Mixed Signals Coming Out of the Marcellus

By Matthew DiLallo - August 19, 2012 | Tickers: BHI, CHK, EQT, RRC, TLM | 0 Comments

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It was supposed to be a game changer for the state of Pennsylvania.  The Steel City was to be catapulted as the energy capital of the east if not of the world.  By the year 2020 nearly a quarter of the natural gas used in the nation was to be produced here.  Yet, the drilling boom from the Marcellus Shale that hit the state is beginning to look fragile.  The price volatility in natural gas is making many drillers rethink their drilling plans while others seem to be going full bore.  What does all this mean for investors?

According to Baker Hughes (NYSE: BHI) the rig count in Pennsylvania continues to drop.  The count is down another three rigs this past week and down 44 from last year’s count.  For the state there are now 72 rigs operating, which is a far cry from the 116 from a year ago, good for a 38% drop in the rig count.  When you take a look at the picture nationwide the drop in the rig count isn’t quite so dramatic.  There are 1,931 rigs currently drilling in the US, just down 28 from a year ago or less than a 2% drop.  So if we’re still drilling in the US, why is the Marcellus falling off and why does it even matter?

You see, natural gas found in the Marcellus shale was supposed to make it the premier energy play for decades to come.  It was to create family sustaining jobs while providing the population centers of the east coast access to low cost energy while being a driving force of our national economy. Maybe that still happens, but when companies like Talisman Energy (NYSE: TLM) basically pull out of the region by pulling the plug on their $1 billion drilling program it should make investors take notice.  In Talisman’s case they are shifting nearly their whole drilling program to their liquids rich Eagle Ford acreage.  One reason they’re pulling out while others are digging in is that they don’t have issues with expiring leases that need to be held by production or lost.  While Canada-based Talisman might not be well known, they were the number two producer in the state in 2011 and were third in active wells with 263.  For them to close up shop and walk away is a pretty big deal.

The top producer in the play, Chesapeake (NYSE: CHK), though is planning to stick around, but at a reduced rate.   They are taking their dry gas rigs from ten down to six while also reducing their wet gas focused rigs from seven to six.  Those rigs seem to be drifting over to the Utica of Ohio as they boost their rig count from eleven to sixteen for the balance of 2012.  While Talisman has made a conscious effort to pull out of the Marcellus completely, Chesapeake’s reduced rig count doesn’t necessarily mean that they’ll be following them south. Like Talisman, they are a big player in the Eagle Ford as they’re currently running 28 rigs but unlike Talisman they plan to reduce that count to 22 for 2013. 

As Range Resources (NYSE: RRC) pointed out in their recent earnings report, reduction in rig count doesn’t mean reduced emphasis on the play.  As the number four producer and top well owner in the state of Pennsylvania, Range said that, “due to improvements in drilling and completion efficiencies, we are expecting to utilize fewer rigs in the second half of the year while still meeting our production targets.”  Where they’ll focus their drilling is on their more liquids rich acreage as well as drilling some test wells into the Utica in their Northwestern Pennsylvania acreage.  Range unlike most of their peers seems to be taking a much longer-term view in that they are embedding themselves in the community through continued marketing efforts such as their My Range Resources program.

While Talisman is out of the Marcellus and both Range and Chesapeake are refocusing their efforts, EQT (NYSE: EQT) is going all in with their drilling program as they’ve made the decision to pull out of their Huron acreage.  They just cannot get the returns from their Huron position as they can get in the Marcellus.  According to management at a recent conference they’d be unlikely to head back there until natural gas prices spike above $6/mcf.  EQT is the number five producer in the state of Pennsylvania and ranked tenth in well count at the end of 2011 with 68 wells.  Yet with acreage positions in just two basins, their options are more limited. 

While drilling in the Marcellus is beginning to show signs of slowing down and producers are giving us mixed signals as to their intentions, the play, one of the largest in the world at 141 Tcf, is far from over.  What we’re really seeing is companies refocusing their drilling efforts on their highest return opportunities in an effort to combat low natural gas prices to satisfy returns starved investors.  Liquids are a big focus for the industry right now and companies like Talisman and Chesapeake have the flexibility to shift capital to these higher return projects. 

The problem many companies will face once prices recover is a public that's even less forgiving than shareholders.  Locals are likening some producers to used car salesmen, here today and gone tomorrow.  That's where the long-term commitment and investment by Range in building brand awareness could eventually pay dividends as they manage the company for the long haul.  The rig counts and producers might be sending mixed signals but the play is too big to be forgotten.  Only time will tell if any bridges are being burned by producers.

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