North America United States Energy Oil and Gas- E&P
14 April 2011 Current Statistics Range Resources Corp. Buy Exchange NYSE Ticker RRC Price at 13 April 2011 (USD) 53.83 Price Target 95.01 Initiating Coverage 52-week range 32.25 - 59.64 Tarek El Gammal-Ortiz Christopher Dowd Senior Analyst Junior Analyst Key Changes (LTM) [email protected] [email protected] Diluted EPS (USD) L $1.18 Oriana Fuentes Jonathan Sutton Revenue K 8.4% Junior Analyst Junior Analyst [email protected] [email protected] Price/ price relative Idea Generation 40.00
30.00
We have a positive outlook for RRC’s reserve growth and its poten- 20.00
tial to sustain high cost efficiency in 2011 and beyond.The availabil- 10.00
ity of technology to access untapped gas reservoirs and the growing 0.00
demand for this resource make natural gas an attractive commodity -10.00 Equity Research Report Equity Research within the energy industry. RRC’s exposure to non-conventional gas -20.00 plays that grant them access to 1,762,766 Mmcf of proved devel- -30.00 oped reserves will permit the company to capture sudden increases -40.00 in demand – increasing their cash flow from operations which they -50.00 can use to further develop organically. We believe that RRC’s above-average growth, low risk profile, and leadership position in the Marcellus merits a higher valuation than what it is currently Range Resources Corp.(RRC) trading at. We are neutral on our near-term outlook on natural gas, S&P 500 INDEX but we believe prices will increase once secular demand picks up S&P 500 Energy INDEX and the transition from coal to natural gas increases. Russel 2000 Index Performance (%) 3M 6M 12M 3Yr Investment Positives RRC 11.8 46.6 7.2 -19.5 S&P 2.4 11.6 9.8 -1.1 RRC displays a high-quality asset base across the low-cost/ higher S&P Energy 8.5 27.9 26.3 -5.0 return Appalachian region and the large volume/ rapid payout of the Russel 2000 2.9 16.6 16.5 20.1 Gulf Coast properties. We appreciate RRC’s focus on developing their core properties, as Selected Financial Data it represents the company’s long-term strategic vision of maximizing Market Cap (USDm) 8679.4 shareholder value. Shares Outstanding (m) 160.6 Net Income (USDm) (239.3) RRC’s dominant presence in the Marcellus Shale and the large EBITDA (USDm) 600.0 acreage holdings will enable them to increase reserve quantities EV (USDm) 10,637.1 and production for several years to come. EV/ EBITDA 17.8x Near term, RRC will benefit from low natural gas prices, as they NAV (USDm) 15,212 NAV per Share 95.01 have a much better cost basis than their peer group. Their margins will be higher than those of their competitors. We believe RRC is a possible takeover target, as their presence in the Marcellus shale along with their upbeat production outlook, gives them a clear advantage over any other company in the industry.
Orange Value Fund, LLC
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via CapitalIQ, Bloomberg and other vendors. April 14, 2011 Range Resources Corp. (NYSE: RRC)
Changes in U.S. Energy Industry
The United States energy industry has dramatically changed throughout the last decade; two main drivers serve as catalysts for these changes: technology and regulation. Sophisticated natural gas producers have developed technologies that have untapped new energy sources while significantly lowering costs and improving efficiency. By combining horizontal drilling, hydraulic fracturing and advanced geoscience techniques to their production practices, operators have reduced the marginal cost of production, increasing reserve recovery on a per unit basis. This has given way to a shift in the supply curve, which will eventually be rebalanced once demand increases and prices normalize.
Simultaneously, the public and government alike have questioned the safety of energy sources. Regulations on energy consumption and drilling practices are continuously being reviewed - even more so recently given the influx of catastrophic events that have shadowed the energy industry. For example, the nuclear meltdown of the Fukushima power plant in Japan, which is second only to the 1986 Chernobyl disaster in severity, has led us to question the future of nuclear power. Although dismissing nuclear power may not seem viable for China and India given their rampant development and lack of energy sources, the U.S. has other options. Here, the abundance of natural gas can certainly sustain a shift in energy consumption. The events occurred in Japan are a result of design flaws that can be addressed through engineering and structural changes. Nuclear energy remains relevant; however, the environmental and safety implications of the leak lead us to question the future of this source.
Types of Natural Gas
Natural gas production is divided in two categories: conventional and unconventional. These are differentiated by the depth of the gas, the type of geological formation and the technology required for its extraction. In conventional reservoirs, gas contained in interconnected pore spaces can readily flow to a wellbore. In contrast, wells in unconventional reservoirs produce from tight, low permeability formations including shales (fine- grained sedimentary rock), tight sands, and coal beds. A technique called horizontal drilling, as opposed to conventional vertical drilling, has been developed to extract gas from shales, which has allowed shale gas to become an economically viable and profitable resource for operators. The development of shale gas is one of the fastest growing trends in onshore domestic oil and gas production. Unconventional production now accounts for 46% of the total US production.1
Advantages of Natural Gas
Inexpensive relative to other energy sources: The cost to extract natural gas has rapidly declined. This is due to the technological developments the industry has experienced throughout the last decade. Today, natural gas is least expensive fuel: 30% cheaper than crude oil.
Cleaner source of energy: The EPA credited natural gas as a key contributor to meeting our nation¶s energy goals, as it is the cleanest of all fossil fuels. Natural gas combustion produces virtually no sulfur dioxide (SO2), and emits lower levels of nitrogen oxides (NOX) and carbon dioxide (CO2). Recent concerns have been raised over the amount of methane released by the production of natural gas, as explained in a report by Cornell Professor Robert Howarth,
1 Energy Information Administration, Modern Shale Gas, Development in the US. Page 7. Page 1 The Orange Value Fund, LLC
April 14, 2011 Range Resources Corp. (NYSE: RRC)
Range Resources immediately dismissed this study as inaccurate. The reality is that little is known about this potential hazard; WKHVWXG\¶VSUHOLPLQDry results suggest that further research must be conducted in order to reach definitive conclusions. It is important to closely follow these developments in order to appropriately forecast the demand for this commodity.
