USRG Shale Final 6-25-13 1

Getting Ahead by Drilling Down
Valuing Oil & Gas Shale Assets to Exploit Market Inefficiency
Independent Buyside Insights

Because sector experience and reporting are not the same thing as sector expertise and analysis
Copyright 2013 Union Square Research Group, LLC
www.unionsquareresearch.com www.unionsquareresearch.com (646) 706-7633
About the Author

Nicholas Snyder has been investing in the oil and gas space for over seven years and has spent the last four of those developing an expertise in the valuation of shale assets. During this period, he has made many industry contacts through his study of geology and petroleum engineering. Prior to co-founding Union Square Research Group, Mr. Snyder headed up the research effort at a family office, where he evaluated private oil and gas opportunities among other responsibilities. He has been directly involved in the evaluation and leasing of natural resources and was interviewed in the May, 2012 issue of Outstanding Investor Digest for his work in the shale space. Mr. Snyder has been a Chartered Financial Analyst (CFA) charterholder since 2010. Union Square Research Group is pleased to be working with Wall Street Access, an independent firm with a 32-year track record of providing research and execution services to its clients. If you are interested in obtaining our research through an execution services firm, please contact Matt Treacy at (212) 232-5690.
Copyright 2013 Union Square Research Group, LLC 2 www.unionsquareresearch.com (646) 706-7633
Executive Summary
An opportunity currently exists to buy hundred-million to multibillion dollar assets for a fraction of what they are worth. For the first time, the value of oil and gas shale assets can be calculated on an NPV basis due to an increase in publicly available data and improved disclosures.
As these assets reach the tipping point in development, when there is visibility into future free cash flow and an NPV can be calculated, the market will adjust and this opportunity will disappear.
*See End Notes for sources
Copyright 2013 Union Square Research Group, LLC 3
Contents
Overview Basic shale play evaluation Evaluating leasehold Case study Conclusions
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Opportunity
Before the real estate crash, real estate assets were valued based on a multiple of expected future income at full occupancy.
After the crash, gun-shy analysts focused solely on current cash flow. Sophisticated investors, who could value properties under development, bought the best ones and made a killing. A similar opportunity exists today for investors who can value shale assets.
Current Cash Flow Value

Imagine two brand new Miami apartment buildings that come up for sale after the real estate crash. Both buildings are 90% vacant. One building is selling for a price based on the NPV of reaching full occupancy over the next few years, while the other is selling for a multiple of current income that is similar to fully-occupied peers.
This is how the market is currently valuing shale E&Ps, due to sell-side limitations
Sell-Side Limitations
Reports are limited in length and scope by their audience and business model
For the same reason the sell-side doesnt value every building in a REIT, it doesnt accurately value shale assets within small E&Ps or large diversified E&Ps
The sell-side still has a black eye from predicting huge per-acre values for gas shale assets before the commodity itself collapsed
Analysts dont want to take the career risk of making a big call before the development picture and road to FCF is crystal clear
The exception is large single shale E&P companies

Once there is a clear path to FCF, the sell-side is willing to build DCF models; consequently, single shale companies like RRC and COG trade at huge premiums to their peers
Skate To Where The Puck Is Going

The sell-side doesnt currently value many shale assets properly for structural reasons.
It will.
Analysts now have enough primary source data to accurately value these assets and capitalize before the sell-side catches up.
Solutions for Analysts

Understand the science and technology behind these emerging resource plays Talk to geologists, engineers, service firms and other boots on the ground Gather primary source data:
EARLY STAGE DATA Subsurface maps Leasing rates Permits Midstream development plans Infrastructure construction Well IP rates Leasehold development (HBP) status
DCF MODEL DATA Company production data State production data Drilling unit permits and spacing Severance tax and royalty info Regional basis differentials Completion technique and cost trends Development plans and resources
Basic Shale Play Evaluation:

Understanding an Asset
Three Levels of Analysis

Level One: geologic models, leasing data, and initial well results provide a roadmap to large area valuation Level Two: Initial type-curves, reservoir studies, larger leasehold transaction, and other scuttlebutt create a more refined understanding of core areas Level Three: larger data set of localized well results combined with study of leasehold allow for discounted cash flow (DCF) valuation of specific assets within a shale play E&P companies follow a similar process when they are acquiring leasehold in a new play
Level One: Geophysical Predictors
GROSS THICKNESS
THERMAL MATURITY
FORMATION DEPTH
ORGANIC THICKNESS
Total organic content (TOC), porosity, and the depth/temperature at which a shale has been cooked in the earths crust are the major indicators of oil and gas in place
Depth and thickness are indicative of pressure and the size of the localized reservoir that can be accessed by a horizontal well
Reservoirs are complex and the ultimate economics of an area will depend on natural permeability and the ability to which it can be increased through fracturing
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Level One: Initial Well Results
Analysts should look for clusters of good wells in areas that make sense within the framework of the geologic model It is important to make sure that big production figures are indicative of good economics and not the result of an operator drilling a huge lateral and running a well flat-out in order to report a big initial production (IP) figure to Wall Street
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Level Two: Core Area Delineation

Big production numbers (from State rather than operator data) and a high ratio of oil/gas indicates best part of the field
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Level Two: Trends in Well Economics
Valuation requires an understanding of the long-run economics of a play, which change quickly during the early stage of development as drilling and completion techniques become more efficient. As a play matures, operator efficiency and pad vs. HBP drilling drive gains.
Level Two: Scuttlebutt

Good well results and increased development budgets can have predictive value
In many resource plays, good well results and large investment plans have been predictive of an upward re-rating of acreage values by the industry, private, and public markets
Initial investments in a resource play can carry the same price-tag and level of risk as a deep water wildcat well
Even multi-hundred million dollar investments may not have good information value caveat emptor
Conservatism is paramount
Negative scuttlebutt should be used to inform when a valuation is not conservative enough rather than using positive data points to increase a valuation; announcement of large initial production figures may not be indicative of good economics
Level Three: Development Model DCF

