Tucked between the rolling hills in the countryside of southern Pennsylvania, a host of service providers with some dozen companies scurries around the #5H and #7H Cardine wellsites atop a flattened rise in Fayette County. Gray clouds and a cool mist envelope the location, and puddles from the previous day's rains spot a protective layer of black tarp. A tangle of lines litters the ground amidst tightly parked pumper trucks and equipment, terminating at two towering wellheads.

Operator Atlas Energy Inc. is preparing to hydraulically fracture the heels of the 3,000-foot laterals landed in Appalachia's gas-rich Marcellus shale. Both toes between 10,000 and 12,000 feet had been fractured earlier, a method predicated by the amount of recycled water held in the nearby frac pond. Today, the completions crew is perforating the wellbores to stimulate the next stages. Its charge spent, a wireline truck hoists out a perforating gun; another waits to be hooked up.

The two Atlas wells are a micro set of the 1,720 horizontal drilling permits issued in Pennsylvania from January through August this year, up 21% from 2009 levels. This ramp-up in activity is in spite of soft natural gas prices that are sending E&Ps on a nationwide hunt to add oil and natural gas liquids to their portfolios. It is also in spite of regional challenges with logistics, infrastructure, environmental concerns and service availability.

The Marcellus has received its share of hype and hoopla during the past couple of years. Grandiose predictions claimed it was one of the world's largest gas fields and that it yielded the best margins in North America. Now that more operators are deeper into development, have they found that the Marcellus is really that good?

Yes, they have. Following a bus tour visiting Marcellus operators in August, KeyBanc Capital Markets analyst Jack Aydin concluded that drilling in Appalachia will continue despite lower gas prices. "A clear message came out of our meetings," Aydin reported, "and that is the Marcellus shale generates strong returns at prices below $4 per MMbtu. Thus, we would not look for the Marcellus shale players to reduce capex because of currently depressed natural gas prices."

As such, he expects continued strong production growth from the basin, which he estimates is now above 1 billion cubic feet (Bcf) per day.

And while suppressed gas prices are squeezing margins in other basins, Seneca Resources Corp. president Matt Cabell confirms why operators in the Marcellus are drilling full speed ahead: "Our economics are still very strong at $4 gas. Given that, we don't really have any reason to slow it down."

Prices be damned; Marcellus operators are licensed to drill.

Best Economics

"I have yet to hear anyone say they're scaling back," says Ray Deacon, senior research analyst with Pritchard Capital Partners. "Every company I talk with says this is the most economical play they've ever been in."

The numbers prove it out. The southwest wet-gas region appears to have the most attractive economics, per Deacon's analysis, generating an internal rate of return (IRR) of 47%, 63% and 79% at $4, $5 and $6 gas, respectively. That is followed by the northeastern dry-gas wells with a 35%, 55% and 76% IRR, respectively, and then 25%, 40% and 57% for southwest dry gas.

"As far as gas plays, the only one that even comes close is the Eagle Ford shale condensate play."

Averaged across the Marcellus, Deacon shows economics working down to $3 gas for a 20% IRR, and notes some companies have said they would drill down to $2.50.

In addition, joint ventures (JVs) featuring lucrative drilling carries are keeping Marcellus-bound drill bits churning. Operators bolstered by drill carries sport a two-to-one finding and developing (F&D) cost advantage. "They definitely change the landscape. If your IRR is 177% at $4 gas, as some claim, why would you stop drilling?"

In September, Pennsylvania's Department of Environmental Protection released for the first time production data from 700 horizontal and vertical Marcellus wells. The data show that Susquehanna County has yielded wells with the highest initial potential (IP) rates, followed by Lycoming and Bradford counties. All are hot spots for permitting.

Superior economics and eagerness to shoot up the learning curve have shifted Marcellus operators into overdrive. Deacon anticipates the rig count in the play will double to about 200 by year-end 2011.

nd where might Marcellus companies rig up? Susquehanna County stands atop the competition with "extremely good" geology: thick, naturally fractured Marcellus with favorable permeability and porosity. Nearby Bradford and Tioga counties follow closely behind. Greene and Fayette counties "look very good," says Deacon, as well as Washington County. In these regions most companies are modeling economics on average estimated ultimate recoveries (EURs) of 4- to 5 Bcfe per well.

In fact, Deacon extrapolates that the play's core could actually be in Greene County in the southwest, where EQT Corp. has drilled several wells with average 30-day rates of 14- to 15 million per day and estimated EURs of 8.8 Bcfe. Buzz is circulating around possible big wells coming online in Clearfield County, but no data are yet available.

