Achieving double-digit growth at an exceptionally low cost

EDITOR’S NOTE: Fort Worth-based Range Resources Corp. operates in Southwestern, Appalachian, and Gulf Coast regions of the United States. The company pursues a growth strategy that targets exploitation of its large inventory of lower-risk development opportunities, including a number of shale and coalbed methane projects, where the company has developed significant expertise. Chairman and CEO John Pinkerton recently took time to field a few questions from OGFJ

OIL & GAS FINANCIAL JOURNAL: Range Resources has moved up to 28th on the OGJ200 list of the largest publicly-traded E&P companies, is the 10th most active driller in the industry, and has delivered 21 consecutive quarters of production growth. What are the main factors driving your success?

JOHN PINKERTON: Our success is driven by the quality of our assets and the quality of our team. A lot of E&P companies make this same claim, but Range has established a track record of consistent, double-digit organic production growth at low costs. According to a Bank of America survey which takes into consideration the all-in cost structure, Range has ranked either #1 or #2 in achieving low costs for each of the last four years. So, it is a simple strategy for success. We have a strong team capable of delivering consistent growth in production and reserves at an exceptionally low cost.

OGFJ: In April, you announced a $200 million increase in your capital expenditures to $1.27 billion. How do you plan to allocate a majority of your capex budget? What accounted for the additional $200 million in spending?

PINKERTON: The increase will be used primarily to increase leasing efforts in the Marcellus shale play in Pennsylvania. Following early indications of drilling success in the play, our board approved additional funding so we could pursue additional leases. Generally, we allocate about 50% of our capital budget to our Appalachian division and 50% to our Southwest division. Historically, this has been our split.

We are continuing to invest in the development of our three key project areas. At the Nora field in Virginia, we will accelerate the drilling of coalbed methane wells with 300 CBM wells planned there in 2008. Since the properties were acquired in late 2004, production has more than tripled. In addition, we are drilling tight gas sand wells in the area and are testing tighter spacing of both CBM and tight gas wells. Initial results from the infill programs appear positive. With continued success, as many as 6,000 CBM and tight gas locations remain. These reserves provide a multi-year inventory of drilling opportunities at extremely low finding and development costs.

What is new and different in the area is the Huron shale play. This is an exciting new target for us. In late 2007, Range drilled and completed the first horizontal Huron shale well ever drilled in Virginia. The Nora field is located just southeast of the Big Sandy field, where several successful horizontal shale wells have recently been drilled by Equitable and other third parties. Our first well appears to have achieved commercial rates and excellent finding costs. Ten horizontal wells are planned in 2008. If successful, this program will de-risk about 1.5 tcfe of reserves net to Range by year-end.

Another key project area for Range is our Barnett shale play in North Texas. In two years we have brought production from zero to approximately 100 MMcfe per day by first quarter 2008. This is the same refrain. We have achieved this due to the quality of the acreage we have acquired and the quality of our technical team that is developing the acreage. The Barnett is the largest producing natural gas field in the onshore US, and it was originally unlocked by Mitchell Energy. Mark Whitley headed the Mitchell technical team, and he now heads up our shale team efforts. In addition, we have been fortunate enough to hire several ex-Mitchell employees who were a part of the original Barnett team. We make an effort to encourage data sharing between our Barnett shale team and our Marcellus shale team. Both of the technical teams are very strong, and data-sharing strengthens both efforts.

Finally our third key project is the Marcellus shale play in Pennsylvania. This is one of the hottest new shale plays in the country, and Range has led the attempt to transfer modern technology to this basin. Range has brought in large top-drive rigs to accomplish horizontal drilling in the shale formations that lie more than a mile beneath the earth’s surface. We were the first to employ a large, Barnett-style, slick water frac in the basin. Hydraulic fracturing is a process that breaks up the dense shale rock and releases natural gas. Range’s early drilling attempts have been very encouraging with initial production rates from the last 10 wells averaging 4.1 MMcfe per day. Based on our land position at year-end 2007, we estimated 10-15+ tcfe in net unrisked reserve potential in this play. Our land position has been steadily increasing, so our upside in the play continues to grow. While we have other projects in the pipeline, these three projects represent roughly 20 tcfe in upside potential or enough to grow the company by almost as 10 times its current reserve base.

