CNX: A CBM and Shale Gas Play

By Chang, Ellen

Since its spin-off in 2005 from Consol Energy, CNX Gas has ramped up its coalbed-methane drilling and acreage, and is moving into shales as well. CNX Gas Corp. is the second-largest coalbed-methane producer in the Appalachian Basin with more than 20 years of CBM experience. Since it was spun off in 2005 from former parent and giant coal producer Consol Energy Inc., CNX is maximizing that experience. It has increased its acreage, employee count, producing wells and stock price.

CNX was spun off because Consol believed the stock price did not reflect the true value of its CBM gas assets, which were overshadowed by coal. Consol anticipated that with a focused management team and direct access to capital markets, CNX could more quickly drill its extensive CBM acreage and unlock more value.

That strategy is coming to fruition. In 2008, CNX expects to drill more than 500 CBM wells, up from an estimated 346 in 2007 and 274 in 2006. It controls 3.7 million gross acres, up 340% from the 1.1 million acres it controlled at the time of the spin-off. And, the company is moving into gas-shale plays in the basin.

The challenge for CNX is to monetize these assets as quickly as possible, says Nicholas Deluliis, president and chief executive, based at headquarters in Pittsburgh.

Since CNX is a low-cost producer, CBM-related acquisitions have been difficult to justify, he says. However, it did make several acreage purchases in 2007. In June, it was involved in a $66.5- million transaction involving two other parties. Consol Energy and Peabody Energy.

The deal involved shifting assets to the company that was best able to monetize them. Deluliis says. Consol Energy transferred a block of coal to Peabody that enabled it to extend the life of Federal No. 2, a mine in northern West Virginia. Peabody then transferred the rights to the CBM on more than a million acres to CNX, which provided some cash to Consol and Peabody.

President and chief executive Nicholas Deluliis is ramping up coalbed and shale drilling budgets in 2008.

“CNX had the experience and technology to more quickly develop the CBM on Peabody’s 1-million-plus acres of coal, and Consol Energy was able to receive cash, which it quickly redeployed with its purchase of Amvest Corp.,” says Deluliis. “So. this was a win-win- win transaction for the shareholders of all three companies. The transaction also highlighted a benefit of having Consol Energy remain as a majority shareholder of CNX.”

CNX Gas now plans to drill shale wells in the New Albany and Marcellus plays. (Photo courtesy of CNX Gas Corp.)

To handle the increase in production, the company has boosted its employee count to 270, compared with about 100 in August 2005.

“The growth has been balanced between field personnel and corporate staff,” says Deluliis. “As we were concluding the Consol/ Peabody transaction, we realized we’d need to beef up the asset assessment team.”

In 2008, CNX will evaluate its existing properties area-by-area to determine whether it makes sense to develop that acreage with an experienced partner or conduct a stand-alone exploration effort. Deluliis says.

“In all cases, the goal will be to maximize net present value.” he says.

EVOLVING STRATEGY

Continuing to advance this strategy, in 2007, the company signed an agreement with coal miner Massey Energy Co. to develop 20,000 acres adjacent to its existing Mountaineer CBM play in southwestern Pennsylvania.

“Our goal in 2008 is to make this a showcase project,” Deluliis says. “We want to drill a lot of this acreage and show others how we can add value for their shareholders by working with us.”

Investors can also expect to see more emphasis on exploring shale acreage in 2008. “We’re formulating our plans now. but what I can share with you is my determination to maximize the net present value of this acreage…I think it means we’ll begin to evolve into more of an E&P company instead of a gas-manufacturing play, which is how some investors now characterize us.

“I would expect us to have a stand-alone exploration budget in 2008. something we haven’t had before. What I don’t want to do is save these assets.”

Traditionally, CNX has produced CBM from vertical frac wells, horizontally drilled wells, and wells drilled in active and sealed mining areas in the Appalachian Basin. CNX, which has developed its own CBM technology, expects to produce 73 billion cubicfeet (Bcf) in 2008, which includes 60 Bcf from Virginia, 10 Bcf from the Mountaineer CBM play in southwestern Pennsylvania and northern West Virginia, and 3 Bcf from the Nittany CBM play in central Pennsylvania and other areas.

The Virginia gas production assumes an early January 2008 start- up from the now-idle Buchanan coal mine.

“As a low-cost, high-margin producer, we’ve been in the fortunate position of being able to grow production without adding debt. This is unusual for this industry. In 2008. we may need to borrow some money to fund a portion of our exploration and non-drilling capital needs.” says Mark Gibbons, senior vice president and chief financial officer.

MOUNTAINEER CBM

Before the spin-off two years ago, CNX was mostly a Virginia CBM player. The CEO’s first task was to establish a second front. That’s when Deluliis targeted 523,000 acres in the company’s Mountaineer CBM play in southwestern Pennsylvania and northern West Virginia.