Gastar Exploration "Super Rich" Marcellus Well Model
Processing and Differential Cost per Mcfe: $1.25 Royalty Rate: 20.0% Cost of Capital: 12.0% $ Thousands Year 1 2 3 4 5 6 7 8 9 10 11-40 Gross MMcfe Produced: 1,228.7 619.5 452.7 366.7 312.6 275.8 249.0 228.2 211.2 196.4 2,430.4 Gross Revenue Based on NYMEX: $6,943 $3,754 $2,822 $2,329 $1,975 $1,743 $1,573 $1,442 $1,335 $1,241 $15,690 Processing and Differentials: ($1,536) ($774) ($566) ($458) ($391) ($345) ($311) ($285) ($264) ($245) ($3,103) Severance Taxes and Royalties: Net Undiscounted Revenue: PV of Future Net Revenue ($1,298) $4,109 $3,877 ($715) $2,265 $1,907 ($541) $1,714 $1,289 ($449) $1,422 $955 ($380) $1,204 $722 ($336) $1,062 $569 ($303) $959 $458 ($278) $879 $375 ($257) $814 $310 ($239) ($3,021) $756 $9,361 $257 $1,279
Present Value of Future Cash Flow: $11,998

Number of Gross Future Well Sites: 100 (50% GST W.I.) ($ Millions) Year Net Wells Per Year Value of Current Production 9 Value of 2013 Drilling Program: 12 Value of 2014 Drilling Program: 14 Value of 2015 Drilling Program: 15 Value of 2016 Drilling Program: Present Value:
Cost per Well: $7,000

30.0 MMcfe/Day 2017 PV in 2018 $15,516 $78,441
NPV per Well:
$4,998
IRR:
36.5%
Valuation of Gastar's "Super Rich" Marcellus Play in Marshall and Wetzel Counties
Existing Production at Year End 2012: 2013 2014 2015 2016 $39,119 $26,295 $20,849 $17,386 $44,981 $59,974 $69,970 $74,968 $79,339 $72,667 $68,302 $62,015
$9,303
$41,990
Present Value of Current Production and Future Wells:
$333,615
Sensitivities of "Super Rich" Marcellus Valuation

($ millions) 16.0% 14.0% 12.0% 10.0% 8.0% ($0.75) $198.1 $231.9 $273.8 $326.6 $394.7 Uniform Change in Natural Gas Futures Curve ($0.50) ($0.25) $0.00 $0.25 $0.50 $214.7 $231.2 $247.8 $264.4 $280.9 $250.0 $268.1 $286.2 $304.3 $322.4 $293.8 $313.7 $333.6 $353.5 $373.5 $348.8 $371.0 $393.1 $415.3 $437.5 $419.6 $444.6 $469.6 $494.6 $519.6 $0.75 $297.5 $340.5 $393.4 $459.7 $544.5
Cost of Capital
Once an analyst has collected enough information to get a clear picture of the economics of individual wells, the number of wells that will be drilled, and the timeframe over which this resource will be developed, an NPV can be calculated just like any other project.
Evaluating Leasehold:
The Overlooked Variable
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Importance of Leasehold Analysis

Analysts often focus on an operators development plan to ascertain the value of a shale asset. This is a mistake. The quality of leasehold is more important than the development plan because of its implications for divestitures and future development costs.
Non-core assets with lease expiration issues fetch terrible prices in the market, because the seller has few options. Large HBP leases are hugely valuable on the market, as they are essentially perpetual call options on the commodity. The future economics of an area under development are vastly different if leases are small and fragmented (like some old coal leases) vs. large blocked up drilling units from recently leased farms/ranches.
Leasehold Quality is Often Ignored

There are three key variables to take into account when valuing shale assets: 1) Well Economics 2) Leasehold Quality 3) Development Plan
Optimistic analysts often focus primarily on well economics, but apply it to too wide an area. Pessimistic analysts often focus only on the area under development, rather than the entire position. Understanding the nature and quality of leasehold is the key to bridging the gap between these other two variables.
Components of Leasehold Value

Leases must be drilled before their term expires to be held by production (HBP)
Leasehold that will not be drilled before expiration has little value to the owner unless there is high demand from buyers
Large blocked-up groups of leases allow for more efficient pad drilling and are significantly more valuable
Retail leasehold < blocked-up drilling units < large groups of drilling units
Availability of local infrastructure and regional take away capacity significantly affect timing and thus economics of drilling leasehold
Royalty rates, state tax regimes, and environmental issues also affect the ultimate value of a leasehold position
Theoretical per Acre Value

Theoretical value of a 8.5 BCF EUR NE Marcellus Well Cost of drilling and completion Cost of 1/8th of wellpad and gathering Cost of SG&A Cost of capital for above (@10%) PV of one well NPV of one well Acres per well Value per acre if drilled today: Years until well comes online Additional cost of capital for up-front infrastructure Time discount to single well NPV (5 years @ 10%): Discounted NPV of one well: Acres per well Value per acre if drilled in five years:
($6,700,000) ($187,500) ($333,333) ($722,083) $11,434,600 $3,491,683 80 $43,646 5 ($114,471) ($1,323,623) $2,053,590 80 $25,670
In a perfect world: one acre of leasehold would translate into a fraction of the NPV of a well dependent only on timing and well spacing
Actual per Acre Value

