Spudding Restart in Pennsylvania Key to Cabot Oil & Gas Success

Cabot Oil & Gas reported in a press release it is temporarily halting hydraulic “fracking” operations at eight drilling sites located in a section of its Marcellus shale leaseholds in Susquehanna County, Pennsylvania on the orders of the state Department of Environmental Protection: three spills of a liquid-gel lubricant within seven days. This accident is but the latest in a string of environmental incidents connected to the natural gas producer’s drilling in the area. Do resultant delays in drilling raise the risk that depletion rates will exceed proven reserve additions this year?

Hydraulic fracturing is a process where fluids and other components are injected into a steel boring under high pressure to force the release of oil or gas from rock formations typically located in already drilled wells between 6,000 and 10,000 feet underground. Cabot admits that there were two releases of frac fluid during operations being performed by Cabot contractors, Baker Corporation and Halliburton, on September 16.

As of year-end 2008, Cabot had approximately 1.9 trillion cubic feet equivalent (Tcfe) in proved reserves (97 percent natural gas) located in three core regions: Gulf Coast, West (Rocky Mountains and Mid-Continent) and the Appalachian Basin (Marcellus Shale) in the East. These regions accounted for 25 percent, 29 percent, and 45 percent, respectively, of the company’s 2008 proved reserves.

In the first half of 2009, comparable natural gas production increased 13 percent to 51.2 Bcfe — largely the result of acquisitions in East Texas (Haynesville Shale region) and increased production in the East region (due to increased drilling activity in the Marcellus Shale fields of West Virginia and northeastern Pennsylvania). Full year guidance is currently 99 Bcfe to 103 Bcfe.

Unfortunately, Cabot’s 2008 annual report estimated that production from developed (producing) reserves would decline sequentially at projected rates of 21 percent, 17 percent, and 12 percent during the years 2009 -2011. Ergo, development of Marcellus Shale leaseholds will grow in importance to Cabot: in addition to known reserves, the region offers longer-life wells with attractive economics. The reserve life per well in the East is approximately 34 years — 2x the life of drilled wells in the Gulf Coast and West — and a spudded horizontal well in Susquehanna County is highly profitable at $4.00 natural gas per MMBtu. Since January, drill time on consecutive horizontal wells spudded in the county has dropped almost 75 percent (to 22 days) and drilling costs have dropped 60 percent to $133 per foot, according to published data at an August energy conference.

Chief executive Dan Dinges told analysts on the second-quarter earnings call that about 90 percent of the $500 million budgeted on capital and exploration activities is earmarked towards Gulf Coast and East operations, with an estimated $374 million of these funds directly targeted for spudding.

Given expected depletion rates, Cabot’s Marcellus production is integral to Cabot’s success going forward. East region production reached a record of 52 million (+) cubic feet of gas per day (MMcfd) for week-ending September 20, according to CEO Dinges. The Susquehanna area is critical to aggregate Marcellus volume, as the first seven horizontal wells in Pennsylvania Marcellus have a 90-day production average of about 6.0 MMcfd and could hold estimated reserves topping more than 4.5 Bcf each.

A company investigation has determined failed piping connections between the frac tanks holding a fresh water supply and the equipment used to pump the fluid into the shale formation caused the fluid spills in Susquehanna County. As the frac fluid is 99.5 percent fresh water and 0.5 percent chemical gel, CEO Dinges contends the mixture is not hazardous or dangerous — and poses minimal threat to the environment. Although sixteen dead cows that dropped dead after drinking water allegedly polluted with frac spillover from nearby Chesapeake Energy natural gas operations in Louisiana — and those with contaminated drinking wells who live near Cabot operations in PA — might disagree, management expects to resolve the concerns of the PA Department of Environmental Protection and quickly restart its Susquehanna County operations. Consequently, management sees no reason to adjust guidance at this point.