In May 2006, the first committed rig arrived, and by September 2006, CNX announced that by using its “turkey-foot” drilling pattern, the company’s horizontal drilling was proving commercially viable. Now the company has five rigs running in Mountaineer. In 2008, the company expects to drill about 100 wells there and produce 10 Bcf. The drilling budget is about $80 million.

The current position in Mountaineer is 686,000 acres. CNX also had to build new gathering and processing infrastructure in the area. The average depth of these horizontal wells is generally 600 to 800 feet. Drilling and completion costs total about $800,000, with another $100,000 for gathering and processing.

One significant development in Mountaineer was the leasing of a 20.000-acre package from Massey Energy. This represented CNX’s first step-out opportunity from Consol-owned or leased coal. CNX intends to develop the Massey reserves in 2008 as a showcase project to show how the company can add value for shareholders of other coal companies.

It has also accelerated drilling in Virginia, where it has 355,000 acres. The company operates primarily in Oakwood and Middle Ridge fields in southwestern Virginia, just east of Nora Field. These three fields contain some of the gassiest coal in the Western Hemisphere, with gas content between 450 and 600 cubic feet per ton, says Deluliis. If combined, the three fields might be among the 10- largest in the U.S., he adds.

CNX drills vertical frac wells in Oakwood Field on 40-acre spacing and in Middle Ridge Field on 60-acre spacing. Oakwood comprises about two-thirds of the company’s 267,000 acres while Middle Ridge comprises the remainder. An additional 88.000 acres in Virginia have yet to be drilled. CNX tested 30-acre spacing at Middle Ridge in 2007, but results from this tighter spacing are not yet available. If successful, however, 30-acre spacing could result in several hundred additional locations above the current estimate of 2,600 future locations.

The company expects to drill 300 wells in Virginia in 2008 and produce 60 Bcf. The drilling budget is about $90 million.

In 2007. the Virginia operations benefited from having the Jewell Ridge Pipeline available all year, with the line opening in October 2006. This second line has dramatically reduced the risk of production curtailment.

CNX recently expanded frac-well drilling in Virginia. In 2005,173 wells were drilled: in 2006, 257 wells were drilled; and in 2007, 278 wells were to be drilled. The average depth is between 2,000 and 2,500 feet with drilling and completion costs of about $300,000.

NITTANY

In central Pennsylvania, at an area called Nittany. CNX began production on November 1, 2007. The company has 248,000 acres in this play.

“I’m especially proud of this area, because it’s the first play that we developed from concept to production, and in a scant 14 months.” Deluliis says. “Here, we are drilling vertically into the Mahoning. Upper Kittanning and Freeport seams. Our initial wells are exceeding our type curves, producing at average flow rates of about 80,000 cubic feet per day. We’re still actively leasing in this area, so I can’t be any more forthcoming. In 2008. though. I do expect to drill about 100 wells and produce about 3 Bcf [billion cubic feet] from Nittany. as well as from some other areas.”

At the end of 2006, the company first drilled two vertical tests to about 1,000 feet with seam-by-seam fracturing. The wells showed average flow rates of 80,000 cubicfeet each after only two to three months. Since the company expected to see 45,000 cubic feet per well after about two years, the results have exceeded average field expectations.

CNX also constructed a 48,000-foot gathering system that included two compressor stations and a measuring and regulating station. In May 2007, seven additional wells were also drilled.

CNX continues to actively lease in this area. Well completion costs have been about $200,000 per well. The company’s preliminary plans are to drill 100 wells in Nittany in 2008 with a drilling budget of about $20 million. MOVING TO SHALES

CNX started 2007 owning 70,000 acres in the New Albany shale, a legacy position in western Kentucky. A three-well program was conducted on this acreage with the first two wells vertical and the third horizontal. Drilling confirmed the shale was about 3,800 feet deep and about 300 feet thick.

During 2007, CNX acquired additional acreage in the play. It now holds a leading position with about 300.000 acres, and has added new positions in southern Illinois and western and southwestern Indiana.

CNX continues to position itself in emerging shale plays. It holds 40,000 acres in the Marcellus shale in southwestern Pennsylvania, 134,000 acres in the Huron shale underneath its CBM field in Virginia and an additional 94,000 Huron shale acres in eastern Kentucky.

During 2008, CNX expects to establish a combination of joint ventures and stand-alone exploration efforts to begin a systematic evaluation of this shale acreage.

Deluliis says the company’s investment strategy is simple.

“CNX Gas has a terrific asset base, and something it didn’t have in 2005: a track record,” he says. “The longerterm goal is to grow total production at a compound annual rate of 15%, while generating one of the highest returns on capital in the industry.”

By Ellen Chang, Contributing Editor

Copyright Hart Energy Publishing, LP Jan 2008

(c) 2008 Oil & Gas Investor. Provided by ProQuest Information and Learning. All rights Reserved.