Furthermore, Chesapeake Energy Corp. has picked up horizontal permitting activity in Sullivan and Wyoming counties. "Considering that both lie south of Bradford and Susquehanna, results could be promising," states Deacon.

Once drilling to hold acreage in the Haynes­ville shale abates, and once gas prices trend up, Deacon believes the Marcellus takes the lead. "The Marcellus is much more resilient down to lower prices and will take market share from other places. The Marcellus will become the big driver of production growth in the U.S."

Wet-Gas Mojo

Labeling Range Resources Corp. the Old Man of the Marcellus might be ignoring the long history of oil and gas drilling in Appalachia, but the company does boast first-mover status in the play. It cracked the code for economic horizontal drilling in 2007, and opened the gates for many more opportunistic shale diggers to follow.

The Fort Worth, Texas-based company holds some 900,000 net acres in two known sweet spots of the play: 600,000 acres in the wet-gas region in southwestern Pennsylvania, and another 300,000 acres in the prolific dry-gas area of the northeast.

President and chief operating officer Jeff Ventura estimates Range's position carries resource potential of 20- to 27 trillion cubic feet equivalent (Tcfe) of gas, adjusted up from its 15 to 22 Tcfe estimate a year ago.

"Given all the additional drilling Range has done as well as other companies, it looks like the probability of our acreage being prospective is significantly higher today than it was this time last year. In fact, because almost all of our acreage is in Pennsylvania, it's almost all highly prospective."

In the scope of the entire Marcellus it's not a big area, but the narrow wet-gas slice in Pennsylvania's southwestern corner and the northwestern counties of West Virginia provides an economic premium. Range is pleased to emphasize that it holds a dominant position in the wet spot and its best-of-class economics.

On 95 producing wells, its EURs have jumped from 4.4 Bcfe to 5 Bcfe, raising returns on investment from 50% to 79% (based on $5 gas). Yields are 3.6 Bcf of gas and 239,000 barrels of liquids. At the same time, Ventura calculates well costs have upticked by about $500,000 to $4 million, reflecting extended completions. Since 2009, laterals have lengthened from 2,500 to 3,050 feet, with 10-stage fracture stimulations versus eight before. Plans are for even longer laterals up to 5,000 feet and 17 frac stages.

"We've made significant improvements in terms of EURs," he says. "Even though the wells cost more, the rates of return are better. Given where oil and gas prices are today, that liquids component is significant in terms of affecting our economics."

With net Marcellus production approaching nearly 200 million cubic feet equivalent per day, all flowing from its southwestern position, the company is now turning its attention to its northeastern properties in Lycoming, Clinton and Centre counties. Ventura notes Range has drilled its best vertical wells in Lycoming County, and its first two horizontal wells there flowed at 13.3- and 13.6 million per day, respectively.

"We drilled two great wells on our first two tries."

Range has signed a deal to gather gas in its northeastern area, and expects to have production online as soon as year-end. "Next year you'll see us do some drilling in those other counties." Range currently has one rig working in this part of the play.

Farther to the northeast, Range has merged its 14,000 acres in Bradford County with neighbor Talisman Energy Inc. Range will hold a 30% nonoperated position, and the deal will leverage the Calgary-based company's rigs, expertise and pipeline taps. "That's their backyard, not ours," says Ventura. "It's a more efficient way to develop that acreage as they dominate that area." The first JV wells are expected to spud by year-end.

Range models a 60% IRR based on $4 gas, and 100% at $6. The company has bolstered its 2010 capital budget with an additional $210 million pumped into the play, and it plans to drill 18 more wells this year. But in doing so the company exceeds cash flow by $400 million, according to analyst estimates.

"We feel that given the economics we have in the Marcellus, it makes a lot of sense for us to continue to drill," Ventura says. "We're getting a strong rate of return even fully loaded."

Ultra's Best Interests

For Ultra Petroleum Corp. chief executive Mike Watford, the mission is simple: "It's all about opportunities and making money." For the past few years the Houston-based explorer, known as the industry's low-F&D cost leader, has focused those attentions on its prolific and repeatable Pinedale Anticline tight-gas assets in Wyoming. Now, add the Marcellus.

"The return opportunity we have there equals what we have in the Pinedale and may exceed it because of better relative gas prices," he says. "And I think the resource is probably bigger than people anticipated a year ago."

Ultra entered the play in 2005 with an eye on the deeper Trenton and Black River formations, but recognized the Marcellus shale opportunity. It began horizontal drilling in 2009 and now has about one year of production history.