Water usage: The amount of water needed to stimulate natural gas production is small in comparison to other volumes of water required to produce other forms of energy. Natural gas uses 56%, 71% and 73% less water than coal, nuclear and solar generation, respectively. 2
Liquefied Natural Gas: Cooling natural gas to about -260 degrees Fahrenheit results in the condensation of the gas 2 into its liquid form. LNG eases the transportation of natural gas, as it takes up one six hundredth the volume of traditional dry gas. Also, LNG vapor is less volatile in an unconfined environment, which means that in the unlikely event of a spill, it is safer than other energy sources. Companies with exposure to LNG will greatly benefit from its unique attributes as an alternative energy source.
The Marcellus Shale
There are several gas shale basins spread across the U.S., amongst them the Marcellus Shale. The Marcellus is the most extended shale territory in America; it spans six states (New York, Pennsylvania, Ohio, West Virginia, Virginia, and Maryland) and covers approximately 95,000 square miles. The Marcellus is projected to become the largest natural gas extraction field in the U.S. and the second largest in the world, with approximately 500 Tcf of natural gas reserves.3
Natural Gas: Prices
Natural gas prices declined approximately 20% in 2010. Improvements in well efficiency and non-conventional shale discoveries have increased the supply of natural JDVGHIODWLQJSULFHV55&¶V&(2ZKHQLQWHUYLHZHGRQ CNBC believes natural gas has hit its floor and that the near-term outlook for prices is favorable. A colder than expected winter has increased gas consumption, therefore increasing prices in the near term. Natural gas prices are expected to remain low until secular demand catches up with excess supply. The gap between supply and demand is unlikely to fully narrow until 2014, at which point natural gas prices will begin to rise. Prices for 2011 are estimated to be between $4.25 and $5.00 per mcf. By 2014, natural gas is projected to reach a mid-cycle prLFH RI 0RVW ( 3 FRPSDQLHV¶ performance is very sensitive to natural gas prices (5-7% for a $.10/Mcf change) 3 and should benefit from upside in price movements.
Natural Gas: Demand Outlook
Natural gas plays a key role in meeting U.S. energy demand, currently supplying about 22% of total energy consumption. Most new electricity generation planned for the U.S. over the next five years is expected to be natural gas-fired, as new technologies make it cost efficient.4 The latest projections from the Energy Information Administration speculate that natural gas consumption will grow at approximately 16% year over year through the course of the next 25 years.
The convergence in supply and demand is anticipated in large part to the expectation that natural gas will begin to replace coal in power generation, and therefore driving up the demand in natural gas. Natural gas, which currently
2 American Exploration and Production Council 3 Energy Information Administration, Modern Shale Gas, Development in the US. Page 21. 4 Energy Information Administration, Outlook 2010 Page 2 The Orange Value Fund, LLC
April 14, 2011 Range Resources Corp. (NYSE: RRC) represents almost 30% of fossil fuel energy consumption in the US, has surpassed other energy sources such as coal, which only represents 25% of consumption.5 The move from coal-to-gas is mainly a response to the current low price of gas, but it also reflects a push to comply with environmental regulations regarding the emissions of nitrous oxide, sulfur dioxide, and mercury. The trend of developing this play has impacted business strategy for firms in the industry; for example, CONSOL energy is making strides from being a pure-play coalminer to becoming a significant player in natural gas extraction. The company acquired 500 thousand acres of land in the Marcellus shale in fiscal year 2010 and plans to focus capital to developing the land over the next few years.
Natural gas is used across all sectors in varying amounts. The graph below illustrates the use of each sector, industrial being the greatest. In particular, the transportation system has a lot to benefit from natural gas. Natural gas use in transportation is still in its early stages of development, as it currently accounts for only 3% of total U.S. natural gas demand.6 This figure is expected to increase in the foreseeable future as legislation enforces more stringent guidelines for the automotive industry. This shift, however, may take time to fully come into effect, as the cost to develop new vehicles can serve as a barrier to most automakers, even more so after a recession.
2009 Natural Gas Consumption in the U.S.
Natural Gas: Production Outlook
As of 2010, global shale gas is limited to North America, with the U.S. accounting for the vast majority of historic and current production.7 Additionally, North America has the largest identified shale gas resources with an estimated 5,500 Tcf.8 With current global consumption estimated at about 110 Tcf annually, if only 25% of shale gas is recovered, it has the potential to meet global demand for over 40 years. From 2006 to 2010, shale gas production has grown at a compound annual rate of nearly 50% and is expected to grow approximately 10.8% year over year from 2010 to 2015.9
Merger and Acquisition Activity
Deal activity within the industry picked up in 2010, as depreciated gas prices heavily discounted the value of independent exploration and production companies. Moreover, larger operators were attracted to the higher yielding returns of non-conventional gas plays. As a result, smaller companies with large exposure to the Appalachian region ZHUHWDUJHWHG:HEHOLHYH55&LVDOLNHO\DFTXLVLWLRQWDUJHWGXHWRLWVLQGXVWU\OHDGLQJFRVWVWUXFWXUH ZLWK³DOO-LQ´ finding and development costs totaling $.72 per Mcfe), its 646 Marcellus drilling permits, and its lack of takeover GHIHQVHV VXFK DV FRQWUROOLQJ JURXSV SRLVRQ SLOOV DQG VWDJJHUHG ERDUGV 55&¶V PDQDJHPHQW KDV DOUHDG\ acknowledged the possibility of being taken over, as they have expressed their willingness to negotiate a transaction
5 US EIA Annual Energy Review 2009 6 NaturalGas.org 7 SBI Energy. February 2011. Global Shale Gas: Technologies and Market. Page 2. 8 SBI Energy. February 2011. Global Shale Gas: Technologies and Market. Page 24. 9 SBI Energy. February 2011. Global Shale Gas: Technologies and Market. Page 3-4. Page 3 The Orange Value Fund, LLC
April 14, 2011 Range Resources Corp. (NYSE: RRC) if the terms deem favorable. The table below lists a few deals that have been accomplished recently within the industry.