$25,000 Efficient operator with large holdings in the area $20,000 Contigous lease that will allow for pad drilling $15,000 Theoretical value per acre of a lease in a homogenous play with NPV per acre of $43,646 and a ten year inventory
Take-away capacity exists or will soon be built by others Lease held by production (HBP)
$10,000
In the real world: resource play development is a manufacturing business, which means that cost control and efficiency are the ultimate arbiters of returns
$6,000
$1,000
4 years left on lease 3 years left on lease 2 years left on lease 1 year left on lease
Glossary
Decline Curve:
A method for estimating reserves and predicting production in oil reservoirs and oil fields. The decline curve shows how oil and gas production rates decrease over time.
Differential:
Drilling Unity: EUR: Five Year Rule: HBP: IP Rate: Net Acre:
The difference between the Henry Hub spot price and the corresponding cash spot price for natural gas in a specified location.
640 acre area in which leases are combined into a single unit and are considered proportional pieces of a large unitized le ase for purposes of revenue sharing, and converting leases to HBP status. Abbreviation for estimated ultimate recovery; the amount of oil and gas expected to be economically recovered from a reservoir or field by the end of its producing life. The general limitation on E&P companies booking reserves that will not be developed within five years. Abbreviation for held by production; a provision in an oil or gas lease that perpetuates a companys right to operate a pro perty or concession as long as the property or concession produces a minimum paying quantity of oil or gas. Initial production rate of an oil or gas well, generally measured over a 24 hour period The amount of acreage owned after adjusting for minority working interest owners (i.e. 70% interest in 100 gross acres = 70 net acres).
Net Well:
Pad Drilling: Resource Play: Type Curve:
The amount of interest owned in a well after adjusting for minority working interest owners (i.e. 70% interest in 10 gross wells = 7 net wells).
The ability to drill multiple horizontal wells from a single well pad, saving on infrastructure costs. A geologically homogenous, area of unconventional reservoir in which well performance is generally repeatable and can be predicted by linear relationships between geophysical factors A representative decline curve for a homogenous area of a resource play, which can be used to accurately predict the initial production, EUR, and production decline of producing well and well yet to be drilled.
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Case Study:
The Steps to Valuing a Shale Asset
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Four Steps to Valuation

1) Perform due diligence on leasehold, current production levels, company and competitor claims regarding the reservoir, State production data, regional infrastructure developments, etc. 2) Delineate core areas and quantify acreage into buckets 3) Model well economics 4) Create a development model and find the NPV of the asset based on conservative assumptions
The majority of the work is in Step 1 Steps 2-4 are relatively straightforward and could be accomplished by most financial analysts who understand the key concepts A good result from Step 4 is dependent on making the right conclusions about data uncovered in step 1
1) Basic Due Diligence
Total Leasehold of 1.4 Million Net Acres

(Net addition by this operator of 400k Marcellus acres during 2009-2012 has increased proportion of core acreage within this leasehold position)
1) Define the Core Area(s)

Utilize disclosures from multiple companies, including smaller competitors that may provide additional details
Analysts must use a mosaic of publicly available information to determine both the boundaries of core areas and sweet spots as well as determine as best as possible the quality of a companys leasehold within these areas
1) Quantify Acreage by Tier

A portion of this county is a sweet spot or super core area, with some of the best economics in the country Disclosures suggest the company holds 100k net acres in the core of the core (10 BCF EUR) and an additional ~300k net acres in the core area (8.5 BCF EUR)
1) Potential Pitfalls to Area Valuations

Wells in this area have double the initial production of those in neighboring counties, which can skew average well production figures There may be regional sweet spots, where over-pressured areas have tremendous economics. It is important to ensure that well results in these areas are not over-represented in the average well type-curve for a larger area.
1) Examine Regional Infrastructure

Almost 2 Bcf/day of new pipeline capacity is being added to this area within the next year, which will ease congestion Insufficient pipeline capacity to move supply out of a producing region will drive down basis differentials to the NYMEX commodity price. The regional price for marginal supply can reach zero in some cases, so this is an important risk to assess.
1) Perform Leasehold Analysis

State records, online landowner groups, permit data, smaller competitor disclosures, trade periodicals and even fractivist groups can be excellent sources for detailed information on leasehold positions down to the drilling unit level Examination of actual leasehold, drilling units, well results and state production data on the county level is imperative to understanding the quality and value of a leasehold position
1) County Level Leasehold Analysis

The majority of the acreage in yellow appears to be in large efficient drilling units, which can drill many wells from the same pad. This makes sense for a rural area without previous production Location of all permitted drilling units shown, with state production data for the last 6-month reporting period superimposed on individual well-pads (shown by size of circle)
1) Examining Key Claims

Core and core of the core area (as defined by the company) superimposed. Un-leased State forest explains lack of activity in Western edge of the core of the core
State production figures show consistent good results within the boundaries the company claims. Major pipelines in the area provide a ready market for future production.
1) Operations on the Township Level

Comparison of wells in these counties to core of the core type-curve will show if wells are below average as they get farther West from acreage in the super core sweet spot to the East of this County It is crucial to examine the actual operations of a company on the Township level. At this level, an analyst gets a view of the actual operations and the future trajectory of development costs.
1) Development Efficiency
Leases are usually pooled together into 640 acre drilling units
(Gathering pipeline placement is illustrative)
Large blocked up landholdings allow for numerous efficiencies in the building of roads, pads, and gathering pipelines, as well as ongoing operating efficiencies for years to come. Bringing new production online from these drilling units may be twice as profitable as developing smaller leases a few miles away.
1) Pad Drilling = Lower Future Costs
Generally, an operator must drill one well in each 640 acre drilling unit in order to hold by production (HBP) all of the leases within the unit. In farm areas like this, operators may be able get large leases that span multiple drilling units. Smaller operators who do not operate on this scale have much higher all-in costs.
1) Initial Construction vs. Development

1,147 acre double drilling unit will accommodate ~16 wells The operator has drilled two wells from this pad, one north and one south Initial wells were drilled to maximize play knowledge and hold acreage by production, not maximize IRR Future wells from this pad will cost less and produce more
1) Examining Individual Wells

Actual Well Permit
Drilled Southeast from the pad and came online in August, 2011 Lateral is only 3,475 feet
Despite the short lateral, this well has outperformed the operators core of the core type-curve by 14% This well was likely drilled short to cheaply establish production in order to HBP the leases in this drilling unit
1) Future Well Pad Economics

Twelve additional wells to be drilled from this pad
Future wells from this pad will produce $400 million in revenue and have an NPV of $98 million (if drilled today).
All infrastructure is inplace and has been paid for.
2) Quantifying Acreage into Buckets

Acreage "Buckets" Pennsylvania "Core of Core" Pennsylvania "Core" Pennsylvania "Tier 1" Pennsylvania "Tier 2" New York "Core" New York "Tier 1" New York "Tier 2" Total: Net Acres 100,000 300,000 200,000 350,000 50,000 50,000 350,000 1,400,000 HBP Status 85% 70% 20% 5% 0% 0% 0% 25% Confidence Level High High Medium Low Low Low Low
Within the Core and Core of Core, this companys leasehold is highly contiguous and most acreage looks to be already held by production (HBP)
3) Understanding Well Economics
Average EUR across 139 wells is 10.4 Bcf, which is better than the core of the core type-curve Decline curve is consistent with competitors and state production data We model production at 90% of the disclosed type-curve
3) Creation of Conservative Type Curve

