KANSAS

More than 60 drilling rigs are at work in Kansas today-eight or so are the large, rotary type that are rated to as much as 20,000 feet and dozens more are truck-mounted rigs that handle shallower depths, particularly seeking coalbed-methane (CBM) targets. Oil and gas production in the Sunflower State dates back to 1860 near the Missouri state line. From there, it quickly spread west as huge discoveries marked the landscape, such as at El Dorado, east of Wichita, that was the 1914 opener of the Mid-Continent Field. It alone provided 9% of U.S. oil supply in 1918 and has produced 300 million barrels so far. Then, the Central Kansas Uplift was tapped. And in 1922, the Hugoton Field opener in western Kansas was drilled; one of the largest gas fields in the U.S., by 1960 it hosted 4,000 wells, and continues today to be a cash cow for many producers. Kansas oil production peaked in 1956 at 124 million barrels. Today, the state is dotted by more than 40,000 oil wells that produced 34 million barrels in 2004, and 18,000 gas wells that gave up 420 billion cubic feet (Bcf). The per-well average is small but the cumulative production is large, says Ed Cross, executive vice president of the 876-member, Wichita-based Kansas Independent Oil & Gas Association (KIOGA): Kansas was the No. 8 oil producer in the U.S. in 2004 and No. 7 in gas production. While many states are struggling with an overall decline curve, Kansas' numbers are growing, Cross adds. Oil output grew a third year in 2004 among the past four, and operators are working at growing their gas production. Nearly 4,000 drilling permits were issued in 2004-a third more than in 2003 and more than double that of 2002. Most of the increased activity is due to higher commodity prices, which have improved well economics. "Most of the operators here in Kansas are locally owned and most of their cash flow is reinvested," Cross says. The state's producers are aided by a friendly environment. The typical mineral royalty structure is one-eighth or 12.5%, and most land and mineral rights are held by private landowners. The state is also rich with pipeline infrastructure, which takes gas production mostly north and east. Output at times is sold at a premium to Nymex prices; usually, it gets slightly less but it almost always sells for more than the Rockies' Colorado Interstate Gas price. Current exploration is focused on the Cherokee and Forest City basins in the east; the Central Kansas Uplift; and the Hugoton and Kansas edge of the Denver-Julesburg Basin in the west. A great deal of total Kansas production comes from the huge Hugoton Basin, which is mostly in the hands of large operators-BP, ExxonMobil, Occidental and others. "It's still a very prolific field," Cross says. "The majors are not going to just walk away. Yet, as the field is depleted, more independents will move in. The majors have sold everything else in Kansas." KIOGA members work steadily on a statewide public-awareness campaign. When President George W. Bush visited Kansas recently, an editorial asked, "What does he think? There's oil here?" Yes, and gas too. Cherokee Basin Oklahoma City-based Quest Resource Corp. has amassed more than 1,000 wells in the CBM-productive Cherokee Basin in southeastern Kansas and northeastern Oklahoma, nearly half of these drilled in 2004 alone. By year-end 2005, the company expects to have roughly 1,200 wells producing a total of 60 million cubic feet of gas per day into 20-inch polypipe, gathering production into 12-inch steel pipe that is tied into the Southern Star pipeline, which pays between 25 and 40 cents below the Nymex price. "This year, we're focusing on increasing production and cash flow," says chairman Jerry Cash, who did a reverse merger of his privately held, Oklahoma-based STP Energy Co. with president Doug Lamb's Chanute-based, publicly held Quest in November 2002. Cash's Cherokee Basin experience and assets were on the Oklahoma side; Lamb's, on the Kansas side. About a third of Quest's wells today are in Oklahoma but the company is focusing on some 200,000 acres in its core area in Neosho, Woodson, Wilson and Allen counties, Kansas, where it sees the most undeveloped opportunity. It holds some 80% of the acreage in Neosho County. Besides drilling approximately 160 more wells this year, Quest will recomplete an additional 300. "A lot of these wells were completed in a single seam, the Mulky or the Summit." These are at the top of the Cherokee group of coals and shales, are between one and three feet thick each, and are found at about 500 feet. In