It's fair to say that lot of people, from shale gas operators to Pennsylvania state revenue collectors, see $$$ every time they think about the Marcellus shale. Only recalcitrant environmentalists worried about polluted drinking water do not salivate at the prospect that many years of U.S. gas supply will come from the Marcellus. Today I will not deal with the environmental issues. Instead, I want to examine the view that resources in the Marcellus are a big part of the shale gas cure-all for America's energy problems.

How much economically recoverable gas exists in the Marcellus? To answer that question, let's take a close look at Range Resources, an operator in southwest Pennsylvania south of Pittsburgh, where I live. Recently, Range provided a Marcellus update—

FORT WORTH, Texas, Apr 12, 2010 (BUSINESS WIRE) --
RANGE RESOURCES CORPORATION today provided an update of its Marcellus Shale operations. Range currently owns approximately 1.3 million net acres in the Marcellus Shale play, with approximately 900,000 net acres in the "fairway" of the play. Of the fairway acreage, approximately 600,000 net acres are located in the southwest portion of the play and 300,000 net acres are located in the northeast portion. Range had previously estimated that its horizontal wells in the southwest averaged 4.4 Bcfe per well at a development cost of $3.5 million...

As a result of increasing the per well resource potential, Range's net unproved resource potential in the southwest has increased to a range of 14 to 19 Tcfe, including 270 to 380 million barrels of liquids and 12.4 to 16.7 Tcf of gas.

[My note: Tcf means trillion cubic feet. Tcfe is trillion cubic feet equivalent, which means you add in the energy from liquids extracted together with "dry" natural gas.]

You are entitled to ask: Is the unproved resource potential 12.4 Tcf? Or is it 16.7 Tcf? Taking this further, we might also ask: what if it turns out to be 8.5 Tcf?  Or 6.3 Tcf? There is reason to believe these smaller number are also possible.

You will notice that Range had previously estimated the estimated ultimate recoverable (EUR) for its southwest horizontal wells at 4.4 Bcfe (billion cubic feet equivalent). This is from a Morningstar document dated July 23, 2009—

The biggest news of the day was the disclosure of a Marcellus production type curve based on production history from the 24 wells that have been producing for greater than 120 days and Range's internal estimates. Based on the graphical presentation, it appears production declines are around 75% in year 1, 35% in year 2, 25% in year 3, 12.5% in year 4, and 10% in year 5. Range is also assuming a 40-year average well life and a 6% terminal decline. Other data points include: initial production rates of around 5 mmcfe/d; gross recoverable reserves of 4.4 bcfe; well costs of $3.5 million, and an average royalty of 15%.

What is this "type curve" this Morningstar document refers to? It sounds impressive, and mathematically, it is. The "type curve" describes a parabolic decline function that petroleum engineers use to compute total reserves based on historical production. Here's a type curve from Ultra, another gas producer in the Marcellus.

The alert reader will note that the graph is labeled Early Marcellus Performance. Based on about 145 days of production, Ultra estimates they will get 3.75 Bcf on average from the 13 wells sampled. This is exactly what Range Resources has done. They recently changed their drilling strategy, and have now revised their reserves estimates upward.

In mid-2009, Range began drilling wells in the southwest using longer laterals and more completion stages. In 2009, Range drilled 17 horizontal wells with average lateral lengths of 3,056 feet with an average completion of ten stages. Based on the results to date, Range estimates the longer lateral wells have reserves of 5.0 Bcfe with an average development cost of $4.0 million per well...

As a result of the additional well control and the performance of the longer lateral wells, Range has increased its estimated resource potential from 3 to 4 Bcfe per well to 4 to 5 Bcfe per well across the 430,000 net acres.

So what's the problem? This is all kosher, right? Well, maybe. Houston geologist Art Berman—full disclosure and friend of mine—points out the problem in Lessons from the Barnett Shale suggest caution in other shale plays—

Since little is known about the commercial potential of new shale plays like the Marcellus and Haynesville, I decided to see what could be learned from the robust production history of the Barnett Shale. What I found surprised me. Most reserve predictions based on hyperbolic production decline methods were too optimistic when compared with production performance. There is little correlation between initial production rates (IP) and ultimately recoverable reserves (EUR).

Average well life is much shorter than predicted, and the volume of the commercially recoverable resource has been greatly over-estimated. Core areas of the play do not have appreciably higher average EURs than the play overall, and the EUR from horizontal wells is not significantly greater than from vertical wells. Finally, average well performance has decreased consistently since 2003 for horizontal wells...

