The development of the Marcellus Shale is only just starting as this play offers superior returns, and is large enough that almost every operator can get a piece. The industry can also choose from a number of other oil and gas shale formations present in the same area. (For additional reading, check out A Guide To Investing In Oil Markets.)
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Although many operators are rushing to develop crude oil plays in pursuit of higher returns, some wet gas plays have rates of return that are competitive with and even better than returns generated from the development of crude oil plays.
The Goldman Sachs Group (NYSE:GS) estimates that the wells drilled into the Marcellus Shale in southwestern Pennsylvania have some of the lowest breakeven costs in the domestic onshore space. The company estimates that a NYMEX natural gas price of $2.00 per one million British thermal units (MMBtu) is required to earn a 12% internal rate of return.
Range Resources (NYSE:RRC) is one of the largest players here, and estimates that a price of $6.00 per MMBtu would boost that return to 134% on an average well. (Find out how to invest and protect your investments in this slippery sector. For more, see What Determines Oil Prices?)
Other Shale Formations
While the Marcellus Shale has garnered the most publicity in the areas where the industry is drilling, this play is not the only shale formation present in Pennsylvania and West Virginia. Much of the Marcellus acreage also contains several Upper Devonian shale formations including the Rhinestreet, Middlesex, Genessee and Burkett plays.
The industry has started testing this acreage and reported some positive results. Rex Energy (Nasdaq:REXX) recently drilled and completed an Upper Devonian Shale well in Pennsylvania, and reported an average production rate of 3 million cubic feet of natural gas per day during the first five days of production. The company was encouraged enough by the results that it has added additional Upper Devonian wells into its 2012 capital program.
Range Resources has also drilled two test wells into the Upper Devonian shale and plans an additional test well in 2012. The company estimates that the Upper Devonian Shale on its properties contains between 10 and 14 trillion cubic feet equivalent of potential resources.
Although most investors know that the Marcellus Shale is present on a large area and spreads across parts of at least six states, the true scale of this resource play is sometimes not fully realized.
The immensity of this play can be better understood by looking at the long-term development plans of some of the largest operator's active in the Marcellus Shale. Chesapeake Energy (NYSE:CHK) and Statoil ASA (NYSE:STO) are involved in a joint venture to develop the Marcellus Shale, and estimate that the joint venture may drill up to 17,000 wells into the Marcellus Shale over the next 20 years.
One industry consultant estimates that pipeline capacity will increase to 8.5 billion cubic feet (Mcf) per day by 2013, up from current levels of 3.5 Mcf per day. Total dry gas production from the Northeastern United States is expected to reach 12 Mcf per day by 2016.
The Bottom Line
The Marcellus Shale is now a household word in millions of homes across the Northeastern United States as domestic oil and gas drilling continues to boom in this region. This development is likely to continue for at least a generation due to the economics of the play, and the large footprint of this and other oil and gas formations. (To know more about oil and gas, read Oil And Gas Industry Primer.)
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At the time of writing, Eric Fox did not own shares in any of the companies mentioned in this article.