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A New Stage in U.S. Shale Gas Development

by | published November 4th, 2011

Yesterday, Chesapeake Energy Corp. (NYSE:CHK) announced that it was completing two land-leasing deals – on property in the Utica Shale basin – worth as much as $3.4 billion.

Chesapeake will bring in an “international major energy company” to jointly develop some of its Utica acreage. The company is not naming the major, but says the deal should be completed next month.

This marks the beginning of a new stage in shale gas development.

Chesapeake, as you know, is the second-largest natural gas producer in the country – after Exxon Mobil Corp. (NYSE:XOM) – and by far the largest independent.

Earlier this year, the company announced that it valued the land it controls in eastern Ohio at $20 billion. That set off a flurry of activity in the region.

See, the Utica is somewhat special.

It is an ultra-deep shale formation. Its producing regions in eastern Ohio and western Pennsylvania lie below the Marcellus – at depths of 12,500 feet and more. And as a concave-structured basin, the Utica grows closer to the surface as you move into central Michigan, but the anticipated volume extractable also declines.

Because it is so deep, it is far more expensive to develop than shallower shale plays.

The average Utica well costs more than $8 million to drill, as compared to about $3 million for a “normal” shale play.

However, it also carries some major potential advantages:

  1. For one thing, this is dry gas. That means there is far less processing expense involved than with “wet” gas – volume that has other constituents (some value-added) that need to be separated from the main gas flow.
  2. Second, the “pay zones” (the strata in which the hydrocarbons actually sit) are wider than in higher drilling locations. It is more expensive to reach the deeper level, but there is more target volume once you reach it.
  3. Additionally – and this is one of the primary attractions of dry volume – there is also the potential for significant crude oil in the pay zone, along with the gas. That boosts the profitability and makes higher costs well worth the trouble.

In some ways, the Utica shale is the perfect stage for what's coming.

The Chesapeake/Utica Model:
A Potential Game-Changer

Now, it's not the farming-in of a foreign company that is new.

Chesapeake has been quite successful in doing just that in earlier projects.

It brought Norwegian major Statoil (NYSE:STO) into the Marcellus, Chinese CNOOC Ltd. (NYSE:CEO) into Eagle Ford in Wyoming, and French Total (NYSE:TOT) into the Barnett.

In each case, the foreign major paid more than $1 billion for 25% of the project, and agreed to accept responsibility for covering initial development costs…

But CHK retained operating status.

From a regulatory and political standpoint, this approach overcomes concerns that foreign companies – especially Chinese – would end up owning drilling projects inside the U.S. CNOOC (or Statoil or Total or…) comes in as a minority partner. A U.S.-owned and run company still calls the shots.

But the Utica development Chesapeake announced yesterday is different… and it's going to usher in a new era in how we develop the vast unconventional reserves in this country.

International Access to U.S. Assets

Chesapeake continues to control the project, as before, with the foreign major essentially remaining a minority partner in a joint venture.

In this case, however, the foreign major is leasing the land itself, not simply contributing to the E&P (exploration and production) budget.

And that opens up a new dimension in international access to American assets.

In some cases, the foreign company's most important considerations are access to U.S. technology, expertise, field practices, and analysis.

That's certainly true with Chinese majors. China is now regarded as having the largest reserves in the world, and Beijing is committed to moving on their development as quickly as possible. And they need us to show them how to do it most efficiently. (See “China's Back-Door Push into Our Front Yard,” May 25, 2010.)

In most other cases, however, the company entering into a venture just wants to book a portion of the field reserves as its own. This is the primary interest among publicly traded companies worldwide, anyway, since it’s the most direct route to improving share value.

Control over the lease, therefore – even if it is not complete – accomplishes the book-to-share value objective.

The move will also pop the price of the U.S. stock – in this instance, CHK.

Development costs are becoming a major consideration as shale gas extractions expand. This is especially the case with basins such as the Utica, where costs are higher than in many other locations.

Having an American producer control a mega domestic project, but deflecting large chunks of the expense to a foreign company, would seem an ideal solution.

