Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

"Pricing power" almost counts as a taunt in the bombed-out natural-gas production business. Range Resources is somehow making a go of it anyway.

That "somehow" relates mainly to its recently closed $4 billion acquisition of Memorial Resource Development. When announced in May, this all-stock deal looked like a clever way of cutting Range's leverage. But, as hinted at by third-quarter results, it had an added strategic benefit: It got Range out of the Marcellus box.

The Marcellus shale in the eastern U.S. is a powerhouse, accounting for a fifth of the country's natural-gas production. And Range Resources has the third-largest acreage position of any E&P company in it, according to Bloomberg Intelligence. Having a lot of gas is great, if that's what you produce -- unless it's too much for the local market to absorb and there aren't enough pipes to take it away to customers elsewhere, which is pretty much where Marcellus drillers find themselves.

As you can see here, the bottlenecks in America's natural-gas pipeline system mean there's really no such thing as "the gas price":

Location, Location, Location
Excess natural gas supply in the Marcellus shale has caused local price markers like Dominion South to disconnect from the Henry Hub benchmark
Source: Bloomberg

For Range, the slight premiums it once earned on its gas have flipped to steep discounts ...

Dogged Discounting
The realized price on Range's gas has been running roughly a fifth below already depressed benchmark prices since the start of 2015
Source: Bloomberg, company filings
Note: Range Resources' realized prices exclude the impact of hedging.

... which has had a predictable effect on Range's margins (NB: These are all-in margins after not just production costs, but also non-income taxes, interest and overhead; see here for a full explanation of Gadfly's E&P cost analysis):

Evaporation
Range's unit margins have collapsed to almost zero
Source: Company filings, Bloomberg Gadfly analysis
Note: Profit is realized price before hedging less production and transportation costs, non-income taxes, G&A, and interest. Liquids converted to a natural gas at a ratio of 1 barrel to 6,000 cubic feet.

Memorial, meanwhile, hails from the South, focused on the Terryville shale in Louisiana, where gas prices are much better:

Southern Comfort
Memorial's gas gets much higher prices than can usually be found in the Marcellus shale
Source: Bloomberg

The Memorial deal had barely closed before the end of the third quarter. Even so, Range saw a modest increase in its realized gas price compared with a year earlier, of 17 cents per thousand cubic feet versus just a 10-cent bump in the average for Henry Hub. Looking ahead, the company expects its average discount to headline gas prices to narrow from about 46 cents to between 30 and 35 cents in 2017. That adds up to a lot of cents when you're producing more than 1.2 billion cubic feet a day (plus liquids).

Beyond a cleaner balance sheet and better pricing, though, there's a bigger strategic benefit for Range: the power of choice. When beholden to the Marcellus, Range's ability to invest there was largely in the hands of companies building new pipelines to get gas out, or extreme heat or cold causing spikes in local demand. Adding Memorial's assets has given Range an option to grow even when bottlenecks or mild weather keep Marcellus pricing muted.

The latter, with its gargantuan reserves, remains the bedrock of Range's long-term value, of course. But its new assets help smooth the path towards it. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net