some wells, the company is producing from the deeper Rowe and Riverton coal seams. "The Riverton coalbed is one of the new seams we're adding. A lot of the recompletions will be in the Riverton-that is probably our largest resource," Cash says. The Mulky coalbed is a competitive reservoir. "This is the reason we hit it first." A good well produces more than 100,000 cubic feet per day; an average well, 70,000 per day. Each well costs approximately $80,000, all-in. In four years, Quest has run more than 1,200 desorption containers, testing the gas content of coals and shales from roughly 250 of its wells. Quest runs a set of samples per every two square miles, resulting in data from 50 wells rather than one. It is drilling on 160-acre spacing for now to hold the land by production and will eventually take the program down to 80 acres. In 2003, Quest acquired Devon Energy Corp.'s position in the Cherokee Basin. Devon's wells had been perforated in all zones. "You really couldn't tell what production was coming from which coal seam," Cash says. "Our approach is slower-you don't get to book reserves as fast, but you end up producing more reserves." Total depth per well is approximately 1,100 feet, which is drilled in a day or two by truck-mounted rigs. All-in costs per well run about $1.60 per thousand cubic feet (Mcf) of booked proved reserves "Anything greater than $3.50 an Mcf, the economics work," Cash says. Quest surprised the marketplace in December 2003 when the virtually unknown producer won a bid for Devon's assets in the basin for $126 million in cash. To fund the deal, Bulletin Board-traded Quest found $105 million of debt financing from Banc One Capital Markets that has since been replaced by UBS, and a $51-million, private-equity placement by ArcLight Capital Partners LLC. Devon's position fit well with Quest's, the opportunity was low-risk and considerable upside remained, says Keith Behrens, a managing director of Dallas-based Energy Capital Solutions, which arranged the financing. "Financing sources also quickly became comfortable that Quest had assembled the right team to exploit the combined asset base," he adds. Cash says of outbidding other, larger operators for the Devon package, "I felt I had as good a feel as anyone as to what the basin could do. It made sense to put the two positions together." Today, Quest has proved reserves of more than 150 billion cubic feet of gas equivalent (54% proved developed) in the Cherokee Basin, controls some 600,000 acres, and owns more than 1,000 miles of pipeline infrastructure, making it the largest operator in the basin. Its 2004 production was 8.7 billion equivalent. Cash says, "We focused last year on drilling and building infrastructure but that wasn't doing anything for cash flow. It was great for building reserves but not cash flow. This year, I know investors will see the fruit of our work from last year." The company doesn't pay a dividend, so shareholders have been waiting for a payday from an increased stock price. "I knew that if I could increase the value of the assets, the rest would come. This year, the focus is on showing everyone the money." Cherokee too Small-cap Admiral Bay Resources Inc. has been gathering acreage and drilling wells in southeast Kansas in Chautauqua, Allen, Neosho, Bourbon, Labette and Greenwood counties since 2003. A coal geologist by degree and oil and gas explorer by trade, Steven Tedesco, Denver-based president, had sold four CBM packages to Toronto-based Admiral Bay, which had a CBM project in Ontario that it has since scrapped. "Admiral Bay's management had asked me where I would go in terms of CBM properties in the U.S.," Tedesco says. His consulting services led to a position with the company, and the CBM projects in Kansas as well as a 6,000-acre block in Pennsylvania. "There is a narrow, updip, stratigraphic trap from southeast Kansas into northeast Oklahoma, a swath of CBM two to four counties wide from Kansas City to Tulsa," Tedesco says. Tedesco, who has had experience in more than 15 CBM projects in eastern Kansas and western Missouri, thought companies' interest in CBM would expire along with favorable tax credits in the 1990s, but the interest has grown instead, helped by higher commodity prices. "It's not surprising, actually," he adds, "the way companies have gone to lower-risk exploration. Most companies look at only short-term results, booking immediate, if undrilled, reserves and low-risk plays. Coalbed-methane and shale gas fit that model." In southeastern Kansas, Admiral Bay has amassed some 120,000 