Discount Rate for Well IRRs: Royalty Rate Severence Tax Operating Expense ($/Mcf) 10% 17% 5% $0.60
Discount to HH (%): Well Spacing (acres): Days to drill (spud to spud): Income Tax (%)
USRG "Core of Core" 9 Bcf EUR wells
-16.3% 80 21 0.0%
Gross Production (MMcf) and Net Revenue ($1,000s) by Month Month: 1 2 3 USRG NE "Core of Core" Wells: 328.5 301.1 275.1 Henry Hub Futures Price $4.22 $4.26 $4.31 Net Monthly Revenue: $760.5 $704.9 $652.5 Month Specific Discount Factor: 1.008 1.016 1.024 Discounted Mthly Net Revs: $754.5 $693.7 $637.2
4 251.9 $4.33 $601.5 1.032 $582.7
5 228.6 $4.32 $544.3 1.041 $523.1
6 209.9 $4.33 $500.3 1.049 $477.0
7 192.1 $4.39 $466.1 1.057 $440.9 21,651
8 177.1 $4.54 $447.6 1.066 $420.1
9 164.6 $4.64 $426.8 1.074 $397.4
10 155.1 $4.60 $397.4 1.083 $367.1
11 147.0 $4.49 $366.3 1.091 $335.6
12 138.2 $4.08 $306.6 1.100 $278.7
13 131.6 $4.07 $291.5 1.109 $262.9 21,087
14 124.9 $4.09 $278.5 1.118 $249.2
15 118.3 $4.12 $266.1 1.127 $236.2
16 112.1 $4.13 $253.0 1.136 $222.8
17 106.6 $4.13 $240.1 1.145 $209.8
18 102.3 $4.15 $232.1 1.154 $201.2
19 98.5 $4.23 $228.2 1.163 $196.2 11,793
20 94.6 $4.42 $231.1 1.172 $197.2
21 90.6 $4.50 $226.4 1.182 $191.6
22 86.9 $4.48 $216.1 1.191 $181.4
23 83.3 $4.41 $202.9 1.200 $169.0
24 79.9 $4.11 $178.7 1.210 $147.7
Wells per year per rig:

Gross Production by Year (MMcf) Year: USRG NE "Core of Core" Wells: Henry Hub Futures Price: Net Revenues by Year Year Specific Discount Factor: Discounted Annual Net Rev:
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first year net production for one rig:
2nd year net production for one rig:
3rd year net production for one rig:
4th year net production for one rig:
1 2,569.1 $4.37 6,174.6 1.050 $5,880.6
2 3 1,229.5 778.1 $4.28 $4.28 2,844.6 1,835.5 1.155 1.271 $2,462.9 $1,444.7
4 558.4 $4.37 1,355.0 1.398 $969.5
5 433.6 $4.50 1,091.0 1.537 $709.7
6 351.3 $4.66 $913.8 1.691 $540.4
7 291.5 $4.86 $797.3 1.860 $428.6
Present Value of Discounted Net Revenue:
$14,552.5
Single well NPV = $7.825 million

8 247.8 $5.10 $717.1 2.046 $350.5
9 214.4 $5.41 $664.9 2.251 $295.4
10 188.6 $5.50 $595.9 2.476 $240.7
11 168.8 $5.50 $533.3 2.723 $195.8
12 152.8 $5.50 $482.6 2.996 $161.1
13 139.4 $5.50 $440.4 3.295 $133.6
14 128.3 $5.50 $405.2 3.625 $111.8
15 118.6 $5.50 $374.8 3.987 $94.0
16 110.3 $5.50 $348.6 4.386 $79.5
17 103.2 $5.50 $325.9 4.825 $67.5
18 97.0 $5.50 $306.3 5.307 $57.7
19 91.2 $5.50 $288.0 5.838 $49.3
20 85.7 $5.50 $270.7 6.422 $42.2
21 80.5 $5.50 $254.4 7.064 $36.0
22 75.7 $5.50 $239.2 7.770 $30.8
23 71.2 $5.50 $224.8 8.547 $26.3
24 66.9 $5.50 $211.3 9.402 $22.5
4) Model Multi-Year Development

Well Cost ($MMs) Discount to HH (%): Well Spacing (acres): Days to drill (spud to spud): Income Tax (%) $6.7 -16.3% 80 21 0.0%
Net Undrilled Acres % Drillable Royalty Rate Severence Tax Operating Expense ($/Mcf) Discount rate for Drilling program:
90,000 100% 17.0% 5% $0.60 10.0%
Net Gas Production (Bcf/year)

