INCREASING OPTIONALITY IN THE MARCELLUS, UTICA SHALES

ANTHONY ANDORA, EDGE CONSULTING, SANTA MONICA, CA

Accounting for approximately 40% of natural gas production in the United States is the Marcellus Shale, the largest natural gas producing shale in the country. As shown in Figure 1, since 2007, production from the Marcellus has grown from roughly 1 billion cubic feet per day (bcfe/d) to approximately 16 bcfe/d (December 2014).

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Playing directly into the shale's massive production growth is the region's pipeline capacity and infrastructure. Since the summer of 2012, production volumes in the Marcellus have outstripped pipeline capacity. Capacity constraints associated with the Marcellus Shale, and now from the emerging Utica Shale, are placing greater downward pressure on natural gas price differentials. Many industry experts believe that rising production volumes, continued capacity constraints and a challenging regulatory environment will weigh on natural gas price differentials into 2016.

Fortunately for E&P producers in the region, ultra-low finding and development costs, combined with improved completion techniques, enable many operators to continue to generate excellent internal rates of return even with negative price differentials. That said, E&P operators with midstream pipeline assets in the region have a hidden gem in their portfolio as they work harder than ever to help alleviate the negative price differentials in the Marcellus Shale.

One such operator is Eureka Hunter Pipeline, a subsidiary of Magnum Hunter Resources. Gary C. Evans, chairman and CEO of Magnum Hunter, foresaw the need for additional pipeline capacity in the region as early as 2010 as many of Magnum Hunter's wells in the West Virginia portion of the Marcellus started to deliver higher than anticipated IP rates (initial production rates) and EUR's (estimated ultimate recoveries).

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Work was done to build out additional throughput capacity in the region.

Evans immediately started to purchase additional right-of-ways and build out the Eureka Hunter subsidiary. The pipeline, initially designed as a gathering system to transport Magnum Hunter's molecules of natural gas, quickly grew into something much larger. Before long, Eureka Hunter began to take on third-party gas from other producers in the region. Eureka's strategic positioning in the Marcellus and Utica shales of West Virginia and southeastern Ohio also attracted investment dollars from ArcLight Capital Partners out of Boston, Massachusetts in March 2012. The initial $100 million investment by ArcLight valued Eureka Hunter at approximately $360 million. In the third quarter of 2014 however, Morgan Stanley Infrastructure (MSI) entered into conversations with Evans and a decision was reached whereby MSI would replace ArcLight as Eureka Hunter's investment partner. Over the roughly 30-month period from March 2012 to September 2014 however, the implied equity valuation on the Eureka Hunter asset rose nearly three-fold from approximately $360 million to roughly $1 billion.

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"Eureka Hunter has grown even faster than any of us anticipated. We're adding new interconnects to accommodate more third-party gas every quarter. These interconnects are serving more and more E&P operators and providing increased access to markets outside the Northeast region. As a result, the relatively small gathering system that we started a few short years ago has become a major hub in the region."—Magnum Hunter chairman and CEO, Gary Evans

By year-end 2015, throughput along the Eureka Hunter system will have increased from >100 MMcfe/d to an estimated 900 MMcfe/d.

But throughput capacity isn't the only factor that goes into the decision-making process at Eureka Hunter. Evans believes that providing E&P operators with increased optionality, or the ability to reduce negative price differentials in the region, is equally important. Evans explained: "As CEO of Magnum Hunter Resources, I understand the needs of today's E&P operator. Providing access to efficient takeaway capacity and increasing optionality for E&P operators is one way that we'll be able to reduce negative price differentials in the region. At Eureka Hunter, we currently have a total of nine interconnects that provide access to multiple markets outside the northeast region. We plan to add an additional five interconnects in the coming months further facilitating increased optionality for E&P operators."

The optionality that Evans refers to is a key differentiator of the Eureka Hunter's pipeline system with its multiple interconnects and third-party clients. For example, approximately 70% of all throughput on the Eureka Hunter system originates from third-party producers; which at last count totaled more than ten producers (see Figure 2). Compare this to other operators in the region that designed and built pipeline systems for the sole purpose of servicing their own wells. While these pipelines are equally important to the companies they serve, they don't necessarily improve optionality for other E&P operators or lead to a reduction in pricing differentials in the region.

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Evans plans to add additional interconnects along the system which will increase ultimate capacity to more than 2.5 bcfe/d. These interconnects, however, are more than just takeaway points for E&P operators, they are the very backbone that is transforming Eureka Hunter from a relatively small gathering system into a major hub in the region (see Figure 3). When asked about the transformation that Eureka Hunter has experienced, Evans replied: "Eureka Hunter has grown even faster than any of us originally anticipated. We're adding new interconnects to accommodate more third-party gas every quarter. These interconnects are serving more and more E&P operators and providing increased access to markets outside the Northeast region. As a result, the relatively small gathering system that we started a few short years ago has become a major hub in the region."

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Given today's challenging regulatory environment and the exorbitant cost of building a major pipeline system in what is now the largest natural gas producing shale in the country, we asked Evans what prompted him to start Eureka Hunter.

"Back in 2010 we took a pretty big gamble," Evans said. "We identified core areas within the region that we believed would act as the backbone for future midstream development. We knew and understood the high-quality rock properties in the play from our successful drilling initiatives at Magnum Hunter. This provided us with a big advantage over other pipeline companies. We also began to see a need for both a dry gas pipeline and a wet gas pipeline, which we believe is a factor that further distinguishes us from our peers in the region. And we developed a strategy of "if we build it they will come." This strategy may have sounded inherently risky at the time, but it paid strong dividends as development costs for a new pipeline laid in the ground at the time were a fraction of what they are today. As a result, we not only built a major hub that provides increased optionality for E&P operators, but the majority of our capital costs are now behind us. Each additional molecule of gas added to the pipeline is reflected as a greater percentage of EBITDA."

When we asked Evans if he had any plans on what he might call the newly developing hub, Evans smiles and said, "What else but Hunter Hub."

ABOUT THE AUTHOR

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Anthony D. Andora is president of Edge Consulting, a communications and branding firm that serves the oil and gas industry. With more than 15 years of experience, Andora has consulted, advised, and represented small-, mid-, and large-cap companies on a variety of issues ranging from detailed focus groups, advertising initiatives, investor relations, and national media campaigns. He has co-produced, developed, and placed content in/on CNBC, FOX Business News, Bloomberg Television, The Wall Street Journal, Barron's, and OGFJ. Anthony@EdgeConsultingSolutions.com

Eureka Hunter

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