The Marcellus Shale Formation

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Several years ago, I took a closer look at an emerging natural gas play beneath 17 Texas counties. At the time, my concentration was fixed on the Canadian oil sands. . .

I remember the day that shale gas hit my radar.

Several years ago, I took a closer look at an emerging natural gas play beneath 17 Texas counties. At the time, my concentration was fixed on the Canadian oil sands.

I still can't pinpoint what initially attracted my attention to the Barnett shale, and the initial feedback I got was skeptical at best. I remember one particular dissenter chiding me for even suggesting that shale gas would ever become a game-changer. He was adamant that it would take natural prices between $20 and $40 to develop the shale gas.

I wonder how he feels about that prediction today...

Approximately 5 Bcf per day of natural gas is being produced from the Barnett shale. In fact, about 10% of onshore U.S. production comes out of the Fort Worth Basin.

Natural Gas Growth Will Spur Activity

We've been waiting for a natural gas comeback ever since prices fell below $4 per Mcf last summer. Looking ahead into 2010, things are looking better for natural gas.

However, it's not the Barnett shale that I've been watching lately. At least, not anymore... and reason is simple enough.

Higher prices will encourage more drilling activity. The number of rigs drilling for natural gas is rising. Last week's rig count was up 11 rigs, totaling 1,189 oil and gas rigs operating in the U.S. That number is still down from the 1,606 rigs that were drilling for natural gas in September 2008.

Unfortunately, the buzz is no longer in the Barnett, now considered a "mature" shale play. The spotlight has shifted to several different shale plays across the U.S., including the Marcellus, Haynesville, and Fayetteville shales.

Of course, the Barnett's success has been attributed to the advancements made in horizontal drilling and hydraulic fracturing.

It's the latter part that has come under fire lately... but I'll get to that in just a second.

What is Hydraulic Fracturing?

Like the name suggests, hydraulic fracturing—known as fracing—involves injecting million of gallons of water, sand, and chemicals into the well. The goal is to fracture the rock. The fissures are kept open from the sand, allowing natural gas to flow up the well.

Simple enough, right?

Not exactly.

Although most of the process involves water and sand, the main controversy is over the unknown chemicals used in the process. Companies currently do not disclose the makeup. Even though we know some of the chemicals being used, the concentrations are unknown. However, most of the chemicals used are also extremely hazardous, which has made people a bit more hesitant.

The Report Calling for a Marcellus Ban

It's been a while since we last talked about the Marcellus shale formation. As you know, the Marcellus is one of the emerging U.S. shale plays that have become a hotbed of activity.

Recently, things haven't been so rosy for drilling certain areas of the Marcellus.

Two weeks ago, the New York City Department of Environmental Protection released a report assessing the dangers of producing natural gas in the city's watershed. The 51-page report wasn't very flattering. The report concluded that large-scale drilling and hydraulic fracturing in the New York City watershed poses a serious risk to the city's water supply.

I guess the no-drilling pledge that Chesapeake Energy made wasn't enough. Back in October, Chesapeake exec Aubrey McClendon pledged the company would not drill in the New York watershed.

The 5,000 acres held by Chesapeake are inconsequential compared to the 1.5 million acres it has in the Marcellus. Will putting a ban on drilling in the NYC watershed really make a difference? No.

However, I can understand the issue that New York officials still have, despite the no-drilling pledge. Once Chesapeake's five-year lease expires, those leases will be up for grabs. At that point, anyone can come in and the entire mess starts over.

Look, I'll let you make up your own mind on whether or not to believe in their no-drilling pledge.

It's not the watershed drilling that investors need to worry about... Instead, it's allowing the EPA to regulate the hydraulic fracturing process.

And they're not the only ones concerned.

Exxon's Escape Clause

By now, I'm sure you've read about the ExxonMobil deal to acquire XTO Energy. What you might not have heard about is Exxon's escape clause.

It's easy enough to understand. Basically, ExxonMobil can back out of the $41 billion deal if Congress passes a law which bans or regulates hydraulic fracturing.

Investing in the Shale Game

So is the shale game still worth playing?

Absolutely.

For starters, I simply don't see legislation passing that would cut off the one positive outlook for U.S. natural gas production.

However, the Marcellus is only one of the shale plays on the rise.

As I mentioned earlier, natural gas prices are going to recover this year—trading around $6/Mcf—and it's only a matter of time before the supply glut works itself out. It won't happen tomorrow, but you can be sure it'll happen sooner than you think. And in this free report, you can find out more about another one of these emerging plays—the Haynesville shale. Just click here to access the report.

You'd be surprised to hear which of those upcoming shale areas has me itching to get out of the office and see for myself. Here's a hint: it's not even on U.S. soil. I'll tell you all about it next week.

Until next time,

Keith Kohl
Energy and Capital

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