OGFJ: While Range has a balanced portfolio of projects, considerable attention has been focused on your emerging play in the Marcellus Shale. What results can you report to date? What is the upside potential in this play?

PINKERTON: Range was the first mover in the Marcellus shale play. Our geologists began focusing on the play in 2004. We were the first company to apply state-of-the-art Barnett style drilling and completion technology in the Appalachian basin. We completed our first well in late 2004 and opened an office in Pittsburgh in early 2007 to focus on our shale effort in Pennsylvania. Initial production rates from our last 10 horizontal wells have averaged 4.1 MMcfe per day. We are quickly climbing the learning curve in this basin.

These are impressive results compared to how long it took to establish commercial production in the Barnett, Fayetteville, and Woodford shale plays. That being said, we have the advantage of building from the knowledge and success acquired in the other shale plays. Of course, not all of the shale plays work. For example, commercial production has yet to be established in the New Albany, the Floyd, and the West Texas Barnett. Our results to date are very encouraging. If this play works, our upside is huge. We estimate approximately 10 to 15+ tcfe in net unrisked reserve potential on our existing acreage position, which continues to increase. At present we own more than 1 million net acres in the trend’s fairway, of which 700,000-plus acres are high-graded for shale exploration. This play alone has the potential to grow the company’s reserves by as much as seven times our current 2.2 tcfe proved reserve base. If a person were going to pick a place in the US to find a huge gas field, they could not pick a better place than the densely-populated Northeast, where demand drives a premium to NYMEX of about $0.35 per mcf.

OGFJ: The Marcellus shale is rapidly turning into one of the hottest plays in the industry. However, access to rigs, a developed infrastructure, and the overall terrain pose many challenges. How will Range address these issues?

PINKERTON: We have had to import the proper rigs, as well as fracing and pumping equipment. Currently, we have the equipment we need to fulfill our 2008 and 2009 drilling program. Our team has been nimble, getting out ahead of the curve to procure what is needed. We are currently involved in building out infrastructure. While the play is close to the gas markets in the East, the existing gathering system was designed to accommodate lower-pressure, lower-rate wells. The higher-rate, higher-pressure shale wells will require a new gathering system, and we are well underway with this project. Our goal is to have the infrastructure in place so that we can grow our production volumes in 2009.

With other E&P companies coming into the play, a number of service companies are moving to the area. Ultimately, this will serve to drive down costs. In terms of the terrain, yes, the spine of the Appalachian mountain range runs through the center of Pennsylvania. It can be rugged in places, but not nearly as rugged as the Rocky Mountains. Range has been drilling in Pennsylvania for the last 30 years. We currently have about 10,000 wells in the state, so I believe our team is well-equipped to deal with the challenges.

OGFJ: You recently increased 2008 production guidance to 19%. Where will this growth come from?

PINKERTON: Our growth is coming from the entire portfolio of projects, not any single play. We have a good portfolio and good growth from all areas. While the Barnett shale and Nora field are key growth drivers, we are also having success in our Midcontinent and Gulf Coast divisions. Much of our volume in the Marcellus is currently shut-in, awaiting pipeline infrastructure, so we won’t see much volume growth there until 2009.

OGFJ: Under what circumstances, if any, would Range consider expanding its operations outside the lower 48 states?

PINKERTON: We plan to stay focused in our core operating areas in the Southwest, Appalachian, and Gulf Coast regions of the United States. Our existing projects currently have potential to grow the company by as much as 8 to 10 times, so we have tremendous growth opportunities in the areas where we are currently operating. At the same time, we have a number of new projects in the pipeline. With our existing operating areas representing growth opportunity of this magnitude, we are not compelled to venture outside of the continental US.

OGFJ: Oil and natural gas prices continue to reach record highs. How does today’s rising price environment impact Range’s hedging strategy? How much of Range’s 2008 production is hedged? At what price?

PINKERTON: Traditionally, Range has hedged up to 80% of anticipated production in a given year. This strategy provides a steady cash flow to ensure that our drilling program is funded. We currently have 73% of anticipated 2008 production hedged at weighted average gas floors of $8.24 per mcf. In 2009, we have 64% of anticipated production hedged at weighted average gas floors of $8.31.

OGFJ: Range Resources has a consistent record of growth with a low cost structure that many other operators could only dream of. Talk to us about how Range is able to deliver consistently strong results with low costs.

