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Range Resources: Infrastructure, Safety Concerns Biggest Bar

Mark Hanson, CFA

Mark Hanson: Hi. I'm Mark Hanson, equity analyst with Morningstar's energy team. I am here today with two members of Range Resources' senior management team Ray Walker and Rodney Waller. Gentlemen, welcome.

Rodney Waller: Good to be here.

Ray Walker: Good to be here.

Hanson: So, we're at the Morningstar Management Behind the Moat Conference, and two of the elements that we think about with economic moats are: how much is the cost to produce the oil and gas that you have rights to, and what can you ultimately sell it for. Range excels on both accounts. Maybe walk us through some of the factors that contribute to your outperformance on those elements?

Waller: Well I think the company has always been focused on the cost structure, even when we were in high-commodity-price environments. We've also achieved this by selling some of our more mature properties and being able to reinvest that cash into higher growth. In 2011, our operating cost was probably about $0.80 per Mcfe at the 1st of the year, and at third quarter it was $0.58. So you sold off the Barnett shale which was about $0.83, while the Marcellus shale is $0.35-$0.40 in operating cost. So you significantly improved your profit margin on that.

If you look at $3.50 gas in the wet-gas area with a Btu and the cost, you've got about $0.80 finding cost for a Marcellus well. When you look at the cost to produce it, at $3.50 you basically have a 50% profit margin, and at $5 you have a 70% profit margin. So when you have high-rates-of-return projects and you make those very, very repeatable is going to translate into big shareholder growth. But you've got to be focused on that every day, and Ray and a lot of his staff and his teams are focused on that every day. How you reduce costs.

Walker: It's really a cultural thing, I think that comes from the top down and very early at Range. Back in 2003 or so, we put a real focus on generating consistent double-digit production growth at a top-quartile cost structure. What that really means is taking things of the bottom of the pile, monetizing them, and taking that money and investing in high-rate-of-return projects. I think that real consistent focus on per-share growth of production, reserves, on keeping our balance sheet very simple, and doing things right, that permeates to the whole team. It's like your mother used to tell you, it's a lot cheaper to do it right the first time, and we see that.

Hanson: So you've got several years worth of inventory, a decade plus. What's the biggest governor to growth right now especially in the Marcellus, you core area?

Waller: Well, I think day in and day out its building infrastructure in the midstream. We are blessed with great rock, great productivity, which is different than what Appalachian has seen. So even if you had infrastructure in an area, it cannot accommodate the volume and the pressure.

So with our midstream partners, we are building those, but with our very large area in the Southwest, we probably have 500,000 acres. In the wet-gas area, we own 80% of that. So you are building track-by-track, pad-by-pad all the necessary compression and gathering. So you've got an upfront task, but as you get to 2013 and 2014, it actually gets easier because you've built the initial infrastructure in there.

So we're still evaluating. It's still very, very early, but it's just really being able to get the necessary connections to the existing pipelines that are very large and have been there for 50 years to utilize. But the resources keep getting bigger. What we built three years ago, probably is a little bit too small today, but it's rightsizing all of that and really being able to move that forward. We have good partners and great rock, but you are just building for the very first time infrastructure that you are going to need for the next 20 years.

That's really the unique story of the Marcellus is that you have a very small company with a very talented staff, who could see the attributes of what the play looked like. And you are able to accumulate these really key areas, especially in the wet-gas area, the liquid-rich area in the Southwest.

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You've never had a company this small accumulate so much legacy assets and what we thought was a very resource-rich area. Then after time, to sit there and find out that there is the upper Devonian, 150 feet above the Marcellus, and then you've got the Utica below it. So, now you find yourself in the first stack pay shale area where the Marcellus is marvelous, but what does that do you enhance, the rates of return.

So, the way shareholders really brought us here, we want them to get the value of a stack pay shale play and the highest rates of return in the U.S., being very prolific. But what you have is you are sitting in the markets of Boston and New York and you've put that resource right on top of 50 years of infrastructure build-out in the major transmission pipelines.

Therefore, not only do we have the opportunity to market the gas to Boston, to New York, but we are selling gas to Chicago, will be moving gas to Canada, and will be moving gas to the Gulf Coast because the infrastructure is already there.

So, your previous question, what's our challenge? Our challenge is get to the pipeline. So, that’s the one piece that we don’t have and that’s our challenge, and Ray and his team is obviously up to that task.

Hanson: Ray, your title is environmental safety regulatory. Headlines have been made recently about hydraulic fracturing and its potential impact on the environment. Maybe if you could speak to some of the challenges that Range might face either perceived or real surrounding that, and then ultimately you think maybe some of these environmental groups, some of their potential impact on the company's operations?