acres. At mid-March, it had some 24 wells producing and another 41 wells awaiting completion and hook-up into a pipeline. Current production from two projects is 500,000 cubic feet per day. At press time, the company expected completion of its new tap facility near Chanute, bringing daily production to more than 1 million cubic feet. It plans 100 more wells this year, each costing about $80,000, depending on depth, and holding 200 million cubic feet of proved reserves. Upon tie-in, Kansas production will total some 5 million cubic feet per day. "CBM exploitation is a methodical project going forward, drilling some good wells and some okay wells," Tedesco says. The main productive coals in the Admiral Bay acreage are also the Riverton and Rowe at up to 2,200 feet. Each seam is one to three feet thick, and a good portion of the produced gas appears to be coming from adjacent layers of shale. "Other companies haven't figured out yet how the play works and, like all coal basins, it takes time and patience to unlock the reservoir characteristics," Tedesco says. Most of Admiral Bay's wells are on 80-acre spacing. "We find, to date, it to be no different than 160-acre. The spacing doesn't seem to affect productivity." Cost management is key, however. "Our overhead is much, much lower than a bigger company's costs." A larger company may need to make between 300,000 and 1 million cubic feet per well per day to break even. "However, as gas prices rise, that may change and make Kansas more attractive to larger players." Forest City Basin North of the Cherokee Basin, Heartland Oil & Gas Corp. began amassing leases in the Forest City Basin in early 2000, eventually putting together some 250,000 acres. Its purchase in 2004 of Denver-based Evergreen Resources Inc.'s 765,000 acres, and some add-ons, brought it to roughly 1 million. Currently it has 950,000 under lease in northeastern and east-central Kansas. "We had done a proprietary, stratigraphic analysis in northeast Kansas of historical drilling logs," says Richard Coglon, president of Vancouver-based Heartland. "We also looked at some of the analogs in the Cherokee Basin. Our analysis showed us some continuity of the coals over the Bourbon Arch from the Cherokee into the Forest City Basin." Coglon was a co-founder of Calgary-based Velvet Exploration Ltd., which was sold in 2001 to El Paso Corp., and prior to that, he negotiated a production-sharing agreement with Yemen for Canada-based TransGlobe Energy Corp. With Heartland, he wanted to be a first-mover in an emerging basin, picking up acreage inexpensively. "We focused on areas the industry had not picked up on yet. In 2000, coalbed methane was still nouveau," Coglon says. Heartland ordered the stratigraphic analysis, went to leasing and did test wells in the Engelke area of Nemaha County. "These tests gave us a lot of hope." The Forest City coal seams are each about as thick as those in the Cherokee but there are more of them, offering cumulative thickness of some 47 feet versus 18 feet or less in the Cherokee. The Engelke tests showed good gas content, good permeability and good thickness. Heartland has been busy in the northern part of the basin; Evergreen offered it exposure to acreage in the southern part, and the information Evergreen had gathered. Part of the purchase terms include that Evergreen executives Mark Sexton, Dennis Carlton, Kevin Collins and Scott Zimmerman serve on an advisory board to Heartland for two years. Since closing, Heartland has drilled 14 wells to further test the economic viability of the acreage, all in the southern part. "We're cautiously optimistic. You have to really get in and understand the science of the coals, and we want to spend money as cautiously as possible, to understand the completion techniques these coals are going to require. "We want to break the code, in the south and apply it to our acreage in the north." Heartland now has 101 wells throughout its northern and southern positions, none of them producing into sales yet. Among them, 77 are dewatering or venting; 15 await stimulation and nine are saltwater disposals. Wells in the southern area cost about $125,000 each to drill and complete; in the north, $140,000 each. The coals in the northern acreage are thicker-up to 47 cumulative feet. "Gas content can vary widely on the northern acreage. The coals to the north are less mature than what we've seen in the Rockies, for example." Evergreen's exit was a pre-closing requirement of its acquisition by Pioneer Natural Resources last year. "A lot of the earlier players