Operated Rig Count: HH gas prices: Commulative net wells drilled: Total net acreage drilled (1,000s): Net Production (MMcf) for vintage: 2013 Net Production (MMcf) for vintage: 2014 Net Production (MMcf) for vintage: 2015 Net Production (MMcf) for vintage: 2016 Net Production (MMcf) for vintage: 2017 Net Production (MMcf) for vintage: 2018 Net Production (MMcf) for vintage: 2019 Net Production (MMcf) for vintage: 2020 Net Production (MMcf) for vintage: 2021 Net Production (MMcf) for vintage: 2022 Net Production (MMcf) for vintage: 2023 Net Gas Production (Bcf): Drilling and completion cost: Net production revenue: Net cash produce by (used in) drilling program: Discounted Net Cash Production:
2013 5 $4.37 86.9 7.0 108.3
2014 6 $4.28 191.2 15.3 105.4 129.9
2015 6 $4.28 295.5 23.6 59.0 126.5 129.9
2016 6 $4.37 399.8 32.0 39.9 70.8 126.5 129.9
2017 6 $4.50 504.0 40.3 29.8 47.9 70.8 126.5 129.9
2018 6 $4.66 608.3 48.7 23.6 35.7 47.9 70.8 126.5 129.9
2019 6 $4.86 712.6 57.0 19.4 28.3 35.7 47.9 70.8 126.5 129.9
2020 6 $5.10 816.9 65.4 16.3 23.2 28.3 35.7 47.9 70.8 126.5 129.9
2021 6 $5.41 921.2 73.7 13.9 19.5 23.2 28.3 35.7 47.9 70.8 126.5 129.9
NPV of all wells in this area, under current development plan = $5.84
$1,162.9 $1,162.9 $352.9 $918.9 $918.9 $763.4 $763.4 $654.0 $654.0 $571.9 $571.9 $508.2 $508.2 $95.8 $457.7 $457.7 $78.4 $416.6 $416.6 $64.9 $382.6 $382.6 $54.2 $353.6 $353.6 $45.5 $544.3 $514.3 $543.0 $253.5 $191.5 $149.1 $118.5 406.0 $0.0 $1,626.6 $1,626.6 290.3 229.4 190.5 163.2 142.8 126.9 114.2 104.0 95.5 88.3 82.0 $328.5 $328.5 $38.4
2022 6 $5.50 1,025.5 82.0 12.2 16.7 19.5 23.2 28.3 35.7 47.9 70.8 126.5 129.9
2023 6 $5.50 1,129.8 90.4 10.8 14.6 16.7 19.5 23.2 28.3 35.7 47.9 70.8 126.5 129.9
2024 $5.50
2025 $5.50
2026 $5.50
2027 $5.50
2028 $5.50
2029 $5.50
2030 $5.50
2031 $5.50
2032 $5.50
2033 $5.50
2034 $5.50
2035 $5.50
2036 $5.50
2037 $5.50
2038 $5.50
2039 $5.50
2040 $5.50
2041 $5.50
2042 $5.50
9.7 13.0 14.6 16.7 19.5 23.2 28.3 35.7 47.9 70.8 126.5
8.8 11.7 13.0 14.6 16.7 19.5 23.2 28.3 35.7 47.9 70.8
8.1 10.6 11.7 13.0 14.6 16.7 19.5 23.2 28.3 35.7 47.9
7.5 9.7 10.6 11.7 13.0 14.6 16.7 19.5 23.2 28.3 35.7
6.9 9.0 9.7 10.6 11.7 13.0 14.6 16.7 19.5 23.2 28.3
6.5 8.3 9.0 9.7 10.6 11.7 13.0 14.6 16.7 19.5 23.2
6.1 7.7 8.3 9.0 9.7 10.6 11.7 13.0 14.6 16.7 19.5
5.7 7.3 7.7 8.3 9.0 9.7 10.6 11.7 13.0 14.6 16.7
5.3 6.8 7.3 7.7 8.3 9.0 9.7 10.6 11.7 13.0 14.6
5.0 6.4 6.8 7.3 7.7 8.3 9.0 9.7 10.6 11.7 13.0
4.7 6.0 6.4 6.8 7.3 7.7 8.3 9.0 9.7 10.6 11.7
4.4 5.7 6.0 6.4 6.8 7.3 7.7 8.3 9.0 9.7 10.6
4.2 5.3 5.7 6.0 6.4 6.8 7.3 7.7 8.3 9.0 9.7
3.9 5.0 5.3 5.7 6.0 6.4 6.8 7.3 7.7 8.3 9.0
3.7 4.7 5.0 5.3 5.7 6.0 6.4 6.8 7.3 7.7 8.3
3.5 4.4 4.7 5.0 5.3 5.7 6.0 6.4 6.8 7.3 7.7
3.3 4.2 4.4 4.7 5.0 5.3 5.7 6.0 6.4 6.8 7.3
3.1 3.9 4.2 4.4 4.7 5.0 5.3 5.7 6.0 6.4 6.8
2.9 3.7 3.9 4.2 4.4 4.7 5.0 5.3 5.7 6.0 6.4 52.2
108.3 -$582.3 $331.4 -$250.8 ($238.9)
235.3 -$698.7 $702.7 $4.0 $3.4
315.4 367.1 404.9 434.4 458.5 478.7 495.9 510.8 524.0 -$698.7 -$698.7 -$698.7 -$698.7 -$698.7 -$698.7 -$698.7 -$698.7 -$698.7 $941.7 $1,123.9 $1,282.3 $1,433.4 $1,590.3 $1,756.6 $1,950.7 $2,046.4 $2,099.5 $243.0 $425.2 $583.6 $734.7 $891.6 $1,057.9 $1,251.9 $1,347.7 $1,400.7 $191.3 $304.2 $379.6 $434.5 $479.3 $517.0 $556.2
billion
$306.3 $306.3 $32.6 $286.5 $286.5 $27.7 $268.5 $268.5 $23.6
76.5
71.5
67.0
62.9
59.1 $236.9 $236.9 $17.2
55.6 $222.6 $222.6 $14.7
$252.1 $252.1 $20.1
$209.3 $209.3 $12.6
43
4) Make Conservative Assumptions

We model this companys Northeast Marcellus asset as if it were a stand-alone company to be conservative:
Fully-load with $150MM in annual SG&A, increasing at 3% annually (~50% more than is currently being spent) Assume no increase in rig-count until the core of the core area is developed
Only 324,000 net acres out of 1.4 million will be developed under this model No value is ascribed to 75% of the acreage
4) Create Development DCF Model