In the Chesapeake scenario, however, it all depends who the “internal major” in this deal turns out to be…

That's because, in an election year, the identity of the “big pocket” foreigner acquiring leases of American acreage may be all that is needed to start a political firestorm.

Just ask those at Unocal Corp. a few years ago.

In 2005, the California oil company ended up getting acquired by Chevron Corp. (NYSE:CVX). But the price Chevron paid was much lower than the one offered by a competing bid.

Congress actually intervened to prevent that competing acquisition, even though it would have provided shareholders with an even greater return.

The move was widely regarded as protectionism…

Because the competing bid came from CNOOC.

Sincerely,

Kent

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  1. Linda Mercurio
    November 4th, 2011 at 12:25 | #1

    Chesapeake also has leased land in the Niobrara formation in Weld County. What is currently happening with those leases and that formation’s development?

  2. John W. Hardy, Ph. D. (math and physics)
    November 4th, 2011 at 13:57 | #2

    I don’t know if it has come to your attention, but, if not:

    There is a small company in Alberta, GasFrac that is using liquified propane
    instead of water in the fracking process. I is claimed to have fractured better and to yield about twice the volume of crude at the well head. Also, the propane can be left in site with it absorbed into the carbonaceous surroundings. They are working on a sort of refinery to recapture the propane.

    I see nothing in the media of the Bakken shale or the Monterey Shale (of California). Shell and Occidental announced locally (with a lot of workers in the field knowing too much about it) of the 400 billion barrels of oil in the Monterey Shale. The shale runs from the Santa Paula valley up past here (near Taft in California) to Sacramento, then across to the sea side. All the work is being done very quietly (guessing that farmers will get a low fee for the leases). Oxy, according to their workers and the neighbors that will be affected in a fair sized village near Taft, is to drill about a hundred wells in that neighborhood.

    Mobile is also involved, but that was not announced in the above disclosure. Mobile and Shell have just received a permit to build a two-hundred-million dollar hydration plant (a plant to such water out of the water table and ship it north). This will provide the water for fracking on the west side of the San Joaquin valley. The farms on the side of the valley near the Coast Range live off irrigation water coming from the Sacramento river. I am not pleased with this arrangement. I live about two miles from where this huge, pumping station will be. It takes 3 acre feet of water to frac for one well. We “seep” water from our river (none is wasted) to maintain the water table. We have just recovered from a 120 drop in the water table.

    Quite by accident, I found that Monterey County has just approved the fracking process inside their borders. That is a surprise, but then it is not one. There are a great number of very wealthy people with holdings of large acreages in that county. I did not recognize the company that had applied for the permit.

    Why isn’t the Bakken given any attention in the media? In the Canadian part, there is a great effort to get the gas and get it to market. China is providing 20 billion for a larger pipeline to go from Alberta to the a port on the west coast (north of Vancouver.

    I have friends (owners) in the business (well drilling and service) who can’t believe the inattention given their successes.
    All of the work done there has been done by junior oil companies. Mobile just bought one of the best run exploration companies. I received a lousy six dollars above the market for what I expected to become a very valuable stock.

    Incidentally, another Canadian company has made a substantial improvement in the fracking process. It also lowers the well generation time and the cost substantially.

    J. Hardy

  3. Albert M. Imamura
    November 4th, 2011 at 14:34 | #3

    Extremely informative.

  4. November 4th, 2011 at 20:17 | #4

    hey kent, i found that rare metal mine i asked about.its all ready to go into production by Christmas. the past employees and supervisor live right there. owned by canadian co. they paid cash for it. they only have to turn on the electric. kenneth,, kldegas@yahoo.com

  5. Craig Kitto MA
    November 5th, 2011 at 23:50 | #5

    Thanks Dr. Moore for the insight! I only have one question! Is the company that wants to be involved with Chesapeake Energy, BP? The reason why I asked is that this would be only thing I can see that would cause a bigger firestorm among Washington politicians than a Chinese or Russian company coming into the picture! So say it is not so!!!

    C. Kitto

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