Walker: Sure. Hydraulic fracturing is a term now in which if I could do anything 30 years ago, I wish, we had never used that word because fracking is now slang for everything bad associated with fossil fuels. We’ve had people go up on the drilling rig floor and see the drill pipe turning in the rotary table and they say that’s fracking right there. So it’s kind of almost funny. But it’s really not funny. In that, the public is really concerned, and our industry has done a horrible job of dealing with those concerns.

For many, many years, it was, tell me what the rules are, that’s what we'll do. We’ll figure it out, and we’ll stay out of the press. And if we’re out of sight and out of mind, everything will work and everything will be happy, and that worked for a long time. It worked in West Texas, it worked in Oklahoma, and it worked in Louisiana. But it's not going to work in the Northeast. We should have recognized that sooner, and we should have dealt with more education and so forth.

Now, the good news, fast forward in time a few years, Range is very proud of how in July 2010, we publicly disclosed all of the additives that we’re putting in our frac fluids on a well-by-well basis. Today, industry is grabbing that with both arms, and everybody is doing it. Since we’ve done that, we’ve yet to have one single question.

I'd sum it up this way in that there is fringe element on each side of the argument. There are people that used to say "not in my backyard," now they say "BANANA" which is "build absolutely nothing anywhere near anything." But you got people on our side that want to do whatever they can do for the almighty dollar, and the rules are good enough for them, and we shouldn’t have to worry about it.

Neither one of those are right. Unfortunately, that’s all we ever read about in the newspaper or on TV, those fringe elements. Through the coalition and through a lot of internal efforts at Range, we’ve learned that if you sit down with people and talk to them, 95% of the time you will agree on 95% of the things you talk about. I can refer to the Environmental Protection Agency today on our hydraulic fracturing study. If you look at everything that’s evolved during the last year since that study was announced, it is real clear that the people and the scientists at the EPA realize that hydraulic fracturing is not an issue.

It is not affecting ground water. But what they do realize is the way we handle chemicals on the surface, the way we handle flowback waters, the way we handle withdrawal of waters, the community impacts, and the construction standards of the well, the pipe, and the cement itself, those do matter. And you're seeing them shift that whole study toward that.

There are probably 15 different best-management-practice efforts going on across the industry trying to say, "OK, we can no longer just say 'Tell me what the rules are and that’s what we'll do.' We’ve got to do better. We can do better, we should do better." What we're now learning, what I'll tell you is, if you go up here and do it better, it will save your money. We've seen it time-after-time-after-time, and we have to gradually bring regulations up to that point. That's only going to happen with education, outreach, and participation in a lot of industry organizations like America's Natural Gas Alliance, of which we're a proud member. Chairman and CEO John Pinkerton's serving in leadership role there. I'm the current chairman of the Marcellus Shale Coalition, which is also doing that work centered around the Marcellus, and you're just seeing a huge wakeup of the industry to go deal with those and in open, honest, transparent manner.

So, the bottom line is it will affect your bottom line, if you don't deal with it. We can no longer ignore it because our long-range plan at Range, we want to do it ourselves, we want to do it organically. This is because we believe for the shareholders, which we are all shareholders, that's the best way we're going to increase our net worth. So, the best way we're going to increase net worth of the people that own shares of Range stock is going to be do it ourselves. We have to assure ourselves that we can sustain that kind of activity for many years to come.

If we don't deal with the communities effectively, if we don't answer their concerns, if we're not transparent and honest about what we're doing, if we don't protect the environment, and if we don't do it safely, we won't be able to do that. And we can't depend on somebody else to do it for us. We have to take an active role each and every one of us, no matter how big Range is, we all have to do it. So the good news is what I call Ray Walker's, you can quote me on this, reasonable man theory.

Most people are pretty reasonable if you listen to them, you address their concerns, and you care about what they're thinking and what their concerns are. We've seen that time after time, and the good news is I think we're at the hump and we're going over. People are waking up, there are jobs, and there is economic impact. People are saying "They can protect my water, they can't protect my air, and they're not going to hurt people. I think we're seeing that happen."

So, we're happy with where things are going, but we can never take it for granted. And we can never slack off, and that's one of the reasons I looked forward to coming back to Fort Worth, Texas, in that role for the company to try to work on long-term sustainability for the company and that's really what it was about so.

Hanson: Well, thank you guys, both so much and for sharing your insights and coming to Morningstar's management behind the moat conference.

Walker: Thank you, for.

Waller: Good to be here. Thank you.

Hanson: Thank you.