Most of Ultra's 255,000-net-acre Marcellus position—about 80%—is nonoperated, opposite its experience in the Pinedale. And that's okay with Watford. "It's not about ownership; it's about developing the inventory and growing the company."

Ultra saw more opportunity in nonoperated positions in Potter and Tioga counties in a partnership with privately held East Resources Inc., recently acquired by Royal Dutch Shell. Ultra then partnered with Anadarko Petroleum Corp. on 80,000 net acres of largely held-by-production leases in Clinton and Centre counties.

Ultra's current wells feature 4,000-foot laterals with 10 to 12 frac stages. Newer wells will reach 6,000 feet heel-to-toe. "The longer you go the better it's getting, and more frac stages are better than fewer," says Watford.

Already, the company's 3.75-Bcf EUR type curve appears to be conservative. Ultra's most recent seven wells have averaged 8 million per day—with a couple close to 12 million per day—and have flatter decline rates than anticipated.

Spacing, too, is tightening. Following two microseismic projects, Ultra determined that 100-acre spacing is too large and now assumes 80 acres. "We need to reduce it to recover all the resources, which means ultimately we'll recover more resources and drill more wells."

Ultra is continuing a single-rig program as it focuses on holding leasehold and derisking acreage. "We're in exploration mode," says Watford. "We're still trying to figure out what we have." Excluding the most recent Anadarko acquisition, up to 80% of Ultra's activity and half of its capital budget are directed to tying up leases. That need should abate in mid-2011.

atford sports high aspirations for the company's new and largely untested position in what he dubs the "C" counties—Clinton, Clearfield and Centre. With only a handful of wells completed there, early results show the Marcellus is deeper, more pressured and features better geology there. Restricted flow rates are averaging 7 million per day.

"Our results in the newly acquired acreage are confirming our view that the resource will be more prolific in this area. We're seeing better recoveries of gas, we're seeing larger-reserve wells, and we expect them to exceed results in the northernmost counties," he says.

The company is pushing forward with development. "Even at today's gas prices in the Marcellus, we have outstanding returns," says Watford, of about 30%. "We have so much headroom for making money, it just makes sense for us to accelerate development."

Ultra's 2011 capital spending is projected to exceed this year's $440 million as well as cash flow. Might a JV be in the offing? "We see joint ventures as similar to selling equity. Our plan is not to sell equity or do a joint venture." Debt funding will be the first option, he says.

With an estimated 8 Tcf net resource potential and $10 billion projected for future development capital for 2,300 net wells, Ultra has room to run.

"The returns in the Marcellus are going to be better than the Haynesville, Fayetteville and others," says Watford. "That's why we're there."

Size Matters

In late September, Seneca Resources Corp. completed a seven-well, 84-stage zipper frac in Tioga County in northern Pennsylvania, just in time to allow it to exceed its fiscal year-end production target of 40 million cubic feet equivalent per day. Most of the company's drilling program uses such multiwell pad drilling, a luxury afforded by having an enormous acreage position unencumbered by leasehold obligations.

"We're in a little bit different spot than most of our competitors that have a strategy that requires them to drill to hold acreage," says Matt Cabell, president of Seneca, the Houston-based E&P subsidiary of National Fuel Gas Co.

With one of the largest land positions in the Marcellus, Seneca's 740,000 acres in the fairway are almost all fee mineral, held for decades. "Because of our large, blocky position and lack of expiring leasehold, we're able to focus on an area we want to develop and pad drill all of it. A lot of companies are running rigs all over the state trying to hold acreage."

Most of the Houston-based company's production to date comes from Tioga, a 15,000-acre offshoot northeast of its core holdings. Here, one-week IP rates average 7.5 million per day. That equates to a 5-Bcf EUR per well and a 43% rate of return at $4 gas. In nearby Lycoming County, its most recent well came in at 15.8 million on a 24-hour rate. And as with Ultra, Seneca is finding decline rates for these wells flatter than the type curves.

"We expected it to be very good," Cabell says, "but it's proven to be even better than expected."

And while its northeastern position has proven particularly attractive, Cabell is quick to point to the opportunity in Seneca's holdings in nine north-central Pennsylvania counties. These are focused around Elk and include McKean, Clearfield and Forest, where the company has spent the past year derisking acreage. Thus far IP rates are 2- to 4 million per day, and Cabell thinks 4 million will be the base once completion techniques are honed.

