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Consol Waiting for Higher Gas Prices, Defers Some Marcellus Drilling

Consol Energy Inc. said Thursday it has too much of a good thing -- natural gas -- and low prices will lead to reduced spending and well drilling in the Marcellus Shale this year.

Last year "ended on a good note," but "markets change," CEO J. Brett Harvey said during a conference call to discuss the company's 4Q2011 and full-year earnings.

Less than two weeks ago Cecil, PA-based gas and coal producer announced that its capital expenditure plan for 2012 would be $1.7 billion. However, it has reduced that figure to $1.5 billion, with $130 million to be taken from the Marcellus Shale. The reductions "are occurring mostly because a combination of mild weather and high production, which has caused natural gas prices to drop to a 10-year low," said Harvey. The company also opted to defer 23 gas wells.

With its joint venture partner Noble Energy Inc., Consol still plans to drill 99 wells in the Marcellus, mostly in southwestern Pennsylvania, said Consol President Nick Deluliis.

What won't be affected is 2012's production, which Consol is forecasting will remain at 160 Bcf. Because Consol backloads its budget, the wells being deferred wouldn't have been drilled until later this year, which means that gas output won't be affected until 2013 and beyond.

"Less drilling in 2012...coupled with the postponement of some pad development spending for the 2013 drilling program is causing the company to reduce its 2013 production guidance to 190-210 Bcfe, which would be 10 Bcfe lower than the earlier projection," said Deluliis. "Consol's 2015 goal of 350 Bcfe, however, remains unchanged because the drilling schedule in the out years has enough flexibility in it to accommodate a slightly reduced production goal in 2013."

Nearly half of the company's forecasted gas production in 2012 also is hedged at $5.25/Mcf, CFO Bill Lyons said. The company this year will turn its attention to "reducing capital expenditures in gas and focusing on high returns in Marcellus liquids."

It's all about costs, said the CEO.

"We don't control gas prices but we control costs," Harvey told analysts. Consol's two "powerful" JV partners are helping to allay some cost concerns, but deferring some spending and drilling into 2013-2015 would do the rest.

Hess Corp. paid Consol $593 million to acquire a half stake in nearly 200,000 net acres in eastern Ohio's Utica Shale (see Shale Daily, Sept. 8, 2011). Also last year Noble secured a $3.4 billion deal with Consol that gave it half of a 663,350 net-acre leasehold in Pennsylvania and West Virginia, including existing wells and midstream infrastructure (see Shale Daily, Aug. 19, 2011).

The two partnerships, along with the sale of an overriding royalty interest to Antero Resources in October (see Shale Daily, Sept. 27, 2011), generated gross proceeds to Consol of $841 million in 2011.

Last year Consol's gas output was a record 153.5 Bcf net, which was 20% higher than in 2010. Gas production actually would have been about 25% higher had Consol not sold properties to Noble and Antero.

"Our record results were even more impressive when one realizes that, on the gas side, weakening gas prices throughout 2011 largely offset our record gas production," said Harvey. "For Consol, 2011 was a year characterized by our ability to seize opportunities and, in some cases, to create opportunities."

Because of the strategic JVs it put into place, "we are flexible on our assets," said Harvey. "We are able to maintain where we're at and these projects, whether in gas or coal, are discretionary to us based on the rate of return and forward looking markets."

In total Consol's Marcellus gas costs in the final period of 2011 were an estimated $2.74/Mcf, said Deluliis. For the full year its Marcellus costs were averaged $3.10/Mcf.

"We strive to be one of the lowest cost producers in the country," said Deluliis. But "Marcellus gas is not the only area where costs need attention. While we are targeting $3 for the Marcellus, we also want to get our CBM [coalbed methane] gas below $3 all-in as well."

About half of Consol's unconventional wells this year will target liquids, not dry gas, he said. With Noble, Consol's objectives for the Marcellus are to "ramp up development of our wet acreage position," focusing on Greene and Westmoreland counties in Pennsylvania.

Consol, which operates the Noble partnership, also wants to "further delineate" its central Pennsylvania and northern West Virginia positions, said Deluliis. Of the 99 gross wells the partners plan to drill, 39 will target liquids.

In the Utica Shale, Consol and Hess plan to drill 22 gross wells -- all targeting liquids.

"The ultimate goal" in the unconventional plays is not to have the highest initial production (IP) rates from the wells but the best estimated ultimate recovery (EUR) rates, said Deluliis.

"We're optimizing our wells in the Marcellus," he said. "You can seen the improvements between '08 and '09 and between '10 and '11. The ultimate goal is not IPs but EURs. That's where the focus will be."

The deferred spending in the Marcellus could reinserted into the budget later this year if gas prices were to improve, Deluliis said.

"The drilling rate by region is driven by returns versus costs...and Noble has a similar allocation philosophy. In southwest Pennsylvania the rate of return at the current price deck is well above the cost to capital. So from that standpoint, we will continue to drill in southwest Pennsylvania.

"In other regions, like central Pennsylvania and northern West Virginia and that Noble operates in [with Consol], we really see a switch back to drilling rates to $3.00-3.50 on returns to get well above the cost to capital. "$3.50 or so is the demarcation line when drilling rates may increase back to prior [plans]."

Consol's news that it will reduce its gas drilling and spending follows a pattern that began on Monday when Chesapeake Energy Corp. said it would cut dry gas spending by 70% this year and slice in half operated gas drilling activity (see Shale Daily, Jan. 24).

In just the past couple of days other producers also have announced plans to reduce their onshore gas drilling plans, including ConocoPhillips, which Wednesday said it was shutting in 100 MMcf/d (see Shale Daily, Jan. 26).

Tudor, Pickering, Holt & Co. said in a note Thursday the decision by Consol to reduce gas spending "looks good." Based on analyst calculations, Consol will reduce its 2012 Marcellus well count by 19% and shave spending by 23% from its initial spending plans.

Analyst Lucas Pipes of Brean Murray Carret & CO. called Consol's decision "sensible" and said it "should be rewarded by investors."

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