It is phase-shift time for the Marcellus shale. Like the Eagle Ford, Fayetteville and Haynesville shales before it, the play is rapidly evolving, from delineation and optimization into a resource harvest phase.

And Marcellus operators are adjusting to the region’s fluid economic and regulatory conditions, according to a panel of two long-time Appalachian Basin operators and a recent E&P start-up. Representatives of the three firms shared perspectives during Hart Energy’s fourth annual DUG East Conference and Exhibition in Pittsburgh in mid-November.

The panelists included Steven Schlotterbeck, senior vice president for exploration and production at EQT Corp.; Greg Muse, president and chief operating officer for start-up PennEnergy Resources LLC; and Dewey Gerdom Jr., chief executive of PDC Mountaineer Inc., a subsidiary of PDC Energy Inc. Both EQT and PDC Mountaineer have lengthy experience in Appalachia—more than a century for EQT, and slightly more than four decades for PDC.

The backdrop for the DUG East conference included a national environment of depressed natural gas prices. Despite that overhang, which has produced a 50% reduction in the gas-directed rig count domestically over the last year, natural gas production is rising in the Marcellus. Several conference presenters pegged output at 8.5 billion cubic feet per day, or a production volume roughly equivalent to the combined output of the Barnett and Fayetteville shales at their peak.

In fact, rising production in the Marcellus has offset natural gas production declines elsewhere, including in the Gulf of Mexico, with the result that U.S. gas production continues to rise both month to month and on a year-over-year basis—despite the decline in gas-directed drilling. Consequently, soft gas prices have led to overcapacity in the oil services sector, and that is helping operators in a tough commodity price environment.

EQT's Steve Schlotterbeck, senior vice president for exploration and production, says one of the few benefits of lower gas prices is the drop in service prices.

“We’ve all seen service prices come down, that’s one of the few benefits of lower gas prices,” EQT’s Steve Schlotterbeck said. Low gas prices are prompting EQT to embrace efforts to improve efficiency. “We are focusing where we drill on the best economic areas and continually working on process to get our efficiencies up. We’re trying to get more frac stages per month, and trying to drill more feet per day.”

PennEnergy’s Greg Muse said low gas prices had not yet been an issue, because the company is a start-up. The company began as a two-person team a little over a year ago, acquired funding from oil and gas private-equity specialist EnCap Investments LP, and is now adding wet-gas acreage to balance its dry-gas portfolio. At press time, PennEnergy was in the process of finalizing a 35,000-acre acquisition in Pennsylvania’s Butler and Armstrong counties.

“We’re developers and that is our background,” Muse said. The PennEnergy chief operating officer previously worked for Marathon Oil and in the Appalachian Basin for Atlas Resources Inc. Chevron Corp. acquired the latter in January 2011 for $3.1 billion in cash and assumed more than a billion dollars in Atlas debt. “We are willing to identify low-risk acreage, pay market price for it, and build a quality experienced operating team to convert that acreage into proven reserves,” he said.

Low gas prices inadvertently assisted the start-up’s strategy. With first production anticipated by the end of 2013, PennEnergy is working on contracts with service providers and anticipating that natural gas will be better priced by the time the company brings new gas to market.

The panelists addressed how the Marcellus presents a unique set of conditions not found in other domestic markets. Regional operators, for example, go head to head with the majors, which have invested more than $12 billion in

Appalachia over the past three years (more than in any other area of the country), and international oil companies, which are participating in the Marcellus and Utica shales via joint ventures with domestic independents.

In fact, the Marcellus joint venture total, at $17 billion, tops all other regions and accounts for 39% of announced JV transaction value over the past four years. At first glance, Appalachia would seem to be a crowded market for public independents competing against deeper-pocketed international firms.

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Greg Muse, president and chief operating officer of startup PennEnergy Resources LLC, says the company is adding wet-gas acreage to balance its dry-gas portfolio.

But PDC Mountaineer’s Dewey Gerdom said that’s not the case.