didn't see the production numbers they needed or they sold for liquidity reasons," Coglon says. "The economics in the Forest City Basin have yet to prove themselves. "That's why we're focusing on the southern acreage first and on getting gas into sales. In the south, the wells are more saturated. In the north, it takes longer to dewater the coals. We haven't announced any commercial production yet. We're still looking at our development plan." Heartland had been paying a dollar an acre for leases before larger companies, including Evergreen, began to look at the area too. By 2004, the average cost per acre was approximately $35 in the basin. Evergreen had spent $55 million in the Forest City Basin; Heartland got it for $22.5 million. C.K. Cooper & Co. and Sterne, Agee & Leach raised the funds to close the deal and provide working capital. "These areas take three to seven years to understand the science," Coglon says. "In the Forest City Basin, the coals are a lot less mature. Your completion techniques have to be redefined based on the thermal maturity of the coals." Two basins, experiences Houston-based, private-equity firm Quantum Energy Partners has invested in two start-up E&P companies with Cherokee Basin assets-Tulsa-based Rockford Energy Partners LLC and Houston-based EnergyQuest Resources LP-and one that has been involved with assets in the Forest City Basin-Denver-based Meritage Energy Partners LLC. "The Forest City Basin is less mature and tougher to crack than the Cherokee Basin," says S. Wil VanLoh Jr., a Quantum managing partner. Meritage, formed by former Basin Exploration executives Sam Winegrad and Tom Corley, acquired a 140,000-acre position in Kansas' Forest City Basin in Linn, Anderson and Bourbon counties and drilled 27 wells in a program funded by Austin, Texas-based Sandefer Capital Partners. Meritage also took up an adjacent position of 67,000 acres. Initial results indicated under-saturated coals and an extended dewatering period. Meritage sold its interest in the venture to Sandefer, retaining overriding royalty interests and its 100% interest in the adjacent, 67,000-acre position. "Based on results to date, the program hasn't generated the economic returns we hoped for," says VanLoh. "We spent a lot of time looking at coalbed methane in Kansas. With some exception, the Forest City Basin has not yet proven to be an economic play." Meritage and Quantum haven't written it off, however. "We are seeing additional activity around our position, including additional pilots being drilled by Sandefer, and will wait to see the results of that activity," VanLoh says. The venture in Kansas was the "exploration" allocation in Meritage's funding, a small portion of its budget. Primarily, Meritage is focused on conventional oil and gas production in the Powder River and Wind River basins in Wyoming. Meanwhile, in the Forest City Basin, Sandefer has grown its position to 150,000 acres and continues drilling additional pilots. "A lot of companies have exited the basin, but we've had very encouraging results recently," says Jeff Vaughan, vice president, project development, for Meritage KCM Exploration, the Sandefer company. "We think the area we're in right now will work." Gas content is good across the acreage, and the most recent pilot indicates fully saturated coals, Vaughan says. "Some areas are making gas right off, but others will need longer dewatering. It is all a function of the level of saturation." The wells are on 160-acre spacing. "In some areas, we may go to 80-acre." The coals are generally those found in the Cherokee group to the south, are thin (one to six feet per seam) and may total 16 feet per well. As in the Cherokee Basin, the Riverton coalbed is one of the main targets, he says. In the Cherokee Basin, Quantum's experience has been different. Rockford Energy Partners, founded by Chuck Perrin and fellow ex-Apache Corp. managers, was successful in CBM exploitation on the Oklahoma side of the basin, and recently sold its assets there to Newfield Exploration Co. Another Quantum portfolio company, EnergyQuest Resources LP, continues to work in the basin-on the Kansas side. It has had good results. The company made an $11-million acquisition from Kanmap Inc. and Cherokee Methane Corp. in December of some 65 wells on 8,500 acres in Montgomery County, and has since drilled three more. Production continues to incline. "These are extremely economic wells, yet they're not but a few miles away from some very poor wells," VanLoh says. EnergyQuest is led by Jerry Crews, formerly of Texoil