“We have high organic production growth with high return on capital employed,” says Nicholas J. DeIulis, CNX chief executive officer.

Spun off from Consol Energy Inc. in 2005, Pittsburgh-based CNX Gas Corp. has taken a meteoric climb to being the largest Appalachian gas producer by revenue, including a record first half of 2008, while dealing with an attempted minority close-out offer that would have meant the parent company would own CNX 100%. Part of that climb for the coalbed-methane producer includes involvement in the Marcellus, Chattanooga, Huron and New Albany shale plays.


The parent company’s close-out offer turned out to be a temporary distraction.


“In January, Consol Energy announced that it will make a close-out offer to the minority shareholders,” CNX chief executive Nicholas J. DeIuliis said while addressing attendees at the recently held A&D Strategies and Opportunities conference presented by Oil and Gas Investor and A&D Watch in Dallas.


“Fast forward to March, when Consol announced that it was going to shut down its offer,” DeIuliis said. “All of this happened in just three months.”


In January, Consol Energy announced it was prepared to make a stock-for-stock deal for CNX. Consol Energy owns about 81.7% of the almost 151 million shares of CNX common stock that is outstanding. Under the terms of the initial deal, Consol was going to offer CNX stockholders 0.4425 share of Consol common stock for each share of CNX common stock that Consol didn’t own. That was the equivalent of about $33.70 a share for CNX’s common stock.


At first blush, the deal was valued at $932 million.


When the close-out offer was made, Consol chief executive J. Brett Harvey said, “We have always believed that a diversified energy portfolio of coal and gas, which combined account for two-thirds of fuel for U.S. electricity generation, is a winning combination. The acquisition of the remaining outstanding shares of CNX Gas will give us the greatest flexibility in the access, allocation and utilization of our capital in growing that diversified portfolio.


“Two years ago, financial markets did not understand or properly value the gas assets and operations of Consol Energy. In the two years since we established CNX Gas as a public company, its visibility and transparency have improved, and financial markets appear to have a greater appreciation for its value, as evidenced by the significant growth in the market value of CNX Gas.”


Immediately after Consol’s announcement, CNX’s board formed a special committee made up of two independent directors who retained UBS Investment Bank as its financial advisor.


DeIuliis says that in January and March, Consol’s shares decreased in price during a time when gas prices rose from $8 per thousand cubic feet to $10. CNX shares traded in line with Consol during the three-month period, until in March, when Consol terminated its buy-out plan.

Building on success
With that issue settled, CNX continues to build on its three years of success as an independent gas producer in Appalachia.


“We have the best of both worlds,” DeIuliis said. “We have high organic production growth with a high return on capital employed.”


CNX reported record net income for the latest quarter of $64.3 million, or $0.42 per share. This was 55% higher than the net income of $41.5 million, or $0.27 per share, for the same time period a year ago, and the highest quarterly net income in the company’s three-year history.


Gas production was also a record at 18.8 billion cubic feet (Bcf), or 206.5 million cubic feet per day for the quarter. This was 26% higher than the 14.9 billion cubic feet, or 163.6 million cubic feet per day, for the same time period last year. DeIuliis says that was also 18% higher than the 15.9 Bcf produced in the March 2008 quarter.


The 2008 production guidance has been increased to 73 Bcf, which represents a 25% gain from the 58.2 Bcf in 2007. DeIuliis says that CNX is maintaining its strategic vision of producing 100 Bcf by 2010 and “will continue to re-invest in its core business as long as we earn a meaningful spread over cost of capital.”


DeIuliis says the average price realized for the company’s gas production was $9.63 per thousand cubic feet for the second quarter, or $1.89 higher than the $7.74 per thousand cubic feet received for the same time period in 2007.


Among other checks in the positive category: The company ranks No. 1 in methane capture in the U.S. energy industry; it is the second-largest capturer of methane in the U.S.; is an offset member of the Chicago Climate Exchange with 8.4 million tons of carbon dioxide offsets registered (the equivalent of removing 1.6 million automobiles from the road); and its ongoing annual credits could be in the range of 2- to 3 million tons.


“We are the lowest-cost producer in the eastern U.S.,” DeIuliis says. “We are one of the highest-margin producers in the U.S.”


The company has 1.3 trillion cubic feet of proved reserves; 941 Bcf of unproved; and 1.3- to 5.2 trillion cubic feet of unrisked resources for a total of 3.6- to 7.4 trillion cubic feet.


With a total of 3.9 million gross acres, DeIuliis says, “CNX Gas has evolved from a de-gasser of coal-mine methane to a global leader in CBM development.” He says the company’s CBM assets lie in four areas including Virginia, which was originally developed in 1982 by Consol. CNX developed Mountaineer in Pennsylvania in 2006, Nittany in Pennsylvania in 2007 and is in the midst of exploration operations in the Illinois Basin.

DeIuliis says that removing methane from the Pocahontas #3 seam in Virginia was an imperative to improving the safety and productivity of Consol’s mines in the state. The Virginia CBM operations consist primarily of two adjacent fields known as Oakwood Field and Middle Ridge Field. These fields, along with nearby Nora Field, contain some of the gassiest coal in the Western Hemisphere, with gas content of 400- to 600 cubic feet per ton.


In 2008, CNX has seven rigs running and planned to drill 300 CBM wells in Virginia.


The Mountaineer operation in Greene Hill and Fallowfield in Pennsylvania and St. Cloud in West Virginia is a legacy position of 523,000 net acres, but had no development effort. Fifteen wells were drilled in 2006, when DeIuliis says CNX proved it could economically engineer the gas out of the ground. In 2007, 62 wells were drilled, exceeding the goal of 57 wells. By year-end 2008, CNX expects to drill 100 wells there.

Fast-paced development
Nittany is the company’s CBM project in central Pennsylvania. When CNX sold shares in a private placement in August 2005, the company had not yet completed cataloging the entire acreage. The 248,000 net acres that now comprise this play were unveiled at the company’s July 2006 investor conference. First sales production occurred in November 2007. Effectively, this project went from concept to production in just 16 months. This year, it plans to drill 100 wells.

DeIuliis says the company has taken a leading position in the eastern shale developments. In the Marcellus, the company has 185,000 acres; 235,000 in the Chattanooga; 198,000 in the Huron; and 336,000 in the New Albany.
CNX has an $88-million exploration program this year, with most of it directed at developing these shale plays.


Of all the shales, CNX is furthest along in testing the Chattanooga in Tennessee. The company has drilled four additional wells to the initial exploration well, which had an open flow of 3.9 million cubic feet per day. This well is now producing at 265,000 cubic feet per day.
During the second quarter, CNX started drilling in its Marcellus acreage in southwestern Pennsylvania. The first Marcellus well was drilled to 8,000 feet as a vertical well at a cost of $1.3 million, where the shale thickness is 80 feet. The well came online July 25 with a flow rate of 1.3 million cubic feet per day.


In the Huron, the company has drilled one horizontal well in eastern Kentucky. The rig has moved to a second location. CNX has said the results of this well will be made public before the end of the fall.


CNX has drilled a shallow, exploratory well on its New Albany shale holdings. The well did not penetrate the shale zone, but did produce more than 1,000 barrels of oil from the shallow formations.


DeIuliis says CNX is occupying a unique niche. “If not for us, a lot of methane would be vented into the atmosphere,” he says. “We are holding a unique position and continuing to build on three years of success.”

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