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Is This Shale Oil and Gas Play Overhyped?

Wednesday - 3/27/2013, 12:00pm  ET

A couple of years ago, Chesapeake Energy's outgoing CEO Aubrey McClendon touted the Utica Shale as "the biggest thing to hit Ohio since the plow." In mid-2011, he even went so far as to claim that the 1.3 million acres of Utica property that Chesapeake had leased contained hydrocarbons worth roughly $20 billion.  

But since that time, McClendon has scaled back his expectations about the Utica's oil potential substantially, as have executives at some other major companies operating in the play. This waning optimism, fueled by wells that yielded far less oil than initially expected, has led some commentators to question whether or not the play will live up to its initial hype.

As Utica drillers continue to derisk their acreage, will they stumble upon huge reserves of oil? Or will the Utica's initial comparison to Texas' prolific Eagle Ford prove overblown? Let's take a look.

Any black gold? Or just a lot of gas?
To be sure, the Utica has yielded impressive quantities of dry gas and natural gas liquids thus far. But skeptics are worried that the play's proportion of oil to natural gas and related liquids may end up being disappointingly low.

For instance, in the second quarter of last year, Devon Energy reported disappointing results from two wells it drilled in the oilier portion of the play. Arousing further suspicion that Devon may be giving up on the play, the company recently announced that it was looking to divest its Utica assets. In January, it placed some 244,000 of its gross acres (195,000 net) in the liquids-rich portion of the Utica in eastern Ohio up for bidding.

Yet while Devon's retrenchment is discouraging, some operators' results give reason for hope and suggest that some portions of the Utica may be brimming with oil. For instance, Gulfport Energy reported that its first 10 Utica wells averaged a peak rate of nearly 800 barrels of oil per day, plus 10 million cubic feet of natural gas and nearly 1,200 barrels of natural gas liquids.

At any rate, it's tough to make a call on the Utica right now since the play is still very much in its infant stages and relatively very little is known about its various zones' geologies and productive potentials. Drilling thus far has been of the experimental kind, as producers seek to get a better understanding of their acreage.

Contributing to the paucity of information about the play is Ohio's lack of transparency in releasing data on oil and gas wells drilled in the state. As a Reuters analysis highlighted, Ohio state regulators only require Utica operators to disclose production statistics on an annual basis. In contrast, most other states publicly disclose production statistics and drilling data on a monthly basis.

Has the Utica's oil potential been overstated?
The lack of data is compounding some investors' fears that the Utica may turn out to be a flop. Even Chesapeake, the first company to charge confidently ahead into the Utica, recently announced that it no longer views the play as central to its oil production growth.

Initially, the company was unabashedly optimistic about the play's oil potential, even announcing in May of last year its plans to ramp up drilling activity significantly in the play's oilier portions. But in subsequent presentations and SEC filings, it has completely de-emphasized oil drilling in the Utica, instead reverting its stated focus toward drilling in the play's wet gas and dry gas windows.

While only time will tell what the Utica's potential will actually be, the wide variation in different producers' well results suggests that the location of acreage will be crucial in determining the proportions of oil to natural gas and natural gas liquids. For instance, consider the fate of different operators in another highly publicized shale play – the Marcellus.

Marcellus shows that acreage location matters big time
With the domestic glut of natural gas having driven prices far below historical norms, producers operating in the Marcellus wet-gas window are faring relatively well, while rigs operating in the dry gas portions of the play have all but disappeared.

For instance, Range Resources is planning on directing roughly 80% of its $1.3 billion capital budget toward drilling operations in the Marcellus. This is mainly because the company is aptly positioned in the wet-gas window of the play, which allows it to realize higher profit margins for its natural gas liquids production.

Meanwhile, EXCO Resources has slashed its rig count from four to one and is heavily downsizing its regional headquarters. Similarly, Talisman Energy , which also currently only has one rig running in the play, has reduced its capital allocation to the Marcellus by 65% and instead diverted its focus to the oilier Eagle Ford Shale in Texas.

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