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Producer: More Contracting Risk in Fast-Moving Shale Patch

Activity in natural gas shale plays has tended to heat up fast, especially when producers get a whiff of liquids-rich gas. Besides buying up acreage, producers are committing to gathering, processing and transportation services, and buyer's remorse can result from moving too fast, a Range Resources executive warned recently.

The risks of overspending at contract time are greater today, says Rodney Waller, Range Resources Corp. senior vice president. "We really have higher risk in the business today than we've had in the last 10 years," Waller told attendees at Bentek Energy LLC's Benposium in Houston last week. "We really introduced a lot of business risk simply because our friends from Oklahoma City [he's talking about you, Chesapeake Energy Corp.] have introduced a whole different business model than what we had historically for 30 or 40 years."

Back in the day, a company would buy acreage, prove it up, buy more acreage, etc. "Today we buy all our acreage within the first 30 days and then that puts on a lot of costs up front," Waller said. "We live off of IP [initial production] rates, and we really don't quite understand what the EUR [estimated ultimate recovery] is going to look like. Then we're drilling hundreds of wells....[W]e're trying to figure out how we're going to get gathering and compression into these areas...

"The rapid pace at which we move today is dramatic. If 10 frack stages was good last week, 20 is even better. So it's bigger, it's better, it's longer."

The producer is also making commitments for gathering, processing and transportation of its gas. As Waller allowed that he likes to say, "it's the producer that pays for everything." The pen might glide more freely across a long-term contract when gas prices are high. It's when prices are low that the consequences of bad decisions are felt.

"If we get too eager, we have to live with what the well price is," Waller said. "And if our interconnect costs, our transportation costs, our gathering, compression, processing...if that gets too expensive, we're going to have to suffer the consequences."

It doesn't help matters for the producer that he is a price-taker, largely at the mercy of "12 guys up in New York City buying natural gas," according to Waller. The buyers' thought process, as Waller described it, is to tally up what's being paid for transportation and storage and then add on something extra for the commodity.

During bidweek, "you don't want to be the last of the guys trying to place your Barnett [Shale] gas in the middle of the summer. You better have started three days before bidweek because you don't want to be the last guy on the call trying to place another 3 MMcf/d. Everybody's full; they don't want your gas. The only way to sell it is very inexpensively.

"If there is no arbitrage between the summer and the winter months, the marketing guy will simply calculate 'what is my cost of storage, what is my cost of transport, what do i think I can sell it in the winter at...'"

In a note Tuesday, analysts at Bank of America Merrill Lynch pointed out compression of the summer-winter spread. "October 2011 to January 2012 spreads are now trading at minus 43 cents, close to 2007-2008 when markets were notoriously tight, and are extremely compressed relative to realized spreads over the last years, both in levels as well as on a percentage basis," the analysts said. "At this point the market is barely covering for the costs of storage, embedding expectations of a below-normal injection season next year."

Others might be suffering from the cost-gas price squeeze more than Marcellus Shale-focused Range because the company is a bit more "sophisticated," Waller said. That includes a focus on keeping costs down -- inside the company and out -- even when commodity prices are high.

"One of the things I've always told the Marcellus midstream segment of the business is, 'Please be careful of how much you build and what it costs. If you build a brand new pipe that costs me more money to transport, then I lose my competitive advantage in servicing that market because you may be able to take Fayetteville gas or Barnett gas under FERC-rated transport and get it to the New York market cheaper than what I have to pay to get it out of the middle of Lycoming County [PA].' Costs are really important when you're talking about $4 gas."

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