Net Gas Production (Bcf/year)
"Core of Core" Operated Rig Count: "Core" Operated Rig Count: HH gas prices: Commulative " Core of Core" net wells drilled: Total "C of C" net acreage drilled (1,000s): Commulative " CORE" net wells drilled: Total "CORE" net acreage drilled (1,000s): Current Production: Net Production (MMcf) for vintage: 2013 Net Production (MMcf) for vintage: 2014 Net Production (MMcf) for vintage: 2015 Net Production (MMcf) for vintage: 2016 Net Production (MMcf) for vintage: 2017 Net Production (MMcf) for vintage: 2018 Net Production (MMcf) for vintage: 2019 Net Production (MMcf) for vintage: 2020 Net Production (MMcf) for vintage: 2021 Net Production (MMcf) for vintage: 2022 Net Production (MMcf) for vintage: 2023 Net Production (MMcf) for vintage: 2024 Net Production (MMcf) for vintage: 2025 Net Production (MMcf) for vintage: 2026 Net Production (MMcf) for vintage: 2027 Net Production (MMcf) for vintage: 2028 Net Production (MMcf) for vintage: 2029 Net Production (MMcf) for vintage: 2030 Net Production (MMcf) for vintage: 2031 Net Production (MMcf) for vintage: 2032 Net Production (MMcf) for vintage: 2033 Net Production (MMcf) for vintage: 2034 Net Production (MMcf) for vintage: 2035 Net Production (MMcf) for vintage: 2036 2013 5 $4.37 86.9 7.0 2014 6 $4.28 191.2 15.3 2015 6 $4.28 295.5 23.6 2016 6 $4.37 399.8 32.0 2017 6 $4.50 504.0 40.3 2018 6 $4.66 608.3 48.7 2019 6 $4.86 712.6 57.0 2020 6 $5.10 816.9 65.4 2021 6 $5.41 921.2 73.7 2022 6 $5.50 1,025.5 82.0 2023 6 $5.50 1,129.8 90.4 2024 12 $5.50 2025 12 $5.50 2026 12 $5.50 2027 12 $5.50 2028 12 $5.50 2029 12 $5.50 2030 12 $5.50 2031 12 $5.50 2032 12 $5.50 2033 12 $5.50 2034 12 $5.50 2035 12 $5.50 2036 12 $5.50 2037 12 $5.50 2038 0 $5.50 2039 0 $5.50 2040 2041 2042 2043 $5.50 $5.50 $5.50 $5.50 194.4 108.3 131.6 105.4 129.9 98.1 59.0 126.5 129.9 77.8 39.9 70.8 126.5 129.9 63.8 29.8 47.9 70.8 126.5 129.9 53.6 23.6 35.7 47.9 70.8 126.5 129.9 46.0 19.4 28.3 35.7 47.9 70.8 126.5 129.9 40.1 16.3 23.2 28.3 35.7 47.9 70.8 126.5 129.9 35.6 13.9 19.5 23.2 28.3 35.7 47.9 70.8 126.5 129.9 32.0 12.2 16.7 19.5 23.2 28.3 35.7 47.9 70.8 126.5 129.9 29.1 10.8 14.6 16.7 19.5 23.2 28.3 35.7 47.9 70.8 126.5 129.9 208.6 16.7 26.7 9.7 13.0 14.6 16.7 19.5 23.2 28.3 35.7 47.9 70.8 126.5 120.8 417.1 33.4 24.6 8.8 11.7 13.0 14.6 16.7 19.5 23.2 28.3 35.7 47.9 70.8 120.0 120.8 625.7 50.1 22.8 8.1 10.6 11.7 13.0 14.6 16.7 19.5 23.2 28.3 35.7 47.9 77.5 120.0 120.8 834.3 66.7 21.3 7.5 9.7 10.6 11.7 13.0 14.6 16.7 19.5 23.2 28.3 35.7 58.4 77.5 120.0 120.8 1,042.9 83.4 20.0 6.9 9.0 9.7 10.6 11.7 13.0 14.6 16.7 19.5 23.2 28.3 48.0 58.4 77.5 120.0 120.8 1,251.4 100.1 18.8 6.5 8.3 9.0 9.7 10.6 11.7 13.0 14.6 16.7 19.5 23.2 43.3 48.0 58.4 77.5 120.0 120.8 1,460.0 116.8 17.6 6.1 7.7 8.3 9.0 9.7 10.6 11.7 13.0 14.6 16.7 19.5 39.8 43.3 48.0 58.4 77.5 120.0 120.8 1,668.6 133.5 16.6 5.7 7.3 7.7 8.3 9.0 9.7 10.6 11.7 13.0 14.6 16.7 37.0 39.8 43.3 48.0 58.4 77.5 120.0 120.8 1,877.1 150.2 15.6 5.3 6.8 7.3 7.7 8.3 9.0 9.7 10.6 11.7 13.0 14.6 34.5 37.0 39.8 43.3 48.0 58.4 77.5 