Dealmaking has been brisk in the Ohio portion of the Utica Shale, an emerging unconventional play that lies beneath the Marcellus Shale and is in the early stages of exploration and development.
Thus far, much of the information available on the field comes from Chesapeake Energy Corp (NYSE: CHK), which quietly began building a position in the play about a year and a half ago and had amassed about 1.36 million net acres at the end of the third quarter of 2011. The independent producer tipped its hand slightly in early November 2010, when the firm announced it had acquired 500,000 acres in the Appalachian Basin from the privately held Anschutz Corp for $850 million.
Since Chesapeake Energy’s July 29, 2011, conference call to discuss second-quarter earnings, the company has revealed that the Utica Shale consists of three zones: a dry-gas window that abuts Ohio’s eastern border with Pennsylvania; a wet-gas segment that includes substantial amounts of natural gas liquids (NGL); and an oil-laden portion to the west of the wet-gas segment.

Source: Chesapeake Energy Corp
During the conference call, Chesapeake Energy’s outspoken CEO Aubrey McClendon asserted that the emerging field could generate better returns than the Eagle Ford Shale, an oil- and NGL-rich play in south Texas: “[W]e believe the Utica will be economically superior to the Eagle Ford because of the quality of the rock and location of the asset.” A Sept. 28, 2011, press release disclosed peak flow rates from three horizontal wells in the wet-gas phase of the Utica Shale:
Buell 10-11-5 8H in Harrison County, Ohio, (6,148-foot lateral) yielded 9.5 million cubic feet (mcf) per day of natural gas and 1,425 barrels per day of NGLs and oil;
Mangun 22-15-5 8H in Carroll County, Ohio, (6,231-foot lateral) flowed 3.1 mcf per day of natural gas and 1,015 barrels per day of liquids; and
Neider 10-14-5 3H in Carroll County, Ohio, (4,152-foot lateral) peaked at 3.8 mcf per day of natural gas and 980 barrels per day of liquids.
These announcements touched off a wave of transactions in the Ohio portion of the Utica Sale and sent lease prices soaring. In fact, McClendon told listeners during a conference call to discuss Chesapeake Energy’s third-quarter results: “We continue to be very pleased with our Utica well results to date, but are not releasing any additional well results this quarter because last time we did it, leasehold prices doubled in the field within weeks.”
Integrated oil company Hess Corp (NYSE: HES) on Sept. 7, 2011, announced a $593 million deal to acquire a 50 percent interest in 200,000 net acres of coal producer CONSOL Energy’s (NYSE: CNX) leasehold in the Utica Shale. A day after unveiling this joint venture, Hess acquired Marquette Exploration and other leases in Ohio’s Utica Shale–roughly 85,000 acres–for about $750 million.
Meanwhile, Denver-based Petroleum Development Corp (NSDQ: PETD) has acquired the rights to up to 40,000 acres in southeastern Ohio for $70 million (about $1,750 per acre), while Marcellus shale operator Rex Energy Corp (NSDQ: REXX) leased 12,900 net acres in Carroll County, Ohio, for a total consideration of more than $40 million.
Although Chesapeake Energy CEO Aubrey McClendon complained that this land rush had elevated leasehold costs in the Utica Shale, the frenzy enabled the firm to secure an impressive joint venture of its own.
The company in December 2011 inked a deal with Total (Paris: FP, NYSE: TOT) that gave the France-based energy giant a 25 percent stake in 542,000 net acres of Chesapeake Energy’s leasehold in the wet-gas segment of the Utica Shale. In return, the US independent producer received USD610 million in cash and up to USD1.42 billion in drilling and completion costs over a seven-year period.
In a follow-up transaction, Devon Energy Corp (NYSE: DVN) took advantage of the shale mania gripping international oil companies to secure a lucrative joint venture. China National Petrochemical Corp (Sinopec) paid a total of USD2.5 billion for a one-third stake in five of the US operator’s emerging shale plays: 300,000 net acres in the Niobrara Shale, 210,000 in the Mississippian Shale, 235,000 in the Ohio portion of the Utica Shale, 340,000 in the Michigan Basin and 265,000 in the Tuscaloosa Marine Shale.
Under the terms of the deal, Devon Energy will receive USD900 million in cash and USD1.6 billion in the form of a drilling carry that should be realized by the end of 2014.
Not only do these and other blockbuster deals in US shale oil and gas plays provide international oil companies with a source of low-risk production growth relative to deepwater plays and regions fraught with political risk, but the experience and knowledge gained in US shale oil fields can also be applied to similar formations located around the world.
That the Ohio portion of the Utica Shale has been billed as one of the last major unconventional discoveries–a field that can compete with the Eagle Ford on profitability–has likewise given latecomers a sense of urgency.
In the wake of these deals, Utica leaseholders Petroleum Development Corp, Rexx Energy and Gulfport Energy Corp (NSDQ: GPOR) all indicated that they, too, would seek joint partners to help fund additional acreage purchases and drilling activity.
The promise of the Utica Shale has also bolstered investor interest in EV Energy Partners LP (NSDQ: EVEP), one of the best-performing master limited partnerships (MLP) in 2011. Units of the publicly traded partnership returned 77 percent last year, while the Alerian MLP Index gained almost 14 percent. This outperformance is impressive when you consider that natural gas accounted for about 70 percent of the company’s annual production mix; in the current pricing environment, investors have tended to favor upstream MLPs with more exposure to oil and NGLs.
Much of this strength stems from EV Energy Partners’ working interest in about 150,000 net acres in the Ohio portion of the Utica Shale and a 2 percent average overriding royalty interest in an additional 880,000 acres. The partnership acquired most of this acreage in 2009 and 2010, well before the recent surge in investment in the Utica Shale.
EV Energy Partners sold a 25 percent stake in 3,750 of its leasehold to Total for USD4.2 billion in cash and USD9.9 billion in drilling carry. Management expects to monetize the remainder of its acreage position in the back half of the year, after other producers’ well results in the oil window are available.
EV Energy Partners’ CFO Michael Mercer on March 7, 2012, explained the rationale behind this strategy at Raymond James Annual Institutional Investor Conference:
Monetization can take many forms. Ideally we’d like to do an asset swap with large oil company where we would sell all or a significant part of our working interest acreage in exchange for mature long-lived, low-risk assets that are appropriate for an MLP, but it may also take the form of cash or can be some combination of cash or properties. And just depending on how the process rolls out, we can end up retaining some position in it. But the goal is to monetize a significant amount or even up to all of our position there, to someone who wants to take over operations on a significant amount of acreage in the play.