Recent T ransactions
Total Transaction Announced Transaction EV Multiple of Target/Issuer Value Buyers/Investors Date Status PV-10 ($USD mm)
11/08/2010 Atlas Energy Closed 5,471 Chevron Corp. 10x Ares Management; 10/29/2010 EXCO Announced 4,022 7X Oaktree Capital East Royal Dutch 05/28/2010 Closed 4,700 N/A Resources Shell 12/14/2009 XTO Energy Closed 40,634 Exxon Mobil 3x
Regulation
There has been recent concern over environmental concerns in Facture Simulation (explained below). There has not been a single case of contaminated water due to hydraulic fracturing since this practice began 60 years ago. More recently, the Texas Railroad Commission voted three to zero, exonerating RRC of the water contamination issue that the EPA accused them of in Parker County. RRC tests all the water within a 1,000 ± 2,000 feet diameter from their well bore before they commence drilling. 35% of private water wells they test do not meet consumption standards before they even turn a shovel of dirt. Management attributes these contamination issues to lax water regulation and not hydraulic fracturing. RRC has taken all the appropriate measures to prevent such a disaster to occur, and they have taken the lead in educating the public about industry practices. Not only have they been the first to recycle water for production purposes, but they have also taken the initiative to disclose the types and exact amounts of chemicals injected into each well in Pennsylvania. Roger Manny, CFO of Range Resources, attributes the regulatory scrutiny to other sectors within the energy industry. As new technology is developed, both winners and losers will emerge. He believes that some losers are heavily pushing these false environmental claims. Contamination has historically been due to traditional mechanical failures and drilling issues and not technological advances.
F racture Simulation: Fracture Stimulation is a technology that allows E&P companies to recover natural gas from hard-to-access resources trapped in deep shale and other unconventional resources. Currently, 90% of all natural gas wells drilled in the U.S. (approximately 35,000) utilizes fracture simulation to recover gas. The Environmental Protection Agency (EPA), Ground Water Protection Council (GWPC), and the Interstate Oil and Gas Compact Commission (IOGCC) have all determined that facture simulation does not create pathways for liquids to contaminate water. The table below illustrates that 99.51% of the mixture makeup of fracturing is water and sand. It also explains that the remaining chemicals used to lubricate the drilling pipes can be found in every-day-use products.
Page 4 The Orange Value Fund, LLC
April 14, 2011 Range Resources Corp. (NYSE: RRC)
*Source: The Real Facts About Fracture Stimulation: The Technology Behind America¶V 1HZ 1DWXUDO *DV Supplies; February, 2010; American Exploration and Production Council
Competitive Landscape
In light of the new technologies that have become available to the industry, attention has been drawn to sources of unconventional gas that deem more cost efficient. Companies are adopting different positioning strategies, specifically within the Marcellus, in order to maintain competitive. The following are mid-cap energy companies (with the exception of Chesapeake, which is a large-cap), positioned in the Marcellus Shale:
Chesapeake focuses on discovering, acquiring, and developing conventional and unconventional natural gas reserves in the United States, primarily in its six natural gas shale plays. As of December 31, 2009, the company owned interests in approximately 44,100 productive wells; and had proved reserves of 14.254 (22,900 net) Tcf of natural gas equivalent. Chesapeake currently has the largest acreage position in the Marcellus Shale.
Page 5 The Orange Value Fund, LLC
April 14, 2011 Range Resources Corp. (NYSE: RRC)
Cabot Oil & Gas operates mainly in the Rocky Mountain and Appalachian areas. However, they are beginning to shift their capital focus toward the Marcellus shale10. In 2009, they sold off their Canadian properties to focus on territories in the U.S. Their reserves are 95% natural gas, the rest being reserves for oil extraction. They have progressively increased their gas reserves by over 47% since 2006. They allocate capital between drilling opportunities, repaying debt, repurchasing stock, and acquiring more reserves.
Ultra Petroleum is an oil and gas company with operations in southwest Wyoming and north-central Pennsylvania. Ultra is making efforts to expand and develop their position in the Marcellus Shale, acquiring 788,221 acres in a transaction that closed February 22, 201011.
E Q T operates through three business segments: production, midstream and distribution. It mainly focuses on natural gas and Natural Gas Liquids (NGLs), with a limited production of crude oil12. The Marcellus Shale is one of their main proved reserve areas; they drilled 46 new Marcellus wells in 2009.
C O NSO L Energy (C N X) has transitioned from a pure play coalminer, in 2008, to having 42% of development wells in the production of gas by the end of 2010. Additionally, in 2011, CNX acquired 500,000 acres in the Marcellus shale. This rapid change from one commodity play to another further confirms the promising nature of the gas industry in the U.S., in particular in the Marcellus Shale.
RRC holds a strong 1.3 million acre position in the Marcellus shale, out of which almost 50% DUHGHYHORSHG55&¶V presence in the Marcellus is not only better than their peer group, but they are also trading at similar discounts. The table below illustrates this. The EV/Present Value of Reserves at a 10% discount rate (PV-10) for each competitor, as well as their current discount to NAV assuming a 6x multiple to PV-10 (a benchmark multiple derived from recent M&A deals in the industry) allows us to believe that RRC seems to be trading at similar discounts. However, the value of their assets is much higher than those of its competitors. This means the discount is much steeper than what the figures below reflect.
