CNX Resources released its first quarter 2019 update yesterday, which shows the company lost $87 million, as opposed to making $527 million in profit in 1Q18. Even so, CEO Nicholas DeIuliis announced the company is upping its drilling budget from the previously announced $700 million to instead spend $885 million, largely to drill more “deep dry” Utica wells. Go big or go home!
In January, CNX said it would drill roughly 72 new wells this year. Scrap that! Now it’s 86 new wells. But here’s the kicker–those new Utica wells CNX wants to drill will be in Pennsylvania, not Ohio. In fact, CNX is putting their drilling work in Monroe County, OH on hold to concentrate on drilling more Utica wells in southwestern PA. The plan, according to DeIuliis, is to drill “deep dry Utica” wells.
“When we disclosed our 2019 minimum activity guidance in February, we discussed our intention to assess performance and data before committing to significant incremental activity in the Utica,” continued Mr. DeIuliis. “Since then a number of developments have helped us to continue to build confidence in the deep dry Utica program. First, CPA Utica type curves continue to perform. Second, drilling efficiencies in the SWPA Utica region create confidence in the ‘D’ of drilling and completion (D&C). Third, refined completion designs should reduce the ‘C’ of D&C. Although we still desire production data for the SWPA region to refine type curve projections, these advancements place us in a position to commit to measured incremental activity for 2019 and early 2020, most of it being in the deep dry Utica.” (1)
As for the decision to go big (spend more) on the drilling & completions program:
For 2019 and 2020 combined, updated capital spend is approximately $885 million in D&C capital to turn-in-line (TIL) 86 wells, which includes approximately $15 million associated with the Shaw 1G event. This compares to the previous guidance of spending approximately $700 million in D&C capital to TIL 72 wells across 2019 and 2020. The incremental activity of 14 wells consists of: 11 deep dry Utica and eight Marcellus wells, less five Monroe County, Ohio, Utica wells that have been deferred as part of the updated guidance. The 11 incremental deep dry Utica wells have substantially lower operating costs, compared to Marcellus wells, and produce meaningful risk-adjusted returns, despite having modestly higher capital costs.
CNX produced 133 billion cubic feet equivalent (Bcfe) of natgas in 1Q19, an increase of 3% from the 130 Bcfe produced in 1Q18. That works out to be 1.48 Bcfe per day.
In 1Q19 CNX used five horizontal rigs to drill nine new wells. CNX used two frac crews to complete 14 wells, including: 7 Marcellus wells in Greene County, PA and 7 Marcellus wells in Washington County, PA. CNX turned-in-line (connected to sales) 18 wells in 1Q19, which included: 13 Marcellus wells in Greene County and five Marcellus wells in Washington County.
Here’s the complete, official CNX update, including financials:
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During the conference call to update analysts, the Shaw 1G Utica Shale well in Westmoreland County came up. You may recall that CNX was fracking the Shaw 1G in January when they detected “a strong drop in pressure” and stopped fracking (see CNX Hits Major Problem Fracking Utica Well Near SWPA Reservoir). Turns out the well was “communicating” (i.e. losing gas to) several nearby conventional wells. The problem was a faulty well casing, which ended up forcing CNX to plug the Shaw 1G, costing big bucks (see CNX Faulty Utica Well in SWPA Will Cost Company $30M+).
DeIuliis had the following to say about Shaw 1G and other wells using the same casing:
Now last quarter we had a challenge and it presented itself to our team, and that of course was the Shaw 1G Utica Shale well in Westmoreland County, where we experienced a pressure anomaly during completions. Following the successful remediation of the Shaw well and a comprehensive investigation, we believe the casing breach was caused by a confluence of a couple of things. Environmental factors, pressures and a material failure in the type of pipe that we used in the well.
So Shaw 1G is currently in the process of being permanently plugged, four drilled but not yet completed wells including three on the Shaw Pad, contain the same casing as the Shaw 1G. The casing on these four wells will be isolated through the use of a liner, which effectively serves as an additional string of pipe before completion operations are commenced in order to ensure the integrity of pipe movement forward.