To that end, the company is pushing laterals to 5,500 feet and plans to land them lower in the Marcellus zone, with up to 15 frac stages. Thus far, IP rates and EURs are "nearly linear" to lateral length.

"We're finding that virtually everywhere we've drilled, we can say we will have commercial development opportunities." Lack of infrastructure has slowed production out of this north-central region, however, with certain wells completed but not yet hooked up.

Cabell doesn't believe E&P neighbors farther south hold special advantage. "I expect results in our legacy acreage to be similar to what we see south of us," he says. In the north-central play, Seneca is a nonoperating partner with EOG Resources Inc. in 320,000 gross acres. In September, the first well in Clearfield County completed with larger 5.5-inch casing and higher pump rates for its fracture stimulation flowed at almost 9 million a day. "This confirms our expectations for high-rate wells."

Based on EURs of 3 Bcf per well, and fee minerals with no royalties, the rate of return is 22% at $4 gas. It's a green light to drill at will, he says. "And we hope to do better than 3 Bcf per well." To further its development, Seneca has engaged Jefferies & Co. Inc. to help it find a JV partner.

Cabell estimates Seneca has upside of some 6,000 drilling locations at approximately 120-acre spacing. The company recently went to four operated rigs, three of which are focused on the northeastern counties. It will add another to the north-central counties in the spring. A year ago Seneca had virtually no Marcellus production; it plans to exit fiscal 2011 with better than 100 million per day.

So is the Marcellus living up to its hype?

"It's exceeding it," Cabell emphasizes. "These are such great wells. They're coming on at higher rates than we expected, and they're declining more slowly than we expected. We don't need a turnaround in gas prices for this to still be a great opportunity for us."

Work in Progress

When Pittsburgh-based coal and natural gas producer Consol Energy Inc. acquired Appalachian E&P Dominion Resources Inc. earlier this year, it leapfrogged its way up the league tables to the third-largest acreage holder in the Marcellus. Its 750,000-acre footprint is concentrated from central Pennsylvania to northern West Virginia. And, the block is almost entirely held by production, a distinct competitive advantage, says Nick DeIuliis, Consol chief operating officer.

"If gas prices stay low, we don't have to drill to hold acreage."

That advantage was the single largest driver motivating the Dominion acquisition, because it gave the company flexibility to control its drilling program and capex. Flexibility could also be critical if regulations or permitting delays affect drill times, which DeIuliis foresees as a real possibility. "We can afford to simply dial down development without putting those acres at risk."

For Consol, a company that excels at long-wall coal mining and processing and coalbed-methane production, the addition of the Dominion assets overlaying and surrounding its acreage created compelling synergies. DeIuliis says the addition is a long-term bet on natural gas, and sees coal and gas as a natural fit. And with discussion of carbon legislation lingering, "One gives you a hedge in terms of the other."

By early October Consol had drilled 20 horizontal Marcellus wells, all within Greene County in the dry-gas region. While results are being held close to the vest pending third-quarter earnings, calculated EURs from five wells earlier in the summer fell between 5.5 and 9.9 Bcf each, on average laterals of 2,200 feet. "On a per-lateral-foot basis, we feel we have the best production results in the industry," he states. Since then Consol has pushed out laterals to 3,800 feet and perforated about 12 stages per well.

The company plans to keep two rigs operating in southwestern Pennsylvania and in the West Virginia panhandle. It has deployed another to target Westmoreland and Indiana counties, and a fourth rig will begin delineating acreage in northern West Virginia by year-end. By 2013, Consol projects 10 rigs drilling 170 wells annually.

DeIuliis has high expectations for these new areas. He bases his anticipation on well-log data and from vertical well results by third parties. The logs look "just as prolific" as in Greene County. "We are as excited—if not slightly more excited—for these prospects as we are for Greene County. Within a couple of months we'll know for sure."

Including a full year of production from the Dominion acquisition, Consol will exit 2010 with about 140 Bcfe of annual production. That volume is anticipated to more than double by 2015 to 350 Bcfe, thanks mainly to the Marcellus.

The Marcellus is a resilient opportunity as a function of gas prices, he says. In a lower-price environment like now, "you want to slow down a bit and focus on delineation and perfecting your drilling technique—if you can. We can." Consol is utilizing an eight-well pad in Westmoreland County, a technique it plans to model going forward.

Though optimistic, DeIuliis cautions that development of the play is still an infant opportunity and a work in progress.

"People think of the Marcellus as a big dial: when gas prices go up, production will come on and dampen prices because supply can instantly meet demand. We're not there yet. It's not a simple dial that's ready to meet the ups and downs of gas demand. We don't have all this figured out yet."

