Exploring The Utica Shale

By Arthur Pinkasovitch | March 11, 2011 AAA

With rising concerns regarding the crisis in Libya spreading to Algeria and major oil producers in the Middle East, joined by a shrinking Canadian trade surplus, a surprising $7.3 billion Chinese trade deficit and negative American unemployment data, investors are feeling the pinch of this week's market pullback. Among members of the Dow Jones, Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) experienced the largest drops as oil prices eased in light of the negative economic data. In fact, all of the Dow's components, except McDonalds (NYSE:MCD), fell into the red on Thursday.

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Environmental Assessment
In addition to these systematic risks, some energy companies are being excessively burdened with unexpected regulatory issues. Quebec, whose energy business environment is fraught with regulatory and political risk, has put an estimated 30-month hold on any subsequent drilling activities in the Utica Shale. As a result, Questerre Energy (TSE:QEC.TO), Junex Inc. (TSXV:JNX.V) and Gastem Inc. (TSXV:GMR.V) are down approximately 25% for the week.

The debate stems from environmental pressure groups who have raised concerns that hydraulic fracturing in the region can result in significant water contamination. As the provincial government and the Ministry of the Environment move forward with the environmental assessment, a strong buying opportunity exists for the players who will not abandon their Utica operations.

Oil and Gas Juniors
Although Questerre owns a diverse portfolio of Canadian land assets, the company holds over 1 million gross acres in the St. Lawrence Lowlands through a joint venture agreement with Talisman (NYSE:TLM). The land under this joint venture forms the largest contiguous strip in the region and has around 18 Tcf of recoverable reserves. The other major players, Junex and Gastem, hold 1.1 million and 415,000 gross acres, respectively. Junex's management states that Utica IP results are comparable to those of the more mature Marcellus and Montney shale formations. Talisman also recently reported a successful horizontal test well.

Despite the fact that Quebec has introduced regulator barriers for exploration companies, the province offers a major incentive for oil and gas firms; Quebec's natural gas extraction royalty is between 10% and 12.5%, about one-third the rate imposed in Alberta.

Exploring the Utica
The Utica Shale covers an extensive region of New York, Ohio, Pennsylvania, Ontario and Quebec and significantly overlaps the Marcellus Boundary. Depth is the major concern for drillers since the Utica Shale is around 2000 to 7000 feet below the Marcellus Shale. However, if drilling in the Utica is economically feasible, it has the potential of being the largest natural gas field discovered to date. The Marcellus is estimated to have over 250 Tcf of natural gas; the Utica is larger and thicker.

In Quebec, local fears about environmental damage have put a halt on well test and expansion programs. What originally started as an expected six-month delay is now projected to be an ongoing two-and-a-half-year debate. While many of the concerns regarding hydraulic fracturing possibly stem from the controversial Sundance prize winning film GasLand (see Debunking GasLand), a significant economic benefit may be realized if Quebec welcomes the natural gas industry. According to an independent study by SECOR, Utica exploration in Quebec could generate $278 million in revenue for the province and create 5000 additional jobs per year.

Bottom Line
Investors looking for beat down stocks with strong upside potential should consider researching Utica Shale operators. However, although Quebec's environmental assessment is likely to find a favorable resolution for natural gas developers, any major share price increases will not be realized in the short term. (For additional reading, see The Alberta Bakken.)

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