As a precautionary measure, on a forward-looking basis, we have seized use of such pipe across our operations where the identified combination of environmental factors and pressures could be present. And for our updated guidance and subject to of course the final DEP approval, we expect to complete the remaining Shaw wells on that pad in 2019. So responsibility, it’s first on our list of values for a reason, and that’s why we extended the investigation on Shaw 1G well across our operations. (2)
CNX Chief Operating Officer Tim Dugan shared the following insights about the company’s drilling program:
Looking at Slide 4. Production in the first quarter was 133 Bcfe or 3.5% increase over the same period last year. As expected volumes declined modestly compared to the fourth quarter last year as the 2018 development program peaked late in the third quarter.
Marcellus volumes increased almost 35% year-over-year as most of our development activity remains in the core Southwest PA Marcellus area. Utica volumes declined about 30% compared to last year because of the divestiture of our joint venture assets in the Ohio wet Utica.
Now looking at costs. We continue to see strong quarterly production cash cost and cash margins of $1.11 and $1.86 per Mcfe respectively. Fully burdened cash costs which include production cash costs, plus all other cash expenses declined 6% compared to the first quarter of 2018, while fully burdened cash margin improved by 6%.
And also of note, Utica production cash costs were just $0.47 per Mcfe in the quarter. Our cost performance continues to be driven by relentless attention to lease operating expenses and our advantage transportation gathering and compression profile compared to peers. We expect this cost advantage to become even more critical over the next couple of years facing a backward dated stripped pricing environment.
Now looking at Slide 5, we turned-in-line 18 wells in the first quarter, all of which were in the Southwest PA Marcellus. At the end of the quarter, we are running five horizontal rigs, two in Southwest PA Marcellus, two in Southwest PA Utica, and one in the West Virginia Marcellus. As Nick mentioned, we did add some incremental activity to the prior minimum guidance which the majority is additional deep Utica wells.
At year-end 2019, we expect to have turned-in-line 62 wells and have started activity on an additional 24 wells that will turn-in-line in 2020. Those 86 wells compared to the 72 wells highlighted last quarter. One thing to point out last quarter, we highlighted that we expected 12 Utica turn-in-lines across 2019 and ’20, and we now have 18.
The 12 Utica wells included a five well pad in Monroe County that is now being deferred and replaced with Pennsylvania deep Utica wells. So our deep Utica well count is actually up by 11 wells out of the 14 well increase. This addition of deep dry Utica well should highlight our continued excitement regarding the prospects for the Utica formation and its impact on the future of CNX development.
Slide 6 highlights our 2019 development program and capital. This is an update of what we provided last quarter. The main take away here is that we now expect to turn-in-line 86 wells across 2019 and ’20 combined for approximately $885 million of D&C capital, which includes approximately $15 million related to the Shaw Event. This compares to the $700 million of D& C capital for 72 wells we highlighted last quarter. The table at the bottom of the page helps reconcile some of the plan changes.
With this updated guidance, we’re adding 11 deep dry Utica wells and eight Southwest PA Marcellus wells. However, we have deferred five Monroe County Utica wells which were in the previous guidance. If you look at the summary table, it appears that we’re only adding six Utica wells but we are in fact adding 11 deep Utica wells.
Moving on to Slide 7. Let’s look at the some of the highlights from the core Southwest PA Marcellus area. As I mentioned, the majority of our activity has been in this piece of our portfolio and specifically in the Morris and Richhill areas. Those fields have legacy wells that we’re able to use as a comparison for our latest batch of activity. Across the Board, we’re seeing improved operational efficiencies and higher EURs.
As an example, in Morris, our EURs have increased more than 110% from the legacy wells turned-in-line back in 2012 and 2013. In Richhill, EURs had increased by about 35% when compared to the much more recent legacy wells turned-in-line in 2015 and 2016. But most importantly, these new wells in both fields are flowing at or above our expected type curves.
A similar story can be seen on Slide 8 where operational efficiencies in EURs have both improved in our Ohio dry Utica SWITZ Field, where we have a couple of remaining pads left to develop. We expect to apply some of the recent lessons to the new locations. That includes optimized proportions with specialty sands, total sand per foot and inter-lateral spacing.
The other advantage of the Ohio dry Utica development program is that it has provided a range of insight that can be applied to Southwest PA and CPA deep dry Utica programs. Data on optimal lateral spacing, sand loading and speciality sand mixes are invaluable to the field and completion design schemes being implemented in Pennsylvania as we speak.