The Target Company
Range Resources, a Fort Worth, Texas independent natural gas company, participates in the exploration, development and acquisition of natural gas properties. The company was incorporated in 1980 under the name Lomak Petroleum. Later that year, they completed an initial public offering and began trading on the NASDAQ. In 1996, Lomak listed on the New York Stock Exchange; in 1998, they changed their name to Range Resources Corporation after merging with Domain Energy Corp.
Properties
Appalachian Region
These properties are mainly located in Pennsylvania, West Virginia and Virginia, and account for 52% of production. The reserves principally produce from the Pennsylvanian (coalbed formation), Upper Devonian, Medina, Huron Shale, Big Lime and Marcellus Shale formations. Reserves at December 31, 2010 were 2.8 Tcfe, an
10 Cabot Oil & Gas 10K, FY 2009. Pg 3 11 Ultra 10k, FY 2009. Pg 7 12 EQT corp 10k, FY 2009 Pg 6 Page 6 The Orange Value Fund, LLC
April 14, 2011 Range Resources Corp. (NYSE: RRC) increase of 1.0 Tcfe or 56% from 2009. They have approximately 1.8 million gross acres, 4,969 net producing wells (78% of which they operate) and approximately 2,750 miles of gas gathering lines.
Southwestern Region
The Southwestern region includes drilling, production and field operations in the Barnett Shale of North Central Texas, the Permian Basin of West Texas and eastern New Mexico, and the East Texas Basin, as well as in the Texas Panhandle, Anadarko Basin of western Oklahoma and Louisiana and Mississippi. In the Southwestern region, they own 1,954 net producing wells and they have approximately 886,000 gross acres under lease. Total proved reserves in the Southwestern region increased 290.9 Bcfe or 22%
G rowth Strategy
RRC pursues an organic growth strategy by focusing on specific core operating areas. They emphasize cost efficiency and target complementary acquisitions where their existing operating and technical knowledge is transferable and drilling results can be accurately forecasted. RRC maintains a multi-year drilling inventory to increase their ability to consistently grow SURGXFWLRQ DQG UHVHUYHV $GGLWLRQDOO\ WKH FRPSDQ\¶V access to long-life proved developed reserves reduces reinvestment risk as they lessen the amount of reinvested capital needed to replace production. Additionally, they KDYH EHHQ DEOH WR GR VR ZLWKRXW GLOXWLQJ VKDUHKROGHUV¶ value. They have been able to fund developments in the Barnett and the Marcellus regions by selling their mature high-cost, lower-growth, properties. RRC has sold about $870 million worth of non-core properties and redeployed those proceeds to higher rate of return projects, mainly in WKH0DUFHOOXV0DQDJHPHQW¶VEHOLHYHVLQORQJ-term value creation so they focus on consistently growing reserves and production on a per share basis at best quartile finding and development costs. It is important to note the per- share factor. RRC does not believe in exclusively growing market cap; they focus on bettering their stock price and credit quality and not on size. Simplifying their balance sheet instead of relying so heavily on capital markets, has allowed them to cut staff level by over 300 full-time equivalents. 13
Barnett Shale Sale
On February 28, 2010, RRC entered into an agreement with a private company to sell their Barnett assets located in North Central Texas. The purchase price for these properties is approximately $900 million. The reason for selling WKH%DUQHWWDVRSSRVHGWRXQGHUGHYHORSHGDFUHDJHLVWKDWWKH%DUQHWW¶SURYHGSURSHUWLHVWUDQVODWHVLQDGROODUSHU mcfe instead of a dollar per acre figure, which ultimately increases proceeds. To put it in perspective, the expected rate of return on a house is a lot higher than simply selling the terrain on which it was built. Management believes they can achieve higher returns by selling proprieties that have already been drilled. Although the Barnett assets are of high quality, and returns from the region are expected to be attractive, management would rather focus on the Marcellus due to lower finding and development costs and higher production rates. In addition to the Barnett Shale sale, RRC has identifies $200-250 million of mostly non-producing assets for sale over the next twelve months.
Focus on the Marcellus Shale
The Marcellus is expected to contain approximately 500 Tcf of Natural Gas. Currently, the Hugoton field is the largest natural gas play with approximately 80 Tcf; the Barnett when first discovered was expected to contain between 20-30 Tcf. The long-term upside potential makes the Marcellus the most attractive play in U.S.
RRC discovered the Marcellus Shale and was one of the first companies to acquire prime acreage in both the dry and liquids-rich portions of the play. RRC continues to add to their 1.3 million acres as they further build
13 Barclays High Yield Conference, March, 2011 Page 7 The Orange Value Fund, LLC
April 14, 2011 Range Resources Corp. (NYSE: RRC) infrastructure in the rHJLRQ7KHFRPSDQ\¶VH[WHQVLYHDFUHDJHSRVLWLRQLQWKHIDLUZD\RIWKH0DUFHOOXVVKDOHSURYLGHV RRC more per share exposure to the play than any other company in the industry. This, along with the fact that only RI55&¶V0DUFHOOXVDFUHDJHLVFXUUHQWO\Eooked as proved reserves, gives the company the potential to increase its proved reserves by as much as 8x.
Production in the Marcellus is increasing. In fact, 2010 production increased 166%. RRC was producing 100 Mcfe per day by 2009, year-end 2010 averaged 212 Mcfe per day, and they expect 400-420 Mcfe per day by year-end 2011. These increased levels of extraction have led RRC to dramatically decrease its well count and finding and development costs, as production has increased relative to drilled locations.
