining the core is a natural step from experimentation and shows the tangible effects of moving up the learning curve.

With the Marcellus in its infancy, well results are varied across the play. Without a critical mass of statistics, positioning remains highly competitive and typically scattered at best. More analysis of core data, seismic data, open hole logging data, and post completion analysis of results is required to identify core areas.

Two developing core areas of note are in northeastern Pennsylvania and southwestern West Virginia. Some recent deals of note that reflect the core development phase include Ultra Petroleum's $400 million land acquisition in Lycoming, Clinton, and Centre counties, Pa., at $5,000/acre. Hess Corp., Seneca Resources, Cabot Oil & Gas, and Chesapeake-Statoil have also been highly active in land acquisitions for infill acreage.

Even when the perceived core area is found (as we won't know until a lot more wells are drilled), companies must continue to build areas of contiguous acreage. As land is a finite resource, interests around the core get very crowded. This will involve more exploration JVs (for example, the Hess Corp.-Newfield Exploration deal covering 140,000 acres); the formation of new areas of mutual interest, and all manner of smaller, under-the-radar swaps, acquisitions, and divestments. Private equity is also a player, including deals from KKR with East Resources and Morgan Stanley Private Equity's majority investment in Triana Energy (Morgan Stanley's fourth investment in the Marcellus).

While the broader value propositions of private equity and established independent E&P shale players may vary, the underlying strategic drivers in the core development phase are the same. The value of contiguous acreage around the core play is worth up to double the value of late noncore entry (using the Fayetteville as an analog).

The value of a company's portfolio with acreage scattered around the core and noncore areas can be fully developed through land highgrading. Acreage positions can be used as mini portfolios, swapping, selling, and purchasing contiguous land tracts to build drill ready sites.

A company with drill ready sites of even small contiguous acreage in the sweet spots will offer considerably more value than a competitor with larger, scattered acreage as the drill-out probability increases and costs can be driven down through full pad development and more efficient logistics and permitting.

Total's $2.25 billion JV with Chesapeake in the Barnett from January 2010 is a direct entry into the core. This kind of entry is likely to occur in the Marcellus the next few years. The effect of a tighter and more focused land portfolio in the core leads to the final development phase, that of exploitation and optimization.

Exploitation and optimization

Because of the sheer size of the Marcellus play, and its geographic and subsurface variability, it will be some time until we can assume that operators are engaged in the exploitation and optimization development phase.

In this phase, new business models are likely to be developed to manage what is essentially a margin business very different from conventional oil and gas organization models. Brian Forbes, Joerg Ehlert, and Herve Wilczynski from Schlumberger Business Consulting have suggested the concept of the flexible factory in unconventional gas development, balancing repeatability and standardized design with the specifics of subsurface characterization (Fig. 3).

The strategic drivers likely to influence this particular development phase include gas price volatility, margin management, competitor benchmarking, lean processes, and aboveground regulatory issues.

Entry into the Marcellus may come from various actors.

Utilities are likely to see entry into the upstream as a hedge or strategic asset, particularly if gas receives a demand boost from legislation aimed at lowering US carbon dioxide emissions. Utilities are used to margin business models and have considerable experience in state and environmental relations.

Private equity will also continue to see opportunities in this development phase looking for countercyclical gas price exposure, consolidation opportunities and providing improved management teams.

Sovereign wealth funds may also make bets on this play, as they have also done in mature basins including the UK continental shelf.

Sustainable success will be measured against those players with consistent top quartile cost positions, which is essentially the best long-term hedge in structurally volatile commodity markets such as natural gas and offers investors superior returns. In this particular phase, the majors may already possess some distinct advantages, through the application of technological innovation, supply chain management, sophisticated IT systems and procurement economies of scale.

This particular operational model could imply that the winners in this phase may actually employ a business model similar to that of the oil and gas service industry, which again may create new cooperation opportunities between the service sector and E&Ps. This is especially true of the Appalachian region, which is a multishale play offering recovery upside through greater subsurface understanding.

Near-term technology developments will need to tackle some key issues including improving recovery rates, water management and recycling of frac fluids, and optimizing logistics. Long-term technological developments will occur as a result of continual problem solving and competition, making the Marcellus a very important place to be for transferring technology to global shale plays.

A wide open space

US shale plays, and the Marcellus in particular, offer a breadth of entry opportunities and are likely to continue to do so in the future due to the lack of consolidation in the shale gas sector.

As the Marcellus matures, the competitor landscape will change with it, bringing in new players that are measuring success and adding value in various ways.

There is no silver bullet application for sustainable success in shale plays, rather the tireless drive for operational efficiency and the application of repeatable technology. For some companies, this will require very different business models than they employ today, engaging aspects of manufacturing and just in time supply-chain management.

The growth of the joint venture model in US shale may also encourage new organizational structures and working practices getting the best out of the Independents and the majors. What is sure in this play is that the level of competition will continue to remain high in the future.

The author

Stephen Bull ([email protected]) is the commercial leader of Statoil ASA's Marcellus shale gas asset. Currently based in Houston, he has previously worked for JP Morgan in London and has been with Statoil for 12 years covering positions within market analysis, risk management, and strategy. He holds an MSc (Econ.) from the London School of Economics.


Locations are being cleared out of dense jungle for two exploratory wells in the Lariang and Karama subbasins onshore central west Sulawesi, Indonesia.

Tately Budong-Budong NV, a subsidiary of Pexco NV, will operate the wells in the exploration phase on the 1.4 million acre Budong-Budong block. Harvest Natural Resources Inc., Houston, is to earn a 47% working interest.

The first well is to spud in mid-March 2010. The wells seek oil in stacked Miocene and Eocene clastics in the West Sulawesi fold belt.


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New Zealand

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West Virginia

Gastar Exploration Ltd., Houston, said its first vertical Marcellus well just south of the West Virginia panhandle proved the company's belief that areas where the shale is thinner can yield "excellent results."

The James Yoho-1 well, in the Green district of Wetzel County, stabilized at 1.5 MMcfd of gas and 120 b/d of condensate with 1,000 psi flowing tubing pressure. It cut 46 ft of Marcellus shale and was completed with a single-stage frac.

Gastar has 100% working interest and has acquired 36,000 net acres in northern West Virginia and southwestern Pennsylvania. Its longer-term development will be geared toward horizontal drilling.

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