Now on Slide 9 is the Perfect Pad concept that we first introduced at our Analyst Day in March of last year. In the last 13 months, we begun implementing several of the key elements of the Perfect Pad that drive capital efficiencies and improve EURs. For example, Cellar technology for subsurface well heads is being used on 11 pads where return trips are planned, which drives savings related to stack pay development.
Our 3D seismic data set drives decision making and where to place lateral as well as how to execute the drill plan. The high pressure low pressure two pipe gathering system is under construction in the Richhill area, which will facilitate our full-scale stacked pay blending strategy.
And lastly, I’d add that we’ve updated our acreage by type curve area in net developed locations that ties to the figures released in our 2018 10-K. The only major change from last year is that the Ohio wet Utica area has been divested as reflected on the map and these slides can be found in appendix. (2)
Here’s the slide deck Tim was referring to as he moved through his prepared presentation:
CNX-first-quarter-2019-earnings-call-slides
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During the Q&A portion of the call, the following back and forth shed more light on the Shaw 1G problem:
Joe Allman
So I’ve got a follow-up on the Shaw 1G. One of the factors you mentioned is environmental. Could you just elaborate on what you mean by environmental factors and how do you know about those factors before you drill the well?
Nick DeIuliis
We did a pretty thorough review of the Shaw incident and brought in a lot of independent experts to help us out with that. Really majority of the date and information pointed to a material failure that was caused due to the high tensile strength pipe being used when exposed to certain environmental conditions. That pipe tends to become brittle and is more prone to environmental stress cracking.
Some of the environmental conditions there – certain temperature ranges the presence of hydrogen that can lead to that. But these findings it wasn’t just something that we came up with ourselves. We had independent experts working with us and confirming and providing thoughts on data to confirm what was being found.
Joe Allman
And just to confirm so it sounds that you might use the same casing in certain circumstances, but in other circumstances where the same environmental factors might exist you’re going to use different casing?
Nick DeIuliis
We have modified our casing program going to a more – put it simply a more ductile pipe that is not prone to embrittlement. But there are areas that – like in our laterals where the temperatures and the pressures are – they are not an impact and the brittleness is not an issue. We may use some of this pipe, but we have – overall we’ve changed our casing design. (2)
Why CNX wants to spend more money in 2019 that in some cases won’t bear fruit until 2020:
Jane Trotsenko
That’s very helpful. Could you maybe explain why exactly you decided that you add incremental activity in 2019 to kind of deliver higher production growth in 2020? What was the motivation by doing that?
Nick DeIuliis
Sure. This goes back again to the rate of returns driving our decision-making. So when we look at the incremental activity whether it’s the capital or the production that will come from the capital investment, we are ultimately looking at the rate of returns and a leading the rest of those metrics become more results versus what we are solving for, we are solving rate of returns. And the risk associated with those rate of returns.
So when we look at our hedge book, particularly for 2020 and 2021 which will be a big determinant of revenue in the front two years of a shale well is going to be a big determinant of the alternative rate of return just because of the well profile. Being able to take that uncertainty off the table and knowing for certain what the hedge book, what the realizations will be that gave us confidence in rate of returns.
We talked about, we didn’t say much on this call actually but we’ve talked about the past quite a bit about the Marcellus and we’ve done some updating of performance metrics in the Marcellus and certainly it continues to perform and frankly outperform.
So with respect to well profiles and the Marcellus and then we talked through on some earlier questions about the confidence that we’re growing with new well profile in the CPA Utica, our drilling complete cost in the Utica. Because of the drilling efficiencies we’ve recently seen in Southwest PA and our completion designs that we refined with respect to Central Pennsylvania and Southwest Pennsylvania Utica.
You add all these together, basically the rate of return that we see coupled with the risk and the uncertainty tied to it put us in a position where we believe it’s prudent to invest in that capital if for solving for intrinsic per share value. (2)
(1) CNX Resources (Apr 30, 2019) – CNX Reports First Quarter Results and Provides Updated 2019 Guidance
(2) Seeking Alpha (Apr 30, 2019) – CNX Resources Corporation (CNX) CEO Nick DeIuliis on Q1 2019 Results – Earnings Call Transcript
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