The Marcellus Acreage
Securing the Marcellus acreage is extremely important for RRC to maintain its competitive advantage, as the low finding and development costs and increases in well efficiency will allow for higher rates of return. RRC secures their leases in multiple ways. First, many of their contracts have the ability to exercise an extension, for which they always do. Recently, RRC has also made half a dozen trades to consolidate their land. For example, last year they gave up some acreage in West Virginia to gain more acreage in Washington County. They do so because drilling secures acreage, and consolidating their land allows them to only drill one well in one location, instead of two wells in two locations. This increases efficiency in gathering systems and decreases capital expenditures.
RRC has capacity advantages in the Marcellus as well. Since RRC discovered the play, they strategically positioned their acreage along active and abandoned pipelines. Unlike others in the industry, capacity is not an issue for RRC.
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April 14, 2011 Range Resources Corp. (NYSE: RRC)
700,000 of the 1.3 million acres RRC holds in the play are believed to be in the fairway. We believe they are at a significant advantage for a company their size given their ability to capitalize on distribution.
New Wells in the M arcellus Shale:
Legend New Permitted Wells RANGE ANADARKO ATLAS CABOT CHESAPEAKE CHIEF/AB CNX EAST/SHELL EOG 139 producing horizontal wells EQT As of 12/31/10 FORTUNA/TAILSMAN Best Range Well ± 10.8 Mmcfe/d TURM (30 day) ULTRA XTO/EXXON OTHERS
Production
PDUNHG 5DQJH¶V HLJKWK FRQVHFXWLYH \HDU RI VHTXHQWLDO SURGXFWLRQ JURZWK Since 2007 RRC production has increased 52%. In 2010, production increased 14% from 2009 with an annual production average of 495.3 Mcfe per day. Targeted drilling to the liquids rich portion of the Marcellus Shale play in Pennsylvania drove most of that SURGXFWLRQJURZWKLQ5DQJH¶VPDQDJHPHQWLVIOH[LEOHZLWKSURGXFWLRQYROumes, as they increased production for both natural gas liquids and oil to offset depreciated natural gas prices. For the year, dry natural gas accounted for 79% of production, while oil and natural gas liquid accounted for 6% and 15%, respectively. This shows PDQDJHPHQW¶VDELOLW\WRPD[LPL]HFDVKIORZDQGHQVXUHDGHTXDWHVRXUFHVRIrevenue.
Page 9 The Orange Value Fund, LLC
April 14, 2011 Range Resources Corp. (NYSE: RRC)
Reserves
In 2010, natural gas, NGL and oil sales increased 8% from 2009 with a 14% increase in production partially offset by a 5% decrease in realized prices. RRC ended 2010 with 4.4 Tcfe of proved reserves, a 42% increase over the prior year. More importantly, proved developed reserves increased by 25%. Their proved undeveloped reserves (PUD) increased from 45% to 51% of total reserves. The increase in PUDs is a result of higher ultimate recovery per well (EUR) achieved by the Marcellus Shale assets. When the Marcellus program began, management expected the EUR to be 3-4 Bcfe per well, now they have revised that figure to 5 Bcfe per well. This is a significant advantage over other play areas, as the Barnett only achieves 2-%FIHSHUZHOODQG5DQJH¶VDYHUDJHUHFRYHU\IRUDOOORFDWLRQVZDV%FIHSHU well. The higher EUR will enable RRC to grow the Marcellus without adding as many PUD properties, as their proved developed properties are becoming more efficient. Hence, although the Marcellus allows for fewer locations to be drilled, each location is much more valuable. This translates in a higher reserve per well ratio and lower capLWDOH[SHQGLWXUHV55&¶VUHVHUYHUHSODFHPHQWUDWHKDVGUDPDWLFDOO\LQFUHDVHGWR - the highest level in its KLVWRU\7KHFRPSDQ\¶VKLJKTXDOLW\DVVHWVVXFKDVWKH1RUWKHUQ9LUJLQLD0LG&RQWLQHQW3HUPLDQDQG%DUQHWW properties continue to perform better than expectations, while the Marcellus drove much of this increase by doubling SURYHGUHVHUYHV0RUHRYHU55&¶VFRVWEDVLVFRQWLQXHVWRGHFUHDVHDVWKHFRPSDQ\VHOOVWKHLUQRQ-core assets with higher F&D costs.
Total reserves have also increased on a per share basis. In 2010, Reserves/share were up 35%, while the compounded annual growth rate from 2005-2010 was 11%. This shows that although RRC has been substantially LQFUHDVLQJLWVUHVHUYHVLWKDVQ¶WGRQHLWDWWKHH[SHQVHRIVKDUHKROGHUYDOXH In fact, that is one of the main positives for RRC. Their growth has been driven by organic cash flow generation, not through the issuance of new shares.
Low Cost Producer ³7KH ODZ RI GLPLQLVKLQJ UHWXUQV KDV EHHQ D IHDWXUH LQ WKH H[SORUDWLRQ DQG SURduction EXVLQHVV´± Roger Manny, CFO.
There has been a dramatic change in the industry for those who have large, unconventional plays. In large shales, the more you drill the better the economics. As RRC continues to drill up their unconventional resources, costs have come down on a unit basis. This has led RRC to concentrate on its core areas; those they believe to have sizeable hydrocarbon deposits in place that will allow them to consistently increase production while controlling costs. This is specifically achieved through their Marcellus properties.