Rhino Resource Partners LP (NYSE: RNO), which generates the majority of its distributable cash flow from coal royalties, also owns about 10,000 net acres in the condensate-rich portion of the Utica Shale in eastern Ohio.
On March 13, 2012, the MLP announced a deal to lease 1,500 net acres of this position to Chesapeake Energy for an initial five-year term with an option to extend the arrangement for another three years. The exploration and production company will pay Rhino Resource Partners $9.6 million within 90 days of signing the lease contract and a 20 percent royalty based on the proceeds from the sale of oil and natural gas produced on the acreage.
Management will weigh the best ways to generate cash flow from its remaining acreage in the Utica Shale. Whether Rhino Resource Partners will develop this acreage on its own, pursue another leasing deal or a joint venture remains to be seen. At the same time, this in-demand asset is a bright spot at a time when the MLP’s coal operations face substantial headwinds. The domestic market for steam coal has weakened substantially after an unseasonably warm winter led to elevated many utilities’ coal inventories.
With acreage positions taking shape in the Utica Shale, operators have begun to announce ambitious drilling programs in this emerging shale play. As of March 4, 2012, the Ohio Dept of Natural Resources’ Division of Oil and Gas Management had granted 150 drilling permits in the Utica Shale and operators had drilled 50 wells, many of which are awaiting completion. This table details the Utica Shale development programs announced by publicly traded operators.

Source: Bloomberg, Company Reports, Ohio Dept of Natural Resources
Much of this appraisal and development will take place in areas with access to existing midstream capacity. As Rex Energy’s Chief Operating Officer Patrick McKinney told analysts in a conference call held on Feb. 22, 2012, “We don’t want to drill wells and strand them.”
Gulfport Energy CEO James Palm likewise emphasized the importance of securing takeaway capacity and maximizing profits from natural gas liquids during the company’s conference call to discuss fourth-quarter earnings:
Selecting the right midstream partner is important to our success because much of our acreage in the Utica is in the rich gas area. And given the current pricing environment, maximizing the value of the natural gas liquids is critical. The agreements that we are finalizing will allow us to maximize the value of our produced gas and natural gas liquids, minimize our gathering and processing costs, and move our gas to market as soon as possible.

