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National Fuel Gas firmly focused on future

Vast resources in hills of Pennsylvania could lead to fundamental transformation

By David Robinson
NEWS BUSINESS REPORTER
Published: 09-05-2010

David F. Smith has seen the future of National Fuel Gas Co.—and it lies beneath the hills of northwestern Pennsylvania.

That’s where, trapped more than a mile underground in a vast rock formation known as the Marcellus Shale, lies vast amounts of natural gas that Smith believes could lead to a fundamental transformation of the Amherst-based energy company.

National Fuel is best known in the Buffalo Niagara region for its utility business that provides natural gas service to homes and businesses, but the Marcellus Shale in the coming years could spur rapid growth in the two other main parts of its business — its oil and gas drilling operations and its business that transports gas through pipelines and stores it underground until it’s needed by consumers.

“People think of us as National Fuel, the local utility. But we’re much more than that,” Smith said. “We’ve gone from being primarily a utility to basically being a business that’s split 50-50 between our regulated [utility and pipeline] units and our unregulated one.”

The regulated utility and pipeline businesses provide a solid earnings base for the company, while its oil and gas drilling operations offer the biggest growth potential. The company’s California oil fields, with oil prices above $70 a barrel, are generating much of the cash National Fuel needs to fund its push in the Marcellus region.

“We like the mix. We like the different roles the companies play,” Smith said.

Yet as National Fuel accelerates what started as a cautious foray into Marcellus drilling into a much more aggressive exploration program, the energy production business will take on an even bigger role, possibly even accounting for as much as 70 percent of its assets, Smith said.

“The shale is a massive game changer,” Smith said. “We’re in a very good place.”

Smith likes National Fuel’s position because, over its decades of doing business, the company has gained control over nearly 740,000 acres of land in the Marcellus Shale that could become drilling sites for more of the high-output wells that now dot the region.

“The company’s large acreage position in Appalachia is the prize jewel,” said Mark Barnett, an analyst at Morningstar Inc., a Chicago research firm.

And the closer National Fuel executives examine their Marcellus holdings, the more gas they think they’ll find. The company last month nearly doubled its estimates of how much natural gas might be found on its Marcellus acreage to 8 trillion to 15 trillion cubic feet, or enough to meet the natural gas needs of 8 million to 15 million households for 15 years.

To get to the gas, National Fuel is ramping up its plans to drill new wells in the Marcellus region, spending an estimated $270 million to drill 60 to 80 new Marcellus wells during the current fiscal year. A joint venture with EOG Resources plans to drill another 40 wells. It expects to spend about $400 million drilling in the Marcellus next year.
If those wells pan out as expected, National Fuel expects its oil and gas production next year to jump by almost a third to about 65 billion cubic feet, with the rapid expansion continuing beyond that.

The potential fly in the ointment for National Fuel’s plans is the price of natural gas, which has plunged from $6 per 1,000 cubic feet in early January to less than $4 today. That’s significant, because drilling wells in the Marcellus Shale is expensive, costing in the ballpark of $3 million to $4 million apiece.

Industry experts generally say natural gas prices need to be around $5 or more for the costly Marcellus wells to make economic sense, although Smith said National Fuel’s unique position in the region will allow it to drill profitably with gas as low as $3.50 to $4.

National Fuel’s biggest advantage with the land it controls in the Marcellus region is that it already controls or owns the drilling rights on the vast majority of those acres. That allows it to avoid paying the 15 percent to 20 percent royalties that drillers typically pay landowners.

“The slide in gas prices has made some of this activity less economical, but National Fuel’s drilling program in Appalachia will still be relatively aggressive,” Barnett said.
Most of the land is clumped together, which makes it less costly to develop and allows for further savings by enabling the company to drill more wells from a single drilling pad. Controlling most of the land also means National Fuel can avoid disputes with landowners over the roads and pipeline gathering systems that are needed to reach the drilling site and bring the gas to market.

With low gas prices squeezing some drillers, Smith said National Fuel is interested in expanding its Marcellus holdings.

“We’ll be looking for opportunities because many of the producers, at these prices, are having difficulty raising the capital they need to drill,” Smith said. “We’re always looking to grow.”

Smith also is confident that, as more natural gas becomes available, the downward effect those growing supplies will have on gas prices will be partly offset by rising demand, as less-polluting natural gas replaces many coal-fired uses, especially at power plants.

Still, National Fuel’s push into the Marcellus has not been without issues. A well drilled by EOG on National Fuel land under the firms’ joint venture suffered a blowout in early June that focused attention on the dangers of drilling and led to a $400,000 fine against EOG by Pennsylvania regulators.

Smith said National Fuel had nothing to do with the well, beyond providing the land. “I wasn’t happy about it, I can tell you that,” he said.

The increasing drilling in the Marcellus region also is raising concerns from residents and environmentalists over the potential impact that it could have on ground water supplies.

Marcellus wells are drilled using a technique called horizontal drilling that goes straight down, just like a traditional well, then turns and proceeds horizontally, enabling the well to capture gas within the narrow shale layer far beyond the wellhead.

But that technique also uses vast amounts of water — upwards of 3 million gallons — mixed with sand and other chemicals, to fracture the rock and release the gas. Environmentalists are concerned that the chemicals could get into water supplies. Industry officials say proper drilling techniques can prevent any infiltration.

Smith noted that National Fuel, in one instance, is using water discharged from an abandoned coal mine that was polluting a nearby stream. National Fuel can use up to 500,000 gallons per day from the mine’s discharge, enough to fracture up to three wells per month. The $3.7 million system, which includes a pipeline system to supply all the water needed by its wells in Tioga County, will reduce National Fuel’s water costs by about $120,000 per well. The company also recovers and reuses most of the water.

“We don’t really have a problem with stricter regulation,” Smith said.

But the Marcellus region isn’t just about wells to National Fuel. The company also is moving to expand its pipeline network to help bring the gas from the region to markets in the United States and Canada.

The company already has completed a $22 million project to build an eight-mile pipeline system to gather gas from new wells in Tioga County and build a new compressor station on another line.

National Fuel also has plans for $224 million in expansion projects on existing pipelines in the region, along with a $260 million portion of its proposed West to East pipeline project stretching between Overbeck and Leida, Pa.

Still, with so much focus on Pennsylvania, Smith said National Fuel, which considered moving its headquarters to Erie, Pa., eight years ago, is committed to remaining in Western New York, where the company employs 1,236 people, including 486 at its headquarters on Main Street in Amherst.

“Frankly, I think it’s important that we remain headquartered here,” Smith said.