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April 14, 2011 Range Resources Corp. (NYSE: RRC)
Bank of America High Yield study has ranked RRC either first, second, or third in achieving low cost production versus its peer group for the last six years. RRC allocates their capital spending on their highest rate-of-return properties. 95% of their capital budget for 2010 was allocated to four key project areas: The Marcellus Shale, the Barnett Shale, the Nora Field and the Texas Panhandle. RRC plans on allocating 90% of its $1.38 billion 2011 capital budget in further developing the Appalachian region, while only 10% will be used for their Southwest properties. The company expects that the proceeds from the asset sales plus cash flow will fund 2011 capex and that 2012 capex will only require $150 million of borrowings from the revolver. By 2013, RRC expects they can IXOO\IXQGFDSH[IURPFDVKIORZVLQSUHYLRXV\HDUV55&¶VDOO-in finding and development costs totaled $.72 per mcfe, as they benefited from the low cost structure of the Marcellus play. What is important to note, is that at $4 gas prices, RRC is still able to generate upwards of a 50% rate of return on the Marcellus play. This accounts for total costs, including land and G&A, and assumes $75 oil prices and $5 gas prices. Fortunately for RRC, the company has the first mover advantage in the Marcellus, which allowed them to secure prime acreage in the region for only $1,000 an acre.
Hedging
RRC uses hedging techniques as a risk-management tool by actively seeking to reduce exposure to short-term fluctuations in oil and gas prices and secure predictable levels of cash flow and earnings. Their hedging strategy is based on implementing a combination of swaps and costless collars. They do not use complex derivatives such as swaptions, knockouts, or extendable swaps. For 2011, 81% of production or 161 Bcfe is hedged. This figure makes RRC one of the most hedged companies in the industry.
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April 14, 2011 Range Resources Corp. (NYSE: RRC)
Top Holders
Common Holder % Stock
T. Rowe Price G roup, Inc. 21,011,688 13.1 BlackRock, Inc. 12,279,033 7.7 The Vanguard G roup, Inc. 8,140,217 5.1 State Street Global Advisors, Inc. 7,188,240 4.5 Capital Research and M anagement Company 5,875,000 3.7 Goldman Sachs Asset M anagement, L.P. 5,259,794 3.3 Neuberger Berman, L L C 4,984,930 3.1 Morgan Stanley Inc. 4,761,624 2.9 A rtisan Partners Limited Partnership 4,055,300 2.5 Marsico Capital M anagement, L L C 3,901,095 2.4
Management Analysis
During the past five years, management has increased their proved reserves 166% (from 1.2 Tcfe in 2004 to 3.1 Tcfe in 2009), while production has increased 122% (from 71,726 Mmcfe in 2004 to 159,112 Mmcfe in 2009) during that same period. In 2009, management increased proven reserves by 18%, marking the eight consecutive year proven reserves have increased. Management will continue to grow their reserves so long as they have the ability to fund capital expenditures. According to the DEF 14A filed on April 6, 2010, all the directors and executive officers as a group (17 individuals) own approximately 1.9% of the total shares outstanding. Of that group, John H. Pinkerton is the largest shareholder with 1.0% of the total shares outstanding. Thus, management do not have any controlling interest in the company.
John H. Pinkerton, Chairman & Chief Executive Officer, became a Director in 1988. He joined the Company as President in 1990 and was named Chief Executive Officer in 1992. Effective May 20, 2008, Mr. Pinkerton was named Chairman and CEO. Previously, Mr. Pinkerton was Senior Vice President-Acquisitions of Snyder Oil Corporation. Prior to joining SOCO in 1980, Mr. Pinkerton was with Arthur Andersen. Mr. Pinkerton received his Bachelor of Arts degree in Business Administration from Texas Christian University and a Master of Arts degree in Business Administration from the University of Texas at Arlington.
Jeff Ventura, President and Chief Operating Officer, joined the company in July 2003 and became a Director in 2005. Previously, Mr. Ventura served as President and Chief Operating Officer at Matador Petroleum Corporation, which he joined in 1997. Prior to 1997, Mr. Ventura spent eight years at Maxus Energy Corporation where he managed various exploration and development operations both domestic and international. He was also responsible for coordinating engineering technology. Early in his career, Mr. Ventura spent 10 years at Tenneco where he held YDULRXVHQJLQHHULQJDQGRSHUDWLQJSRVLWLRQVLQWKH86DQGDEURDG0U9HQWXUDKROGVDEDFKHORU¶VRIVFLHQFHdegree in Petroleum and Natural Gas Engineering from The Pennsylvania State University.
Roger S. Manny joined the Company in October 2003 as Senior Vice President & Chief Financial Officer. Effective May 20, 2008, he was named Executive Vice President and CFO. Previously, Mr. Manny served as Executive Vice President and Chief Financial Officer for Matador Petroleum Corporation. Before joining Matador in 1998, Mr. Manny spent 18 years at Bank of America and its predecessors where he served as Senior Vice PrHVLGHQWLQWKHHQHUJ\JURXS0U0DQQ\KROGVDEDFKHORU¶VGHJUHHLQ%XVLQHVV$GPLQLVWUDWLRQLQ)LQDQFHIURPWKH 8QLYHUVLW\RI+RXVWRQDQGDPDVWHU¶VGHJUHHLQ%XVLQHVV$GPLQLVWUDWLRQIURP+RXVWRQ%DSWLVW8QLYHUVLW\
Mark D. Whitley, Senior Vice President - Southwest, joined the Company in December 2005. Previously, he served as Vice President ± Operations with Quicksilver Resources for two years. Prior to that, he served as
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April 14, 2011 Range Resources Corp. (NYSE: RRC)
Production/Operation Manager for Devon Energy, following the Devon/Mitchell merger. From 1982 to 2002, Mr. Whitley held a variety of technical and managerial roles with Mitchell Energy. Notably he led the team of engineers at Mitchell Energy who applied new stimulation techniques to unlock the shale gas potential in the Fort Worth Basin. Previous positions included serving as a production and reservoir engineer with Shell Oil. He holds a %DFKHORU¶V GHJUHH LQ &KHPLFDO (QJLQHHULQJ IURP :RUFKHVWHU 3RO\WHFKQLF ,QVWLWXWH DQG D 0DVWHU¶V GHJUHH LQ Chemical Engineering from the University of Kentucky.