Pushing Out

"The Marcellus shale is a substantial resource. We think it's one of the top three natural gas reserves in the world and we believe it's the lowest-cost source of natural gas in North America," says Rich Weber, president of Atlas Energy Inc. "It makes all the sense in the world, especially in this new age of low natural gas prices, to be focusing on the Marcellus shale."

Formerly a master limited partnership targeting long-lived Appalachia production, Atlas found itself sitting on 86,000 acres of world-class gas reserves with the discovery of the Marcellus. Once it determined the play to be economically viable, it built a footprint of 340,000 acres largely in southwestern Pennsylvania. It then changed its MLP stripes into a C-Corp to plow cash back into reserves.

At present the Pittsburgh-based company operates two horizontal rigs in southern Pennsylvania, where IP rates are averaging 4- to 6 million per day. Weber estimates EURs at 6 Bcfe, but emphasizes it's too early to declare that as "absolute" fact. However, he notes with optimism, "we have exceeded our type curve estimates over the last nine months."

Recent well results in Greene County, including an EQT Corp. completion at 24 million per day, have some portending this bottom-left county in Pennsylvania to be the epicenter of the southern core of the play. Weber, though, doesn't see the limits so narrowly. Specifically, he sees the southern core "at least" as including surrounding Washington, Fayette and Westmoreland counties. His opinion is influenced by Atlas' recent 21-million-per-day IP well in Westmoreland. "We believe this is one of the best wells drilled in the Marcellus shale."

Beyond those counties, Weber points to Armstrong, Indiana and Butler in north-central Pennsylvania as a developing core. He references again EQT, which released a 15-million-per-day well in Armstrong in late September.

He is quick to note the variability of the play across these regions, however, and that what works in Greene County may not work the same way in other counties. "That's something we've proven to ourselves."

Better completion techniques are pushing out the boundaries of the core, he says. In the dry-gas area of southwestern Pennsylvania, "there's no question the hottest part of the shale is in the lowest zone of the Marcellus. We're getting much stronger results from laterals landed low." Atlas continues pushing out lateral lengths as well, now typically reaching 4,000 to 5,000 feet. It has not yet reached a point of diminishing returns.

"If we can lengthen what is the lowest-cost part of our wellbore and continue to get solid returns, we're going to do that all day long," he says.

The most inhibiting factor to lateral length is not technology, but leasehold configuration. In Pennsylvania, pooling of drilling units is voluntary, so often laterals are limited by fence lines. Atlas supports a compulsory lease-pooling law that would both improve returns and result in less surface disturbance, says Weber.

As a result of a cash-rich JV with India's Reliance Industries Ltd., Atlas has its sights on a 300-well-per-year program by 2013. Total capital investment will be some $4 billion. The company is adding a third rig by year-end, and will ramp up to six by year-end 2011. As part of the JV carry, Atlas will pay 15% of each well for a 60% working interest.

"Our capital expenditures over the next five years will be very modest given the amount of production growth we're going to see." Even ignoring the financial effects of the JV, "at $4 gas we're looking at a 30% rate of return. Take into account the drilling carry and it's near 100%."

While just half of Atlas' acreage is held by production, Weber emphasizes the company is in full development mode and is not trying to hold land with its horizontal program. Instead, it is drilling shallow Upper Devonian wells and relying on lease renewals to hold expiring acreage.

"We're focused on the most efficient development of our horizontal Marcellus program."

Nonetheless, Atlas found its development stymied in second-half 2009 when its burgeoning Marcellus production overwhelmed its legacy gathering system. It had to move its rigs to areas with take-away capacity. Since, Atlas Energy's affiliated midstream enterprise, Atlas Pipeline Partners LP, has sold its gathering lines into a 49% nonoperated partnership with The Williams Cos., named Laurel Mountain Midstream LLC, which is spending $1 billion over five years to build out the system. New capacity will become available by year-end, and significantly more by midyear 2011.

"It's been a frustrating process. Once we start producing into this header system, we will see exponential growth in our production. That will be a great day," Weber says.

It's too early to determine if southwestern Pennsylvania will prove better geologically than the prolific northeastern counties, he says, but it has logistic advantages in established infrastructure, pipeline capacity and a populace that is familiar with and comfortable with the industry.

Overall, the Marcellus opportunity is exceeding expectations, he confirms. "A few years ago we would never have dreamed of the rates of production we're getting out of these wells—and at the finding costs that we're realizing. There's no question in my mind that this is the lowest-cost source of natural gas in North America."