In Hunt for Shale Oil, Early Results Need to Be Massaged

NEW YORK ( TheStreet) -- Initial results are in from drilling in Ohio's Utica shale region, and the results show that the boom assumed for one of the U.S. shale hopefuls is still far from certain.

The state of Ohio tried to put a positive spin on what it's hoping will be a budding economic juggernaut for its drilling industry. Chesapeake Energy ( CHK), a pioneer in the Utica, has been talking up the shale play for years.

The actual results, though, were described by analysts in a less optimistic tone. There's still a lot of work left to do before Wall Street will be convinced that the Utica will pay off where it counts the most, in its production mix of natural gas liquids and oil.

The state of Ohio release was the first set of annual results from the Utica shale, nine wells in all, all of which are owned by Chesapeake Energy. Chesapeake has a joint venture with Total ( TOT) in the Utica shale, announced at the beginning of 2012.

Chesapeake Energy is engaged in a significant shift from the dry gas basins to the liquids rich shale plays amid historic lows in natural gas pricing, making success in the shale plays critical.

The Ohio results show wells that are not producing oil at a rate that would impress, and a mix of production that may be too tilted to natural gas.

Analysts consulted on the initial Utica results said the data was "underwhelming" when considered in a vacuum. However, given that it's still early days in the Utica and these are the first wells, the results are likely to be neutral as far as the market outlook on Chesapeake Energy.

"Maybe between overwhelming and underwhelming, or 'whelming,' would be the right way to put it," quipped one Chesapeake Energy stock analyst, Tim Rezvan at Sterne Agee. In the least, the Utica results were the most anticipated set of shale drilling results so far in 2012.

Chesapeake shares were up 0.6% on Monday, slightly trailing the energy sector rally, up close to 1%. Gulfport Energy ( GPOR), which has acreage close to Chesapeake's in the Utica, was up by 0.3%, also short of the energy sector return on Monday.

Earlier this year, Chesapeake Energy alluded to disappointments in some of its shale drilling plays in the early days of development, notably the Williston basin of North Dakota.

The state of Ohio said in its data release that it is unlikely that the wells are being produced at anything near full capacity, as wells produced at high initial rates have the potential of being permanently damaged.

"The reported volumes of oil are lower than estimated, but higher than conventional wells," Ohio said in the report.

However, none of the five wells at commercial production in 2011 reached a 100 barrel per day level, which is the low bar in production that would be considered noteworthy, analysts said.

The two highest-producing oil wells in the Utica generated between 12 and 13 thousands barrels in 2011 (though neither was in service for a full calendar year), which worked out to daily production of roughly 60 to 70 barrels of oil.

The report added two caveats about the Utica that would not be music to the ears of investors hoping for "black gold" to move Chesapeake Energy shares out of the rut they've been mired in for the past several years.

Oil production may be incidental to gas production in much of the Utica play, and reported oil volumes likely include condensate volumes, Ohio stated in the data release.

Chesapeake Energy strives to focus investors on its liquids production, however, and the company does not break out natural gas liquids from oil specifically in its reports to investors. While natural gas liquids pricing is much better than dry gas pricing, oil is the only commodity that is not facing downward pressure.

A production split that would make the Utica equal to the Eagle Ford shale -- which is one of the most economic drilling plays -- would be at least in the range of one-third each natural gas, natural gas liquids and oil. The early results from the Utica did not reflect this desired split, nor did the state's comment on oil relative to NGLs.

Natural gas liquids supply will find increasing outlets in the chemicals and heating markets in the years to come as U.S. infrastructure is built out to support the shale boom, but in the near-term the pricing is expected to be directionally down. Consultant Bentek Energy expects 42% growth in the NGL market in the next five years - from 2.2 million cubic feet daily to 3.1 million cubic feet -- and it will only be beyond 2016 that the demand catches up to the growing supply.

Ohio noted the infrastructure constraints for wet gas in writing, "Markets and pipeline capacity are somewhat limited so production is likely choked back. Once processing plants are up and running, the produced 'wet' gas volumes will dramatically increase."

Chesapeake's Buell Well gas production equals 2% of the state's total gas production, Ohio said. Ultimately, though, investors will be looking for oil.

"Just having NGLs doesn't work anymore," Sterne Agee's Rezvan said, adding, "Black gold is where the money will be." Rezvan said even with reservations the initial results could be judged as being more or less as expected, but remain an incomplete data set, with the percentage of natural gas liquids within the gas production not broken out by Ohio.

-- Written by Eric Rosenbaum from New York.

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