Ray N. Walker, Jr., Senior Vice President ± Marcellus Shale, joined Range in 2006 and was elected to his current position in February 2010. Previously, Mr. Walker served as Vice President ± Marcellus Shale, where he led the development of the Compan\¶V0DUFHOOXV6KDOHGLYLVLRQ Mr. Walker is a Registered Petroleum Engineer with more than 34 years of oil and gas operations and management experience, having previously been employed by Halliburton in various technical and management roles, Union Pacific Resources and several companies in which Mr. Walker served as an officer. 0U :DONHU KDV D %DFKHORU¶V GHJUHH RI 6FLHQFH ZLWK KRQRUV LQ $JULFXOWXUDO Engineering from Texas A&M University.
Non-Equity Name and Position Stock Option Incentive All Other (With RR C Since) Year Salary Awards Awards14 Compensation Compensation Total
John H. Pinkerton 2009 $ 641,346 $ 3,054,272 $ 2,563,814 $ 1,022,000 $ 147,786 $ 7,429,218 Chairman & CEO 2008 $ 557,500 $ 3,095,775 $ 2,569,917 $ 945,000 $ 131,014 $ 7,299,206 (1990) 2007 $ 503,077 $ 2,332,451 $ 2,062,125 $ 950,000 $ 97,362 $ 5,945,015
Jeffrey L. Ventura 2009 $ 481,539 $ 2,291,661 $ 1,923,673 $ 767,000 $ 82,606 $ 5,546,479 President & COO 2008 $ 423,077 $ 2,354,250 $ 1,954,330 $ 725,000 $ 75,638 $ 5,532,295 (2003) 2007 $ 383,077 $ 1,388,985 $ 1,227,978 $ 730,000 $ 62,483 $ 3,792,523
Roger S. Manny 2009 $ 361,154 $ 1,159,142 $ 973,012 $ 460,000 $ 61,684 $ 3,014,992 EVP & CFO 2008 $ 317,308 $ 954,525 $ 792,382 $ 326,000 $ 58,431 $ 2,448,646 (2003) 2007 $ 287,308 $ 702,572 $ 621,143 $ 330,000 $ 48,306 $ 1,989,329
Mark D. Whitley 2009 $ 326,923 $ 854,630 $ 717,400 $ 312,000 $ 56,855 $ 2,267,808 SVP 2008 $ 289,423 $ 852,675 $ 707,788 $ 297,000 $ 54,319 $ 2,201,205 (2005) 2007 $ 264,423 $ 623,148 $ 550,906 $ 300,000 $ 46,984 $ 1,785,461
Ray N. Walker, Jr. 2009 $ 272,500 $ 2,243,489 $ 250,334 $ 170,000 $ 845,786 $ 3,782,109 SVP 2008 $ 248,885 $ 294,524 $ 248,741 $ 150,000 $ 53,354 $ 995,504 (2006) 2007 $ 237,692 $ 310,000 $ 198,394 $ 100,000 $ 420,936 $ 1,267,022
Leverage and Liquidity
55&¶V contractual obligations include long-term debt, operating leases, drilling commitments, derivative obligations, asset retirement obligations, and transportation commitments. Long-term debt at December 31, 2010 totaled $1.96 billion, including $274.0 million of bank credit facility debt and $1.7 billion of senior subordinated notes. RRC has $218 million in contractual obligations due during fiscal year 2011. Net cash generated from operating activities, unused committed borrowing capacity under the bank credit facility and proceeds from asset sales combined will adequately satisfy near-term financial obligations and liquidity needs.
RRC continues to take steps to ensure adequate capital resources and liquidity to fund capital expenditures, which are expected to be $1.38 billion in 2011 (excluding acquisitions). On February 18, 2011, RRC entered into a new
14 The aggregate fair value of the Option Awards/SARs granted during the calendar year Page 13 The Orange Value Fund, LLC
April 14, 2011 Range Resources Corp. (NYSE: RRC) credit agreement with J.P. Morgan Chase as their advisor. The agreement is comprised of a bank group with twenty- seven commercial banks; with no one bank holding more than 7.0% of the bank credit facility. This new Senior Secured Credit Facility has a maximum facility amount of $2.0 billion and is secured by substantially all of the assets of the Company. This agreement is set to mature on February 18, 2016.
Capital Structure 2010 Bank debt $ 274,000 Senior subordinated notes 1,686,536 Total debt 1,960,536 6WRFNKROGHUV¶HTXLW\ 2,223,761 Total capitalization $ 4,184,297 Debt to capitalization ratio 46.9%
Debt Paydown
Valuation
Note: The reported value of proved reserves is not necessarily indicative of either fair market value or present value of future net cash flows because prices, costs and governmental policies do not remain static, appropriate discount rates may vary, and extensive judgment is required to estimate the timing of production.
All E&P companies are required to report reserve valuation based on SEC guidelines, which allows for an equal comparison of reserves among companies in the industry. The standardized measure of SEC discounted future net cash flows from production of proved reserves was developed as follows:
1. Estimates of current proved reserves and future amounts are made based on year-end economic conditions. 2. Estimated future cash inflows are calculated by applying a twelve-month average realized price of natural gas and oil to the quantities of those reserves produced in each future year. 3. Future cash inflows are reduced by estimated production costs, administrative costs, costs to develop and produce the proved reserves and abandonment costs ± all based on current year- end economic conditions. 4. Future tax expenses are based on current year-end statutory tax rates 5. The resulting future net cash flows are discounted to present value by applying a 10% discount rate.