120.0 120.8 2,085.7 166.9 14.6 5.0 6.4 6.8 7.3 7.7 8.3 9.0 9.7 10.6 11.7 13.0 32.3 34.5 37.0 39.8 43.3 48.0 58.4 77.5 120.0 120.8 2,294.3 183.5 13.8 4.7 6.0 6.4 6.8 7.3 7.7 8.3 9.0 9.7 10.6 11.7 30.4 32.3 34.5 37.0 39.8 43.3 48.0 58.4 77.5 120.0 120.8 2,502.9 200.2 12.9 4.4 5.7 6.0 6.4 6.8 7.3 7.7 8.3 9.0 9.7 10.6 28.5 30.4 32.3 34.5 37.0 39.8 43.3 48.0 58.4 77.5 120.0 120.8 2,711.4 216.9 12.2 4.2 5.3 5.7 6.0 6.4 6.8 7.3 7.7 8.3 9.0 9.7 26.8 28.5 30.4 32.3 34.5 37.0 39.8 43.3 48.0 58.4 77.5 120.0 120.8 2,920.0 233.6 11.4 3.9 5.0 5.3 5.7 6.0 6.4 6.8 7.3 7.7 8.3 9.0 25.2 26.8 28.5 30.4 32.3 34.5 37.0 39.8 43.3 48.0 58.4 77.5 120.0 120.8 10.7 3.7 4.7 5.0 5.3 5.7 6.0 6.4 6.8 7.3 7.7 8.3 23.7 25.2 26.8 28.5 30.4 32.3 34.5 37.0 39.8 43.3 48.0 58.4 77.5 120.0 10.1 3.5 4.4 4.7 5.0 5.3 5.7 6.0 6.4 6.8 7.3 7.7 22.3 23.7 25.2 26.8 28.5 30.4 32.3 34.5 37.0 39.8 43.3 48.0 58.4 77.5 9.5 3.3 4.2 4.4 4.7 5.0 5.3 5.7 6.0 6.4 6.8 7.3 20.9 22.3 23.7 25.2 26.8 28.5 30.4 32.3 34.5 37.0 39.8 43.3 48.0 58.4 8.9 3.1 3.9 4.2 4.4 4.7 5.0 5.3 5.7 6.0 6.4 6.8 19.7 20.9 22.3 23.7 25.2 26.8 28.5 30.4 32.3 34.5 37.0 39.8 43.3 48.0 8.4 2.9 3.7 3.9 4.2 4.4 4.7 5.0 5.3 5.7 6.0 6.4 18.5 19.7 20.9 22.3 23.7 25.2 26.8 28.5 30.4 32.3 34.5 37.0 39.8 43.3 7.9 2.7 3.5 3.7 3.9 4.2 4.4 4.7 5.0 5.3 5.7 6.0 17.4 18.5 19.7 20.9 22.3 23.7 25.2 26.8 28.5 30.4 32.3 34.5 37.0 39.8
2044
$5
1 1 1 1 2 2 2 2 2 2 3 3 3 3
Net Gas Production (Bcf): Drilling and completion cost: Net production revenue: Net cash produce by (used in) drilling program: SG&A per year: Discounted Net Income:
302.6 366.9 413.5 444.9 468.7 488.0 504.5 518.8 531.4 542.8 553.2 553.5 555.7 570.6 588.6 607.9 629.5 652.4 675.7 699.0 721.9 744.1 765.6 786.1 805.6 703.3 600.9 539.9 497.0 463.7 434.2 40 ($582.3) ($698.7) ($698.7) ($698.7) ($698.7) ($698.7) ($698.7) ($698.7) ($698.7) ($698.7) ($698.7) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) ($1,397.4) $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0 $926.5 $1,095.6 $1,234.7 $1,362.2 $1,484.4 $1,610.3 $1,749.7 $1,903.8 $2,090.7 $2,174.8 $2,216.1 $2,217.5 $2,226.3 $2,285.8 $2,358.0 $2,435.5 $2,522.1 $2,613.5 $2,706.9 $2,800.3 $2,892.0 $2,981.2 $3,067.1 $3,149.3 $3,227.5 $2,817.7 $2,407.2 $2,162.9 $1,991.3 $1,857.7 $1,739.4 $1,631 $344.3 $396.9 $535.9 $663.4 $785.7 $911.6 $1,051.0 $1,205.1 $1,392.0 $1,476.1 $1,517.4 $820.1 $828.9 $888.4 $960.6 $1,038.1 $1,124.7 $1,216.1 $1,309.5 $1,402.8 $1,494.6 $1,583.8 $1,669.6 $1,751.8 $1,830.1 $2,817.7 $2,407.2 $2,162.9 $1,991.3 $1,857.7 $1,739.4 $1,631 ($150.0) ($154.5) ($159.1) ($163.9) ($168.8) ($173.9) ($179.1) ($184.5) ($190.0) ($195.7) ($201.6) ($207.6) ($213.9) ($220.3) ($226.9) ($233.7) ($240.7) ($247.9) ($255.4) ($263.0) ($270.9) ($279.0) ($287.4) ($296.0) ($304.9) ($314.1) ($323.5) ($333.2) ($343.2) ($353.5) ($364.1) ($375 $185.0 $209.9 $296.6 $357.4 $401.3 $436.2 $468.7 $498.8 $534.0 $517.1 $483.1 $204.4 $186.6 $184.3 $184.0 $183.4 $183.2 $182.4 $180.6 $177.5 $173.2 $167.9 $161.7 $154.8 $147.5 $220.1 $166.5 $132.9 $108.8 $90.3 $75.1
$62
Net present value = $8.0 billion