“I started my career with Chevron,” he noted. “It’s a great company. But the advantage of being small is you are much more nimble. Half of my team I can meet walking down the hall. We make decisions much faster, and we have the extreme advantage of having existing relationships. PDC Energy started in the Appalachian Basin in 1969, so that name has been a mainstay in the industry from a local standpoint. We maintain a great relationship in our community and people would rather lease with us than lease with other companies. It’s a big advantage.”

EQT’s Steve Schlotterbeck agrees. With more than a century working in the Appalachian Basin, EQT had established long-term relationships with service providers. While the majors or joint-venture operations may provide larger business volume to service providers, EQT offers the assurance of sustained work over the long haul.

“Another advantage of having the larger companies come into the basin is, yes, they might get first call on services, but more services are attracted to Appalachia when Shell is here, Chevron is here and ExxonMobil is here. Service providers that maybe wouldn’t have come to the Northeast are here now and that is good for all of us,” he said.

The Marcellus shale is large enough to support a full industry spectrum, from small start-ups to the supermajors. “That is one of the beauties of the shale plays,” Schlotterbeck said. “They are large and everyone can find their niche. The niche for small companies has been technology. Small companies have been nimble enough, been entrepreneurial enough, to be leaders in technology, and that is good for everybody.”

While the majors or large joint ventures have formidable balance sheets with which to compete, they also provide an industrywide benefit.

“One of the big advantages to the majors is they bring best practices,” Schlotterbeck said. “Small and medium-sized companies are maybe not quite up to speed on the best way to build a pad or a pit to minimize the impact on the environment. Clearly, that is a big, big plus.”

Perhaps the most significant factor separating Appalachian oil and gas from the rest of the U.S. is its rigorous and fluid environment for regulatory and community relations, in a region where tight-formation oil and gas is an economic newcomer.

Dewey Gerdom Jr., chief executive of PDC Mountaineer Inc., says the company benefits from the longtime presence of its parent, PDC Energy Inc., in the Appalachian Basin.

The solutions that oil and gas companies develop in the Marcellus in dealing with regulatory, environmental and community relations issues will ultimately influence how the industry operates elsewhere, whether the issue is water handling and disposal or community outreach.

“I’ve worked a dozen or more states over my career and every state has its own rules, its own regulations,” PennEnergy’s Muse said. “You simply need to work with the regulators to understand—and hopefully anticipate—that change is coming down the road. Compliance is not an option; it is an expectation of the regulators. It is an expectation of the communities and, frankly, it’s an expectation of our company.”

Muse said the biggest challenge in Pennsylvania is rules and regulations are changing so quickly that it is difficult for operators and regulators to understand what is necessary for best practices.

“We continue to get different answers from different offices and different individuals,” he said. “It is what it is. We are trying to work alongside to communicate, educate, and learn what the new expectations are. That’s the lay of the land.”

In West Virginia, the issues are similar, according to PDC Mountaineer’s Gerdom.

“West Virginia is a very friendly state for oil and gas, but they are also looking over the border and trying to figure out what they need to do from a best-practices standpoint,” he said.

“The best practices we did three years ago didn’t apply six months after that. Best practices from six months ago don’t even apply any more. It affects us from a land standpoint. We could plan and pick locations, follow all the rules and stay within compliance, and that was a 120-day process from the planning stage to building a location. That process is now a full year.”

Recent legislative changes in West Virginia have created new rules for wetlands, though neither regulators nor operators have had time to develop an understanding of how those rules should be implemented. Gerdom anticipates additional rules applying to air quality are imminent, along with expanded regulations on wastewater and fluid disposal.

“As an industry, we have obligations to educate and carry on the best we can and continue to do best practices,” he said. “The independents used to be able to, maybe, not do it quite as well and get away with it. My message to every independent is, ‘that boat don’t float anymore.’ Any time we have something bad, no matter who does it, it affects everyone in this room.”