In 2007, I projected EUR for almost 2,000 horizontal wells in the Barnett Shale (World Oil, November 2007). At that time, these were the only horizontal wells with enough production history to evaluate. Now, with two additional years of production, I revised the decline curves for the same control set of 1,977 horizontal wells. The overall EUR decreased 30% from my previous estimate, and the average per-well EUR fell from 1.24 Bcf to 0.84 Bcf. The reason is clear: most wells do not maintain the hyperbolic decline projection indicated from their first months or years of production. Production rates commonly exhibit abrupt, catastrophic departures from hyperbolic decline as early as 12-18 months into the production cycle but, more commonly, in the fourth or fifth years for the control group. Pressure is drawn down and hydraulically produced fractures close...

Operators often state that shale plays have about a 30 to 40-year production life, but I found that the average commercial life for horizontal wells is about 7.5 years, although the mode is four years. There are many wells that should have 8-12 years of production but few that will extend beyond 15 years. About 75 percent of predicted EUR in horizontal Barnett wells has been produced by Year 5. In the control group, the first wells were drilled in 2003, and already 15% have reached their economic limit five to six years into their production
life cycle...

I decided to examine the validity of the other common technique used in new play evaluation: prediction of EUR from IP. I projected decline curves for all the horizontal wells in the Barnett, and the resulting cross-plot of IP versus EUR provided a broad range of EURs that might be associated with a particular IP. For example, the well with the highest EUR in the Barnett Shale (8.8 Bcf) has a good correlation with IP (7.94 MMcfd). The next-best well has a EUR of 8.6 Bcf and a poor correlation to an IP of 4.28 MMcfd, while the fourth-best well has a EUR of 7.1 Bcf and an even poorer correlation to the IP of 1.9 MMcfd. In the end, I would prefer a high IP to a low one but, since approximately half of the EUR is produced in the first year, a well’s early decline rate is more important than IP in predicting reserves.

[My note: IP stands for initial production. High IP rates are always cited to back up EUR claims in the Marcellus. Also, I did not consult with Art Berman in preparing this post.]

Based on the Barnett, the only shale play for which extensive historical data exists, the Range EUR claims for their southwest Marcellus acreage could be far too high. Range does admit a large degree of uncertainty in their stated range 12.4-16.7 Tcf.

Note that I didn't say Range's estimates are wrong, because we don't know yet how their southwest Pennsylvania play will turn out. We can also see that Range has assumed a standard 40-year lifetime for its wells, but the average commercial life for horizontal wells in the Barnett turned out to be 7.5 years. Range's use of a type curve based on some unknown but relatively short period of initial production to revise its EUR upwards does not seem to follow the cautious, go-slow approach Art Berman recommends.

In fact, without a robust production history, one might claim that Range's EUR claims are bullshit, but I am not ready to say that yet because only time will tell in the Marcellus. Still, there's other suspicious stuff going on. 

Range Resources Corp.'s holdings in the Marcellus Shale natural gas formation are worth four times the $14,000-an-acre price that other sales have brought, CEO John Pinkerton said Tuesday. Fort Worth-based Range would need a "Godfather" offer it couldn't refuse to sell a stake in some of the 1.3 million acres it has leased in the Northeast deposit, Pinkerton told investors at a New York conference sponsored by the Independent Petroleum Association of America.

Reliance Industries Ltd., India's largest company by market value, agreed to pay $14,167 an acre for a stake in a venture with Atlas Energy Inc. last week, and Mitsui & Co. paid the equivalent of $14,000 an acre in the area for a joint venture with Anadarko Petroleum Corp.

"We view a joint venture as an asset sale," Pinkerton said in response to a question about whether he would consider selling part of his stake in the Marcellus to a joint-venture partner. "If I sold today for $14,000 an acre, I'd be selling it for a quarter of what it's worth," he said...

Earlier at the same conference, Aubrey McClendon, CEO of Oklahoma City-based Chesapeake Energy Corp., estimated his company's 1.57 million acres of Marcellus leases are worth $35,900 an acre.

Range's leases are worth more than Chesapeake's because they contain more natural gas liquids, which sell at a premium to natural gas.

Want to buy some Range acreage in the Marcellus? CEO John Pinkerton is telling you it might be available at a bargain basement price of (at least) $40,000 an acre. The value of the acreage is based on the estimated EUR in that acreage ... and the estimated EUR is based on Range's type curve, which is likely based on a few hundred days of production...

Oh what a tangled web we weave, When first we practice to deceive... — Sir Walter Scott

Later, I'm outtahere.