Inc. (sold to Ocean Energy) and Aroc Inc. (sold to GE Capital), and Wayne Greenwalt, formerly of Energy Partners Ltd. The pair aimed to build EnergyQuest with South Texas and Gulf Coast assets. "But we were getting blown out of the water on the bids these assets were getting, and we started looking at Kansas," VanLoh says. "There wasn't much competition there for producing-property acquisitions." The glance toward Kansas has been worthwhile. EnergyQuest will probably drill 30 wells there this year, and continue to acquire additional assets. Outside of good geology in the Cherokee Basin, cost management is key, VanLoh says. "Once you have gas, cost becomes the No. 1 driver. The whole play is a cost game." Northwestern Kansas The prolific Denver-Julesburg Basin stretches into northwestern Kansas and southwestern Nebraska but many traditional DJ Basin operators have not ventured there-until now. Denver-based Bill Barrett Corp. and California-based Berry Petroleum Co. are among operators who are looking to tap the Niobrara gas formation across the Colorado state line. Kurt Reinecke, Bill Barrett vice president, exploration, southern division, has been with Rockies gas-focused Bill Barrett and its predecessor company Barrett Resources since the 1980s. "I kept wondering what was happening on the Kansas side, but I would have had to buy data not traditionally bought by Rockies players to know," Reinecke says. "There is almost a state-line fault. If you want to work on the Kansas side, you have to make that extra expenditure." In 2000 and 2001, after Barrett Resources was sold to The Williams Cos. and Bill Barrett was restarting, Reinecke was looking for new ideas. Gas prices were low at the time. He bought the Kansas-side well information and openhole logs. "When you look at the Niobrara on well logs, it's just the same as what you have in Yuma County (Colorado)." Kansas operators have produced from the formation but few have applied current technology to exploit the bountiful gas resource. "The resource has always been there; it's just been inefficiently produced." The Niobrara gas target is biogenic-shallow and cool. "It has its own challenges, but it has a number of positive attributes that attracted us to it." Also, drilling and other work can be done on the acreage year-round, and it is privately held land-where the landowners have welcomed drillers. Competition for leases on the Kansas side of the DJ Basin was practically nonexistent at the time, Reinecke says. 3-D seismic-newly in use in Kansas-is helping pinpoint bright spots that signify gas, particularly in the Niobrara formation. It is also illuminating structural anomalies in the deeper Pennsylvanian at about 5,000 feet. The Pennsylvanian is a bonus. Current exploration targets include the Sharon Springs organic shale, a member of the Pierre formation, that sits on the Niobrara and may be developed in tandem or with the Niobrara chalk. Both are gas-prone, low-pressure, low-temperature biogenic gas. Exploration will be with a combination of vertical and horizontal wells, some of the latter traversing as much as 1,500 feet. "This horizontal application may be the tool to unlock this resource," Reinecke says. "This area has very pervasive gas formations. We just need to unlock them." The area of mutual interest involved in the Barrett-Berry partnership is nearly 1 million acres, says Logan Magruder, Denver-based senior vice president of Berry Petroleum, which has a 50% working interest in the acreage. "We're really excited about the resource potential in the partnership area," he says. "The western area of Kansas is a hydrocarbon-bearing fairway that has been underexplored. The Niobrara chalk is thick, up to 45 feet in some areas." The region has also been constrained by pipeline takeaway capacity. The Pony Express and Southern Star systems have serviced the area for many years; additional takeaway capacity is now available via the new Cheyenne Plains pipeline. All three take gas to favorable Midwest and East Coast markets, offering about 12 cents more than the Colorado Interstate Gas index, which runs some 80 cents below Nymex. Barrett and Berry's two test wells in Kansas were to spud in mid-April. Barrett is running the exploration phase; if promising, Berry will run the development phase. Central Kansas Uplift The injection of carbon dioxide can result in more oil recovery from fields across Kansas, but Kansas doesn't have naturally occurring, subsurface CO2 as is found in West Texas. It does have a large agriculture industry-Kansas' largest