Marcellus Madness

When major oil company Royal Dutch Shell snapped up private-equity-backed and Marcellus shale-focused East Resources Inc. for $4.7 billion, the acquisition accented a spate of M&A activity in the Appalachian resource play during first-half 2010, marking the next phase of its development and establishing solid price metrics. The deal is the largest transaction in the Marcellus shale to date.

“The Marcellus has become the king of the gas shales,” says Bill Marko, managing director for Houston-based advisory firm Jefferies & Co. Inc. “The deal flow should pick up as more gets developed, and there is much more that needs to be developed. It’s going to build on itself.”

Through May, some $13.4 billion of transactions have been executed in the Marcellus, covering 2.1 million net acres and generating an average of $6,317 per acre, according to analysts at Global Hunter Securities LLC. However, the values range from just under $2,000 per acre to just over $17,000 per acre, due largely to location, deal structure, and if the acreage has been de-risked.

Analysts at Tudor, Pickering, Holt & Co. estimate overall Marcellus year-to-date average metrics are approximately $8,200 per acre with a range of $3,000 to $14,000 per acre.

“Supply is catching up with the remaining demand for positions in the Marcellus,” says Grey Pipkin, managing director of investment banking, Barclays Capital.

Greg Pipkin, managing director of investment banking for Barclays Capital, says Shell’s acquisition adds validity to the play. “They think there is a lot of running room to develop a substantial resource.”

Marcellus Metrics

Shell’s acquisition of East marked the major’s entry into the basin, adding to its shale-gas positions in the Eagle Ford and Haynesville shales and the Horn River Basin in Canada. East Resources is a 25-year-old Appalachian explorer with more than 1 million acres in the basin and 650,000 prospective for the Marcellus. Just one year ago the company received a cash infusion from private-equity provider Kohlberg Kravis Roberts & Co. to accelerate drilling. Analysts value the deal at $7,200 per acre.

The move by Shell underscores that “the big guys like U.S. gas and are paying strong prices,” the TPH analysts say, but they note the $5-billion price tag “doesn’t seem like a particularly big bite for a company of Shell’s size.” They expect more add-on acquisitions.

Other big ticket deals have come to the fore as well. Pittsburgh-based coal producer Consol Energy Inc. stoked up on an additional 500,000 acres in the play in a $3.5-billion asset deal from Dominion Resources Inc. as it strives to diversify into natural gas. Consol reported it paid $2,000 per acre after backing out proved reserves, but analysts put the price at $4,000 to $7,000 per acre when carving out Marcellus-only holdings.

There has been a flurry of high-value deals in the Marcellus shale of late.

Indian energy conglomerate Reliance Industries Ltd. drove its stake into North American shale gas with a $1.7-billion joint venture with Atlas Energy Inc. for 120,000 net acres. Most of the acquisition price is in the form of a drilling carry for a 40% interest which, when included, values the deal at $14,000 per acre, according to Pritchard Capital Partners LLC.

Likewise, Japan’s Mitsui & Co. Ltd. bought a piece of Anadarko Petroleum Inc.’s Marcellus holdings, a 32% interest for $1.4 billion. The deal metrics also equate to $14,000 per acre, estimates Jack Aydin, senior managing director with KeyBanc Capital Markets Inc.

British major BG Group Plc joined Dallas’ Exco Resources Inc. in a second joint venture, following its partnership in the Haynesville shale, for a piece of Marcellus pie. The $950-million combo involves a 50% stake in Exco’s 654,000 net acres, with 150,000 prospective for Marcellus. Aydin valued the deal at $10,800 per acre, which he viewed as an “excellent” price considering some 85% of the deal was in upfront cash.

And just a few days prior to the Shell announcement, privately held Alta Resources LLC, Houston, backed by private-equity firm Denham Capital Management LP, sold some 42,000 acres in northwestern Pennsylvania to Tulsa, Oklahoma-based Williams Co. Inc. for $501 million. The deal was valued at $11,929 per acre by Aydin.

Peak Supply?

Marko, whose company, Jefferies & Co., represented two of the sellers—East and Atlas Energy—says the sheer size of the play, combined with a host of small and tenured Appalachian producers with big acreage positions, has led to the rapid ramp-up in deal flow.

“The people we’ve seen come to the forefront are generally those with track records, with drilling results leading to better EURs (estimated ultimate recoveries). And those with the best acreage are the ones that have been selling. Companies don’t want to buy risky acreage at $2,000 per acre when they can buy quality acreage for $14,000 an acre.”

He describes existing Marcellus operators as “an interesting collection” of small-to-medium-sized private companies and small public companies; solid conventional Appalachian producers that were off the radar until the Marcellus hit the scene. “Now they wake up and they’ve got hundreds of thousands of acres (prospective for Marcellus). They’re continuously thinking about what to do with it and when to do it.”

Deal flow will continue toward the bigger and well-capitalized companies, says Barclay’s Pipkin. Pipkin advised on two recent Marcellus deals, representing Reliance and Dominion.“In this lower gas-price environment, you have to have substantial capital resources and a longer view about where we’re going to be with natural gas over a period of time. That sets up for bigger players instead of smaller.”

Yet while acreage prices have trended up significantly over the past 24 months, he believes they may have peaked.

“I don’t see values going significantly higher per acre given the number of transactions that have already occurred and the number of potential acreage deals, both JVs and outright sales, that are in the marketplace today. Supply is catching up with the remaining demand for positions in the Marcellus.”

He estimates about 10 companies holding upward of 50,000 acres remain in play to sell or to seek a joint-venture partner, flushed into the marketplace by the recent metrics.

But, “given the number of deals now in the marketplace, if they think they’re going to get higher prices than we’ve seen in the last three to four deals, they’re going to be disappointed. We could be hitting equilibrium,” Pipkin says.

Safest Bet

Though still in its early stages of development, the current transactional environment is setting up the large-scale development of the play. “We’re in the fifth inning of the first game,” suggests Marko.

The reservoir is huge, has the best location to the biggest gas market in the country, and is rising to the top of all shale plays as the lowest cost to develop. It features the lowest break-even price at $2.50 to $3 per Mcf, compared with $4 to $5 for other more mature shales.

“It’s the safest shale, even if you’re worried about low gas prices,” he says. “It will be the best place to be no matter what the gas price is, and it will be the place money flows to with weak gas prices.”

A year ago, says Marko, E&Ps were worried about being able to get rigs and well servicing, take-away capacity, water supply for fracs and disposal, and infrastructure, including roads and bridges to move rigs. Now, as the play has developed, people feel more comfortable regarding those issues and are solving problems.

“As long as we’re producing gas, the Marcellus is going to be some of the first gas that gets produced because it’s going to be some of the cheapest gas to produce. That’s why people like it the best: it’s the safest bet in a down market.”