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April 14, 2011 Range Resources Corp. (NYSE: RRC)
Two different valuations were performed: a going concern and an exit value based on a PV-10 6x multiple. The present value of the reserves was determined by assuming a 10% discount rate, a 15% tax rate (which is the historical five year tax to sales ratio) and the following price and operating assumptions:
Assumptions Going Concern Price Forecasted Expenditure as a % of Sales 35% Change in Production Oil & NGL NG Short-term 14.0% 10% Mid-term 10% 14% Long-term 0% 5% Additions to Reserves Oil & NGL NG Short-term 14% 10% Mid-term 8% 14% Long-term 0% 1%
The following table illustrates the Net Asset Value of RRC based on the assumptions previously mentioned:
Net Asset Value PV-10 Scenario Going Concern 6x multiple
PV Proved Oil and Gas Reserves $ 16,369,882 $ 4 ,647,352 Book Value of Unproved Properties $ 811,800 Other LT Assets $ 159,710 Net Working Capital $ (168,848) Gro s s A s s et Valu e $ 17,172,544 $ 27,884,112 Long-term debt $ (1,960,536) $ (1,960,536) Net Asset Value $ 15,212,008 $ 25,923,576 Shares outstanding $ 160,114 $ 160,114 NAV/Share $ 9 5.01 $ 161.91 Current Price $ 53.83 $ 53.83 Discount to NAV 43.3% 66.8%
For our going concern approach we assumed RRC was adding to their 2010 year-end proved reserves (as apposed to the pure depletion PV-10 method the SEC mandates. Production figures were also forecasted by averaging the previous three years of production and applying conservative growth rates going forward. A second, and more simple, valuation was done by applying a 6x multiple to the compan\¶V39-10. This multiple was determined by comparing recent M&A transactions in the industry. The NAV/Share for the Going Concern scenario is $95.01 or a 47% premium, while the NAV/Share for the exit scenario is $161.91 or approximately a 67% discount to current prices.
We also did a pure depletion scenario to compare it with the SEC PV-10 methodology used by the company. Our PV-10 calculation of reserves equaled $5.3 billion or $700 million more than the $4.6 billion calculation provided by the company. We believe the difference in both calculations is due to different costs and tax forecasts. In a pure depletion or resource conversion scenario, the value of Range Resources is expected to be $26.13. Although this scenario is truly unrealistic, it gives us a worst-FDVHVHWWLQJRIWKHFRPSDQ\¶VLQWULQVLFYDOXH
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April 14, 2011 Range Resources Corp. (NYSE: RRC)
Recommendation:
Reasons to Buy:
x RRC displays a high-quality asset base across the low-cost/ higher return Appalachian region and the large volume/ rapid payout of the Gulf Coast properties. We believe the contrasting investment opportunities that WKH FRPSDQ\¶V DVVHW EDVH SURYLGHV ZLOO HQDEOH WKHP WR FRQWLQXH JHQHUDWLQJ VWHDG\ FDVK IORZV ZKLOH simultaneously building out infrastructure in the Northeastern play. x :HDSSUHFLDWH55&¶VIRFXVRQGHYHORSLQJWKHLUFRUHSURSHUWLHVDVLWUHSUHVHQWVWKHFRPSDQ\¶VORQJ-term VWUDWHJLFYLVLRQRIPD[LPL]LQJVKDUHKROGHUYDOXH7KHFRPSDQ\LVQRWHDVLO\PRYHGE\WKHPDUNHW¶VVKRUW- term sentiment. Rather, management has clearly expressed their long-term view on natural gas plays by selling their Barnett properties to further focus on the Marcellus. x 55&¶VGRPLQDQWSUHVHQFHLQWKH0DUFHOOXVDQGWKHLUODUJHDFUHDJHKROGLQJVLQWKHSOD\ZLOOHQDEOHWKHPWR increase reserve quantities and production for several years to come. x Near term, RRC will benefit from low natural gas prices, as they have a much better cost basis than their peer group. They also consistently decrease their bottom line costs, while also substantially ramping up production. x We believe RRC is a possible takeover target, as their presence in the Marcellus shale along with their upbeat production outlook, gives them a clear advantage over any other company in the industry. Large operators and international companies have yet to fully penetrate the market for unconventional gas plays in the Marcellus region. Hence, as these larger conglomerates gain interest in the lower-cost/ higher return investments of the Marcellus, RRC will certainly be in the forefront of possible targets.
Risks:
x Although Range will benefit from a low-price environment compared to their peers, they are still susceptible to the volatility of natural gas prices until supply and demand balance out. Prices are expected to remain under pressure until secular demand picks up and the transition from coal generated plants to natural gas is fully underway. x The Marcellus Shale properties are still in the beginning stages of development. RRC certainly needs more capital as well as high pressured lines to develop and gather Marcellus gas. Also, disappointing results in the Marcellus could cause the stock to underperform our expectations. Management, however, believes they will be cash flow neutral by 2013 and are confident that they will be able to finance their growth. o Cost inflation for services and equipment, delays in pipeline development, and environmental UHJXODWLRQVPD\IXUWKHUGDPS55&¶VJURZWKSRWHQWLDO
Current Catalysts likely to unlock value:
x Turmoil in the Middle East and increased demand from China are likely to keep oil prices elevated. x Nuclear problems in Japan are expected to shift the focus from nuclear to NG and NGL. x The transition to NG fuel in the U.S. transportation industry may greatly benefit the use of this commodity. x A large number of gas-powered power plants are expected to increase demand for NG. x Increased amount of M&A activity in the Marcellus Shale will certainly unlock great value.
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April 14, 2011 Range Resources Corp. (NYSE: RRC)
Appendix
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April 14, 2011 Range Resources Corp. (NYSE: RRC)
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April 14, 2011 Range Resources Corp. (NYSE: RRC)
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