National Fuel Gas Co. (NFG) said low natural gas prices were forcing its Seneca Resources Corp. subsidiary to scale back capital expenditures (capex) on exploration and production (E&P) for fiscal 2012, which includes dropping two of its six drilling rigs in the Marcellus Shale.

Despite the spending cutbacks, executives predicted production would grow by about one-third year/year, driven by an expanding presence in the Marcellus and Utica shales.

"Simply put, at these gas prices, we're not planning to grow at the pace we had contemplated," CEO David Smith told financial analysts during Friday's conference call to discuss 1Q2012 earnings. He said National Fuel would cut capex for Seneca's East Division, which includes the Marcellus and Utica shales, by $70 million, or 8%, to between $720 million and $800 million. Seneca East would also move to a four-rig program, with the rigs under longer-term contracts being held.

"Let me emphasize that the reduction in our plan level E&P spending is entirely related to gas prices," Smith said. "Should they improve, we can and will move quickly to add rigs to our program. Should they continue to deteriorate, we have the flexibility to further reduce our capital budget."

Smith added that even with a reduced program, the company still expects production to grow by about 33%. "Our focus in Appalachia will be twofold -- drilling Marcellus wells that produce the best economics, and continuing the delineation of acreage that is perspective in the Utica," he said.

Matthew Cabel, president of Houston-based Seneca, the exploration arm, said for the remainder this year two rigs would operate at Tract 100 in Lycoming County, PA. One is to be deployed to Tract 595 in Tioga County, PA, and one is to drill into the Utica Shale.

Seneca's joint venture with EOG Resources Inc. is "not expected to change substantially," said Cabel, but if natural gas prices remained low the company "will have the option of not participating in the EOG wells in FY2013, while still maintaining the 20% royalty interest in wells drilled on our fee acreage" (see Shale Daily, Jan. 11, 2011)

For 2013 and 2014 Seneca is evaluating a multi-rig program to develop Marcellus wet gas acreage in western Pennsylvania's Elk and Forest counties. "Initially, this would be the westernmost portion of our Owl's Nest area," Cabel said. "Utilizing a cryogenic processing plant, running in partial ethane rejection mode, we believe we can achieve an 80-90 cent/Mcf uplift in revenues from these wells net of the cost of processing."

Gas and oil production is the fiscal first quarter increased 2.6 Bcfe to 18.2 Bcfe, which was about 17% more than in the year-ago period. Around 11.3 Bcfe was from the Marcellus, a 12% increase from 4Q2011 and nearly double (91%) more than a year ago.

Cabel predicted that there would be a "substantial jump" in production in March and April as the wells in Tioga and Lycoming counties are brought into production and flow on the Trout Run gathering system.

"This new production will have only a modest impact on second quarter volumes, but will increase our fiscal third quarter substantially," Cabel said. "At Boone Mountain, in southern Elk County [PA], we have tested two new Marcellus horizontal wells at rates of 3.8 MMcf/d and 4.2 MMcf/d. One additional well will be coming on next week."

During 2Q2012 Seneca plans to wrap up a delineation program in the Marcellus by drilling a test well in the Rich Valley area of Cameron County, PA.

"At that point, we will have drilled, [hydraulically fractured] and tested horizontal Marcellus wells across a broad swath of our acreage," Cabel said. "While additional delineation drilling will be needed, particularly in the wet gas window, we have established anticipated [estimated ultimate recovery] for many areas, with most of the development area in the 3-5 Bcf range, and most of the Eastern development area in the 5.5-8 Bcf range."

Seneca continues to evaluate the Utica Shale, where it has drilled two verticals wells and purchased a horizontal one. "We have two more horizontal wells planned to test the Utica in two additional areas," Cabel said. "Depending on the results, our plans for FY2013 and FY2014 may involve substantial additional Utica drilling...However, I should point out that Seneca can continue to grow production in FY2013 and FY2014, even without adding additional rigs."

NFG reported earnings of $60.7 million (73 cents/share) for 1Q2012, up $2.2 million (3 cents) from the $58.5 million (70 cents/share) recorded for 1Q2011. The increase in production for the quarter came despite the sale of offshore Gulf of Mexico assets, which produced 2.6 Bcfe in 1Q2011 (see Shale Daily, March 29, 2011).