The management team further elaborated on this challenge during the Q-and-A portion of the teleconference:
<Q – Biju Z. Perincheril>: Got it. And then, moving over to Utica, as you start to bring on some of these wells, thinking there will be a pretty good portion of ethane production with it. Could that be a constraint near-term? Is there enough demand locally until some of these ethane projects come on stream?

<A – James D. Palm>: Well, it’s not a constraint in the sense that it would keep you from drilling the wells, but you do have to give it away at first until you’ve got the processing capability in there. But as markets are developed for it and as the plants are put into handle it, then it’s going to start being a revenue producer. So initially we don’t get any value for it. We just have to give it away. But we want to see the value and so do these midstream companies. They want to get the value for it. So they’re working as hard and fast as they can to be able to extract the value out of it and that benefits both them and us.

<A – Michael G. Moore>: So, just to clarify, Biju, it’s not just us, it’s everyone in Utica. Everyone has the same issue, but it will be part of our long-term solution that we mentioned earlier with our midstream partner.

By all accounts, midstream operators are moving quickly to expand takeaway capacity in the Utica Shale.
MarkWest Energy Partners LP (NYSE: MWE), a leading provider of midstream solutions in the Marcellus Shale, launched a joint venture with the private investment firm The Energy & Minerals Group to build natural gas gathering, transportation and processing and NGL fractionation, transportation and marketing infrastructure in the Utica Shale.

This joint venture’s initial projects include: an extensive gathering system that’s slated to come onstream in 2012; a facility capable of processing 200 million cubic feet of natural gas per day, the first phase of which will be completed in mid-2012; a NGL fractionation, storage and marketing complex with the capacity to handle 100 barrels per day; and a processing complex in Monroe County that’s slated for 2013.

On March 3, 2011, MarkWest Energy Partners announced that the joint venture had signed a letter of intent with GulfPort Energy to provide the producer’s operations in the liquids-rich window with takeaway capacity.

Spectra Energy Corp (NYSE: SE), the general partner of Spectra Energy Partners LP (NYSE: SEP) and DCP Midstream Partners LP (NYSE: DPM), in December 2011 announced that it had inked a memorandum of understanding with Chesapeake Energy, the leading producer in the Utica Shale, and electric utility American Electric Power (NYSE: AEP) to develop the Ohio Pipeline Energy Network (OPEN). This 70-mile pipeline will expand Spectra Energy’s Texas Eastern pipeline system and connect the Utica Shale and Marcellus Shale to serve Ohio-based utilities and industrial concerns, many of which will transition to natural gas from coal.
The company also announced an open season for capacity on its proposed Renaissance Gas Transmission Project, a plan that would enable end users in Tennessee, Alabama and Georgia to access natural gas from multiple supply basins in the north and south, including the Utica Shale.
Exploration and production companies are also taking matters into their own hands. Magnum Hunter Resources Corp (NYSE: MHR), for example, is entertaining the idea of expanding its Eureka Hunter pipeline system in the West Virginia portion of the Marcellus Shale into Ohio. Another option on the table is spinning off the company’s midstream infrastructure as an MLP and using the proceeds to fund its drilling program.
Meanwhile, Chesapeake Energy on March 13 announced a partnership with EV Energy Partners and privately held M3 Midstream LLC to build a $900 million gas processing and NGL fractionation complex in Harrison County. According to the press release, the project will initially include 600 million cubic feet per day of gas-processing capacity, 870,000 barrels of NGL storage and fractionation capacity of 90,000 barrels per day. Chesapeake Energy expects the processing and fractionation capacity to come onstream by the second quarter of 2013.
With shares of EV Energy Partners overbought at current levels and Rhino Resource Partners facing considerable headwinds in its core business lines, midstream developments in the Utica Shale could offer enticing opportunities for investors. That being said, general partners won’t necessarily drop down these assets right away to their limited partners. We will continue to monitor developments in this region.