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Appalachian drillers get more for less in Q1 as pipes become critical

Appalachian shale drillers again produced a record amount ofnatural gas while spending much less in the first quarter and now are waitingfor higher prices as Eagle Ford and Haynesville producers slow down.

Of the 10 largest publicly traded producers in Appalachia,only Cabot Oil & GasCorp. reported a year-over year decline in natural gas productionin the first quarter, while drillers such as Rice Energy Inc. and Gulfport Energy Corp. in the southwestern Marcellus andUtica drilled like it was hurricane season in 2008. Gulfport increasedproduction 63%, to 692 MMcf/d, while Rice added 53%, to 675 MMcf/d, though bothfirms are working from much smaller year-ago bases than larger local drillerssuch as Range Resources and EQT.

All 10 reported less capital spending in the quarter, andfour — the well-hedged AnteroResources Corp., Gulfport, Rice and — reported adjusted profits.

An index of all 10 companies' stocks has outperformed boththe S&P's oil and gas exploration and production measure and the S&P500 year-to-date.

On first-quarter earnings conference calls, CEOs asked for alittle more patience from investors waiting for higher prices to ride to therescue in the low-cost Marcellus and Utica shale region.

"We continue to believe that dramatically lower rigactivity must at some point correlate to meaningfully lower supply growth[nationwide]," Gulfport Energy CEO Michael Moore said on a May 5conference call. "While the Northeast production supply growth is slowing,we are seeing evidence of material declines in production from associated gas,conventional gas in higher cost shale basins, such as Haynesville, Fayettevilleand Barnett. Net-net, North American gas supply appears to be demonstratingearly evidence of a rollover."

According to Rice CEO Daniel Rice IV, producers in theMarcellus and Utica shales are helping that production decline along bydrilling fewer wells than are required to keep production flat, given the steepproduction decline curves of shale wells.

"Our analysis of the historical state data tells us thebasin needs 50 to 55 rigs to maintain flat production," Rice said on a May5 earnings call. "In every month that we are below 50 rigs, we thinkproduction will be relatively flat as we move into 2017. We think this isimportant, because Appalachia has been a driver of U.S. supply over the lastseveral years and is presumed to fill capacity of new infrastructure projectsin order to meet growing domestic and international demand for natural gas inthe coming years. We think this lack of growth from the basin sets the stagefor an improving gas market in 2017 and 2018 above the strip."

According to Baker Hughes Inc.'s North American rig count, there were39 rigs active in the Appalachian shale states of Ohio, West Virginia andPennsylvania for the week ended April 29.

Jefferies & Co. analyst Jonathan Wolff said the realwinners in the northeast U.S. will be companies with firm transportation out ofthe shale, particularly in light of the delay of 's to NewYork and postponement of KinderMorgan Inc.'s Northeast Energy Direct to New England.

"The long-term-investment case [in Appalachia] remainsintact," Wolff said. "Long-life, low-cost gas producers retain avaluable embedded call option on higher prices and resource expansion.Producers that look best able to participate in a revaluation of gas havelong-dated, low-cost drilling inventory and market access."

"The overwhelming source of new U.S. gas supply has comefrom the northeast region (20+ Bcf/d in 6 years!)," Wolff added. "Butlimits on pipeline evacuation to demand centers have created severe bottlenecksand the future outlook for new evacuation has become murky," Wolff toldhis clients. "We see the end to the hyper-growth phase for northeast gasdiluting its overall influence on US prices."

Antero, the leader among the group with $47 million inadjusted first-quarter profits and a portfolio of rich hedges delivering$4.54/Mcf in average realized prices, added to its advantages by shipping onM3 Appalachia GatheringLLC's newly opened Stonewall Gathering System in West Virginia.With seven rigs drilling in both the Marcellus and Utica shales, Antero is themost active driller in Appalachia, financed by a hedge book delivering anaverage of $3.91/Mcfe for 94% of its production through the end of the year.

"[Antero] benefited from its first full quarter of accessto the Stonewall pipeline in 1Q, enabling it to bypass weaker Dominion Southand M-2 in favor of TCO and NYMEX based pricing," Wolfe Research analystBob Parijas said May 2. "Although the peer group also benefited overallfrom more favorable basis differentials in the quarter, [Antero] is the onlycompany to date that has reported a premium (albeit tiny $0.01/mcf)differential. With the recent cancellation/delay in the Northeast Energy Directand Constitution pipelines, we are reminded of the importance of flexiblepipeline takeaway to an E&P's long-term growth ambitions."