This is a conservative approximation of how this asset would be valued if it was spun-off as a public company or sold
4) Create Development DCF Model
Stand-alone entity is FCF positive in every year

This would provide flexibility in development plan Upside to valuation if development is accelerated or the 1.1 million net acres not included in the development plan are monetized
SEC Reserve Value of Case Study
No value ascribed to these reserves
SEC PV10 value is only $1 billion

Due to trailing 12-month pricing regime
Even if SEC PV10 is adjusted for strip pricing, it captures less than $4 billion in present value
Sell-Side Valuation of Case Study

While neither company breaks it out specifically, this asset appears to be valued by GS at ~$8.5 billion and by JPM at less than $4 billion. This is a huge disparity for a single asset. Goldman uses a sum-of-parts valuation JPM uses a limited DCF methodology similar to SEC PV10 Neither analyst wants to stick their neck out:
Goldman analyst subtracts ~$9 billion in phantom liabilities at the parent level to justify a neutral JP Morgan uses a clearly broken SEC methodology to justify a neutral
How will the market value assets like this when they are producing free cash flow (if not sold or spun-off)?
Pure Play Valuation Disparity

Diversified shale E&P A ~70% of assets are shale 10+ years of drilling inventory Enterprise value >$10 billion EV/EBITDA 6 Single shale E&P B ~90% of assets are shale 10+ years of drilling inventory Enterprise value >$10 billion EV/EBITDA 14
Valued by the sell-side on a peer EV/EBITDA ratio or on an SEC proved reserve value
Valued by the sell-side under a multi-year development model DCF
49
Conclusions
There are huge valuation disparities in the public market for shale assets, both high and low Investors willing to perform substantial due diligence can arrive at firm and robust valuations There are tremendous opportunities due to the current dislocations in the public market:
Cheap shale assets within smaller under-analyzed E&P companies Cheap shale assets within larger diversified E&P companies Expensive pure play shale companies, which can be used to set up long-short trades or express a view on the underlying commodity
50
About USRG
Union Square Research is a group of buy side analysts working on both a consulting and subscription/commission basis for institutional investors of all sizes. In an industry where reporting often passes for analysis and sector experience passes for sector expertise, we differentiate ourselves through real industry expertise learned through operational everything experience and a rigorous research process, which is second to none. We are able to make actionable non-consensus calls through a combination of our expertise, our no-stone-uncovered process, and most importantly, our patience. Our clients know that our research track record is our most important asset; our clients say we've earned their trust. Contact us to learn about our services. We are pleased to be working with Wall Street Access, an independent firm with a 32-year track record of providing research and execution services to its clients. If you are interested in obtaining our research through an execution services firm, please contact Matt Treacy at (212) 232-5690.
Disclaimer
The information herein reflects the opinions and projections of Union Square Research Group, LLC (collectively USRG) and its affiliates as of the date of publication, which is subject to change without notice at any time subsequent to the date of issue, and serves as a limited supplement to a verbal presentation. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. USRG is not a tax expert and nothing within this presentation should be construed as tax advice. All information provided in this presentation is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. Any logos, graphics, presentation materials or photos included in this presentation are the express property of their owners. USRG as well as funds and clients advised by USRG may have an economic interest in the price movement of securities mentioned in this presentation, but this economic interest is subject to change without notice. This presentation my not be reproduced without prior written permission from USRG.
End Notes
Slide 4: Picture Source: http://llenrock.com/blog/tag/stuyvesant-town/ Slide 5: Picture Source: http://www.miamicondoinvestments.com/condo/one-thousand-museum-condos/ Slide 7: Picture Source: http://www.whatsupyasieve.com/2013/01/26/birthday-boy-wayne-gretzky-2/ Slide 9: Picture Source: http://content.cdlib.org/ark:/13030/kt838nd424/ Slide 11: Picture Source: searchanddiscovery.org, American Oil and Gas Reporter, American Association of Petroleum Geologists (aapg.org) Slide 12: Picture Source: modified from IEA report; http://www.eia.gov/todayinenergy/detail.cfm?id=3750 Slide 13: Picture Source: modified from IEA report; http://www.eia.gov/todayinenergy/detail.cfm?id=3750 Slide 14: Sources: Tudor Pickering & Holt presentation and Southwestern Energy company presentation Slide 16: Sources: Gastar Exploration corporate presentation and USRG proprietary valuation model Slide 17: Picture Source: http://www.paranet.com/Portals/107491/images/it%20due%20diligence.jpg Slide 23: Source: definitions adapted from Schlumbergers Oilfield Glossary, Investopedia, and SEC.gov Slide 24: Picture Source: Modified from an image at: http://www.n2ndochina.org/wp-content/uploads/2013/03/Puzzle-pieces5132.jpg Slide 26: Sources: Chesapeake Energy November 2012 and June 2013 corporate presentations; Southwestern Energy 4/29/13 press release Slide 28: Sources: CHK disclosed with their Q1, 2013 report that they held ~100k net acres in the core of core and multiples of that in the core Slide 30: Source: www.eia.gov/naturalgas/pipelines/EIA-NaturalGasPipelineProjects.xls Slide 32: Source: Adapted from a graphic in Northeast Driller Vol. 4 No. 3 April 2013 Slide 33: Source: Adapted from a graphic in Northeast Driller Vol. 4 No. 3 April 2013, Chesapeake Energy May, 2013 corporate presentation, and state records Slide 34: Source: Adapted from a graphic in Northeast Driller Vol. 4 No. 3 April 2013, Chesapeake Energy May, 2013 corporate presentation, and state records Slide 35: Source: Adapted from a graphic in Northeast Driller Vol. 4 No. 3 April 2013, Chesapeake Energy May, 2013 corporate presentation, and state records Slide 36: Source: Adapted from a graphic in Northeast Driller Vol. 4 No. 3 April 2013, Chesapeake Energy May, 2013 corporate presentation, state permit data and Google maps satellite image Slide 37: Source: Google satellite maps and state permit data Slide 38: Source: Google satellite maps and state permit data Slide 39: Source: Google satellite maps and state permit data and Zimbio.com Slide 41: Source: Chesapeake Energy May 2013 corporate presentation Slide 48: Sources: Goldman Sachs May 30, 2013 research note; JPM May 15, 2013 research note
53

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Getting Ahead by Drilling Down

Valuing Oil & Gas Shale Assets to Exploit Market Inefficiency

Independent Buyside Insights

Copyright 2013 Union Square Research Group, LLC

www.unionsquareresearch.com www.unionsquareresearch.com (646) 706-7633

About the Author

Current Cash Flow Value

The exception is large single shale E&P companies

Copyright 2013 Union Square Research Group, LLC

www.unionsquareresearch.com (646) 706-7633

Skate To Where The Puck Is Going

Solutions for Analysts

Basic Shale Play Evaluation:

Copyright 2013 Union Square Research Group, LLC

www.unionsquareresearch.com (646) 706-7633

Three Levels of Analysis

Level One: Geophysical Predictors

Copyright 2013 Union Square Research Group, LLC

Level One: Initial Well Results

Copyright 2013 Union Square Research Group, LLC

www.unionsquareresearch.com (646) 706-7633

Level Two: Core Area Delineation

Copyright 2013 Union Square Research Group, LLC

www.unionsquareresearch.com (646) 706-7633

Level Two: Trends in Well Economics

Level Two: Scuttlebutt

Level Three: Development Model DCF

Present Value of Future Cash Flow: $11,998

Cost per Well: $7,000

NPV per Well:

Present Value of Current Production and Future Wells:

Sensitivities of "Super Rich" Marcellus Valuation

Copyright 2013 Union Square Research Group, LLC

www.unionsquareresearch.com (646) 706-7633

Importance of Leasehold Analysis

Leasehold Quality is Often Ignored

Components of Leasehold Value

Theoretical per Acre Value

www.unionsquareresearch.com (646) 706-7633

Actual per Acre Value

Copyright 2013 Union Square Research Group, LLC

www.unionsquareresearch.com (646) 706-7633

Copyright 2013 Union Square Research Group, LLC

www.unionsquareresearch.com (646) 706-7633

Four Steps to Valuation

Copyright 2013 Union Square Research Group, LLC

1) Basic Due Diligence

Total Leasehold of 1.4 Million Net Acres

1) Define the Core Area(s)

1) Quantify Acreage by Tier

1) Potential Pitfalls to Area Valuations

1) Examine Regional Infrastructure

1) Perform Leasehold Analysis

1) County Level Leasehold Analysis

1) Examining Key Claims

1) Operations on the Township Level

(Gathering pipeline placement is illustrative)

1) Pad Drilling = Lower Future Costs

1) Initial Construction vs. Development

1) Examining Individual Wells

1) Future Well Pad Economics

2) Quantifying Acreage into Buckets

3) Understanding Well Economics