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The shale gas shell game

With the election frenzy behind us, and the Fed printing money like there's no tomorrow, it seems like a good time to return to the shale gas "boom" in the Marcellus. You will recall that shale gas production, not only in Pennsylvania but elsewhere in the lower 48, Canada and all over the world, is going to provide us with far more energy over the next 250 years than we could ever figure out what to do with.

In Shale Gas Shenanigans, I questioned whether development (in the Marcellus and elsewhere in the U.S.) was economic with natural gas prices well below $5/MMBtu. I concluded that it was not, but that didn't matter to the smaller operators like Range Resources, EQT and Atlas drilling in Pennsylvania—

These shale gas producers are an asset play. And this outcome obviously benefits the Wall Street banks who lend them money. Indeed, this is their exit strategy from the unprofitable drilling treadmill they are currently on. If shale gas production can be said to be in a bubble, this is where that bubble lies. And the strategy is working!

The shale gas boom has been the sole bright spot in America's energy picture, and maybe the only bright spot in the economy as a whole. And what does that bright spot turn out to be? An asset play whereby shale gas producers, conniving with bankers, inflate their own value, hoping to get out while the getting is good.

What else would you expect in 21st century America?

In other words, the smaller operators, who leased far more acreage than they could ever develop, have hyped shale gas to keep their share prices up, and dangled themselves before the majors as merger & acquisition targets. As I said in Shale Gas Shenanigans, the strategy was and is working. Exxon had previously acquired XTO, and now Chevron has acquired Atlas for $4.3 billion. The Bloomberg report Range Resources, EQT May Be Targets After Chevron Deal says it all—

Range Resources Corp., EQT Corp. and Ultra Petroleum Corp. are among companies that may attract takeover bids because of their holdings in the Marcellus Shale formation, where natural gas output has exceeded forecasts, analysts said.

Investors expect more deals to follow yesterday’s agreement by Chevron Corp. to buy Atlas Energy Inc. for $3.2 billion in cash to gain access to natural gas in the Marcellus. The deal is worth $4.3 billion including assumed debt, which would make it Chevron’s biggest since it bought Unocal Corp. in 2005.

Range, EQT, and Ultra, along with Atlas, all control hundreds of thousands of acres in the Marcellus, a layer of gas- rich shale rock under Pennsylvania and adjacent states. The three have below-average enterprise values — the value of stock plus debt — compared with reserves among the 65 largest U.S. oil and gas producers, according to a Bloomberg data analysis.

“The Marcellus is the best gas shale play in the U.S.,” Brian Lively, an analyst for Tudor, Pickering, Holt & Co. in Houston, said in an interview yesterday. “You’re also very close to market, so you tend to get a premium for your gas"...

“Majors just don’t do $4 billion deals and then go quietly into the night,” according to a note issued today by Tudor, Pickering analysts including Lively. “There will be more acquisitions” and companies going private, the analysts wrote...

“If I were acquiring a company and had all the money in the world, the three I would target first would be Ultra, Range and Petrohawk," Michael Bodino, a Fort Worth, Texas-based analyst for Global Hunter Securities, said in an interview yesterday.

Ultra and Range hold acreage in the Marcellus Shale, while Houston-based Petrohawk Energy Corp. has holdings in the Texas Eagle Ford shale that produces oil...

These takeover targets have accumulated massive amounts of debt but can't make a profit (Range Resources) with gas selling in the $4-5 per MMBtu range. (EQT, which is selling off assets, seems to be an exception.) But that doesn't matter to Chevron. From Bloomberg again—

Chevron and other integrated oil companies are buying shale-gas assets based on a 30-year outlook for energy prices, confident that natural gas will sell for more than the current price of about $4.24 per million British thermal units, said Jonathan Dison, a managing director at Bender Consulting Services Inc. in Houston, whose clients have included Chevron. Exxon Mobil has said it expects use of natural gas will outpace that of oil as global energy demand rises.

Shale gas production has become so squeezed by low natural gas prices that Range Resources and others mentioned by Bloomberg like Pioneer Natural Resources, Inc. have sold off assets and moved into liquids-rich projects where prices and potential profits are higher. Jack Z. Smith reported on the trend in the Fort Worth Star Telegram

Range Resources Corp., predominantly a natural gas producer, is increasingly going "wet" as it escalates production of more-lucrative crude oil and natural gas liquids.

In the meantime, the Fort Worth-based company is continuing to chalk up record production numbers boosted by its leading role in the big Marcellus Shale gas play in Pennsylvania. In an operations update released Thursday, Range said it reached a milestone in the third quarter: Its production exceeded the equivalent of 500 million cubic feet of natural gas per day for the first time. The daily average of 503 million marked the 31st consecutive quarter of production growth.

Notably, third-quarter production was 23 percent natural gas liquids and oil, compared with 16 percent a year earlier.

Oil and natural gas liquids, which include propane and butane, are commanding significantly better prices than "dry" natural gas. That's a driving force behind a drilling upsurge in areas such as the Eagle Ford Shale in South Texas and the Permian Basin in West Texas.

Range said it "continues to redirect capital into its higher-return liquids and oil-rich properties, while reducing drilling in dry natural gas areas."

In short, to show any profitability at all, Range Resources is diverting resources to "wet" acreage to increase their condensate and gas liquids production. They are losing money with natural gas going for $4.21/MMBtu (the December contract).

While Range Resources scrambles to show a quarterly profit and maintain their share price, it should be clear by now that their real intention is to get bought out by Exxon Mobil or Chevron or some other major oil company, big players who can wait for the price of natural gas to get to $6-7 per MMBtu or higher, a price at which many Marcellus operations become truly profitable.

But for the Chevrons of this world, what really matters is not the relatively small amounts of money they will make on Marcellus shale gas when prices eventually rise into the $6-7/MMBtu range—unless gas prices go through the roof. What really matters is the reserves they can claim by acquiring the leases on all those acres of land in Pennsylvania, New York and West Virginia. That makes them look really good on paper, which is what counts for investor sentiment and share price down the road. Hyping the potential of shale gas just makes them look that much sweeter.

Welcome to the shale gas shell game.

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