Oil Shale News

From: Wall Street Journal

By RYAN DEZEMBER And BEN LEFEBVRE

HOUSTON—Moves by Chesapeake Energy Corp. and Devon Energy Corp. signal that eastern Ohio’s newest oil-shale field is so rich that it could trigger a Rust Belt oil revival—and perhaps reverse the fortunes of the battered East Coast refining industry.

If the Utica Shale holds as much oil as some producers and analysts think it does, a new source of relatively cheap domestic oil could boost the razor-thin profit margins of local refineries that must now source oil tied to European benchmark Brent, which is trading at a premium to most crudes that come from the interior of the U.S.

Although some refiners are taking a wait-and-see attitude toward the Utica shale, Findlay, Ohio-based Marathon Petroleum Corp.’s Chief Executive Gary Heminger made no bones about the impact production would have in bringing crude oil directly to the company’s refineries in Ohio and Kentucky.

“We will have a tremendous appetite if they can develop the [Utica] crude source,” Mr. Heminger said during a recent conference call with investors.

If producers have any estimates of how much oil the Utica holds, they are keeping them to themselves. But leasing activity and excited explorers portend a bonanza, analysts and executives say.

The Utica is a deeply buried rock formation that sprawls below parts of eight states from Tennessee to New York. But it is eastern Ohio where explorers believe the richest oil reserves lie and where, for the past year and a half, some have quietly amassed vast land holdings.

Chesapeake, which makes a business of buying drilling rights in unexplored areas and then selling stakes in the fields once oil and natural gas are found, said the roughly $2 billion it spent for drilling rights on 1.25 million acres in eastern Ohio could now be worth 10 times that much now that it has drilling results.

“The Utica should emerge as a key driver in the future growth of U.S. energy supplies,” Chesapeake Chief Executive Aubrey McClendon said during a July 29 conference call with investors.

Chesapeake has drilled 15 Utica wells this year without saying what exactly, or how much of it, has come out of the ground. But the results have prompted it to say it will expand the number of rigs working there from five to 40 by the end of 2014.

Meanwhile, Devon recently disclosed that it acquired 110,000 acres in the region and plans to drill three wells there this year.

The recent disclosures by those companies, which have long track records of ferreting out prolific shale formations, have helped propel lease prices to about $4,000 an acre, about double what they were a month ago and as much as eight times the rates at the start of the year, said Manuj Nikhanj, head of energy research at trading house Investment Technology Group Inc.

“If you say it’s worth $15-$20 billion, you’re saying it’s a home run,” Mr. Nikhanj said. “In two to four months we should see some [production] rates because there’s a lot of pressure from the investment community.”

A boom in northeastern U.S. oil production would throw a lifeline to fuel refiners in the region, some of which have been there for more than a century. Besides Marathon Petroleum’s two refineries sitting atop the Utica shale, BP PLC’s refinery in Whiting, Ind.—originally built in 1889—is nearby.

Just as importantly, production from the Utica could lift refineries east of the Alleghenies. Refineries run by Sunoco Inc. in Pennsylvania and PBF Holdings in New Jersey and Delaware have little access to the oil being produced in the so-called mid-continent area, where shale formations like the Bakken in North Dakota and the Eagle Ford in south Texas have led to lower prices amid a supply glut in the oil storage hub of Cushing, Okla. ConocoPhillips, Valero Energy Corp. and other refiners with access to Cushing crude have seen their profit margins soar this year.

Instead, East Coast refiners often have to pay prices based on Brent, which has cost as much as $24 a barrel more than mid-continent benchmark West Texas Intermediate. The premium paid for oil in the region—and the competition from fuel imported into nearby New York Harbor—has caused some refiners such as Valero to exit the Northeast.

Utica oil would therefore hit a pricing sweet spot, as East Coast refiners might happily pay prices higher than those for Cushing-based WTI to enjoy any discount to those for Brent, said Michael Wojiechowski, refining analyst for Wood Mackenzie.

“The Utica guys will get a better price than sending it to Cushing, the northeast refiners get crude cheaper than Brent, and then the guys in the mid-continent will have fewer barrels to compete against,” Mr. Wojiechowski said. “Everyone is better off.”

It may still be too early for Northeastern refiners to count on lower crude costs, however. Even if the Utica shale contains the wealth of oil that Devon and Chesapeake have foretold, it could take years to reach meaningful production levels, said Tim Evans, energy analyst at Citi.

“We have some time,” Mr. Evans said. “The Utica shale isn’t going to get drilled in September.”