PINKERTON: Again it comes down to the people, the properties, and the strategy. We have a great technical team at Range working high-quality properties. This team is continually generating creative ideas that help us cut costs, reduce drilling time, increase recoveries, and thereby maximize the value of our properties. We target low-cost, low-risk, repeatable projects in areas where we have technical expertise. Our goal is to consistently grow production and reserves at top-quartile or better finding costs. With success, we believe this strategy will continue to deliver increased value for our shareholders.

OGFJ: How difficult is it to recruit and retain talent in today’s oil and natural gas industry? What steps is Range taking to ensure that it always employs and always has access to the best and brightest employees?

PINKERTON: Clearly, the quality of the team drives the value of a company. At Range, we have granted equity awards to all employees for each of the last 18 years. As the company has success and builds value for shareholders, the employees get to participate in that. This serves as a great incentive. Over the past five years, our company has established a great track record of growth, and our stock price has increased roughly 1200%. Obviously, this has created a lot of value for the employees and serves as a great tool to help us attract and retain talent. Not only that, but our culture at Range helps to attract and retain people.

We have a relatively flat organization, and we give individual employees a lot of responsibility. Technical people like to be active and drill wells. As the country’s 10th most active driller, drilling roughly 1,000 wells per year, the team is active and engaged. Finally, we like to draw the analogy of a sports team. Employees like to belong to a winning organization. They take pride in their organization. Over the past five years, our turnover has been close to zero, and because of our success and growth we are attracting a higher caliber of employee. We have a lot of exciting growth opportunities in our portfolio, and the challenge, work environment, and rewards are helping us attract some of the industry’s best and brightest.

OGFJ: What are the greatest challenges you see in the oil and natural gas industry today?

PINKERTON: Hiring and retaining top talent is always a challenge. With many industry employees now nearing the age of retirement, efforts are increasing to educate young people about the opportunities in this industry. As a result, we are seeing college enrollments rise for technical personnel such as engineers and geologists. We also find that many people enjoy their work and are postponing retirement. So with more young people coming into the industry and older workers staying in the workforce longer, it is helping to bridge the gap. Another key challenge is equipment. Steel is in short supply given the current international demand and consolidation of manufacturers. The scarcity drives up the price of rigs, pipes, pumps, and other materials and makes timely procurement difficult.

OGFJ: What new technologies is Range using to unlock reserve potential? What is on the forefront?

PINKERTON: Resource plays are the hottest thing in the industry right now, and technology is the key that unlocks them. In the last decade, shale plays have been made commercial by rising commodity prices, combined with advances in seismic imaging, horizontal drilling and hydraulic fracturing. Now companies are moving toward refracing horizontal wells to increase recoveries. The success of resource plays has a lot to do with a mindset change within the industry. Years ago, shale formations were never considered reservoir rocks. Today we know that they contain a vast amount of hydrocarbons, and although they are very tight and dense, with sufficient fracturing the rock can be shattered and the gas released. The good news is that shale gas represents a large, domestic supply of a clean-burning fuel.

OGFJ: Range Resources is predominantly a natural gas company. With oil trading at $130 to $140 per barrel, is Range considering expanding its oil exploration and production efforts?

PINKERTON: We are an opportunity-driven company. Our goal is to grow production and reserves at low finding costs. While we are engaged in the exploration for both oil and natural gas, roughly 80% of our reserves are natural gas. With our current portfolio of projects, we have the potential to grow our reserve base almost 10-fold. So we have ample growth opportunities ahead without seeking out additional opportunities. That said, we feel very positive about the future of natural gas. No doubt there is a strong move toward cleaner-burning fuels. No matter which candidate is elected, this trend will continue. Natural gas and nuclear energy are the cleanest burning fuels, and it takes a lot of lead time to build nuclear plants. So for the foreseeable future, we believe clean-burning natural gas will play a key role in meeting our nation’s energy needs.

OGFJ: Range has delivered more than a five-year 1200% return to shareholders. How do you convince investors who do not currently own the stock that there is still significant room for growth?

PINKERTON: Five years ago our portfolio of projects had the potential to double the company’s reserve base. Today the portfolio has the potential to grow the company’s reserve base by 10 times or more. While the past five years have been great, today our growth potential is significantly greater than at any time in our history.

OGFJ: Thanks for taking the time to talk with us.