industry-however. And, several ethanol plants have been built in central and western Kansas, making ethanol from green sorghum and corn to ship west to Colorado and California, which are swapping the controversial MTBE in their motor fuel for ethanol. For the past year, injection of the CO2 byproduct of that ethanol production has been under way in a pilot project at two leases in Russell County in the Hall-Gurney oil field in the Central Kansas Uplift. The state, U.S. Department of Energy (DOE) and industry partners are funding the test. Industry partners include MV (Murfin-Vess) Energy LLC, Kinder Morgan CO2 Co. LP and ICM Inc. Public partners, besides the DOE, are the Kansas Department of Commerce and the University of Kansas in Lawrence. "CO2 should work here," says Tim Carr, chief of energy research for the Kansas Geological Survey. With a year's worth of results already, "we know right now that we have a technical success." The demonstration area is a 40-acre six spot with a central injection well and five surrounding production wells. Oil there is produced from the Lansing/Kansas City "C" zone at 2,900 feet. The existing production wells have been making oil since the 1930s. For the project, a new well was drilled as the CO2 injector. Extensive waterflooding-the second recovery phase-has been used in the Central Kansas Uplift since the 1950s to encourage additional oil output. In the third, or tertiary, recovery phase, importing CO2 via pipeline from natural sources-such as the world's largest CO2 field, the huge McElmo Dome in southwestern Colorado-has been considered. If CO2, whether from ethanol plants or pipeline, is successful in pushing additional commercial amounts of remaining oil to the surface, the prize may be large. The Central Kansas Uplift has produced 6.3 billion barrels of oil to date. Carr believes it has between 100 million and 1 billion of additional oil to give up. Home-grown Wichita-based Lario Oil & Gas Co., founded, owned and operated by the O'Shaughnessy family, is a long-time Kansas producer, having made its first big strike in 1927 with the 22,000-barrel-per-day Oxford pool in Sumner County. Early on, the company targeted reserves in Kansas and Oklahoma, while today, Lario has added core areas in Canada, West Texas, the Rockies and California. Nearly half of its drilling activity remains focused in Kansas, says Mike O'Shaughnessy, Lario's Denver-based president. Having an early career with Tenneco Oil and then Impel Energy (one of the Hunt family oil companies), O'Shaughnessy joined the family firm in 1977. Of the 105 wells Lario drilled or participated in during 2004, 47 were in Kansas, balanced over four focus areas: the deep Mississippian and Pennsylvanian oil-bearing rocks of the Hugoton Embayment; oil and gas targets in the Sedgwick Basin west of Wichita; oil zones in the shallow Arbuckle and Lansing-Kansas City of the Central Kansas Uplift; and oil and gas targets on the west flank of the Pratt Anticline in Comanche County. Lario will keep five conventional rigs busy in the state during most of 2005. Some of its activity in Kansas is almost by default. "It's easier to get permits in Kansas," O'Shaughnessy says. "We wanted to drill 20 wells in Wyoming last year and only got nine in because of the federal permitting process." Currently, about 30% of total company production is operated, and 55% is oil. About one quarter of output is from Canadian interests, but more than 20% is from Kansas, and that figure will grow. "Our Kansas capex is growing both in dollars and percentage of total because of the multitude of prospects you can come up with in Kansas. There's no shortage of ideas here-there are so many local experts. There are many prospective zones as well, so you get to look at a lot of horizons with productive potential." Across its acreage, the company is applying 3-D seismic for both wildcatting and development. "It's not new technology but it is relatively new to Kansas." Specifically, Lario has had notable success with shooting 3-D over old fields to find smaller pinnacle-type sweet spots that otherwise would have been missed by conventional 20- or 40-acre spacing. And in the Sedgwick Basin, Kingman County in particular, Lario is applying new fracturing techniques to enhance permeability in a typically low-perm Chert reservoir. Are these modern methods working? "Time will tell," says O'Shaughnessy, "but we think we are seeing improvements initially." Would an established Kansas operator such as Lario want to encourage competition for leases from newcomers? O'Shaughnessy replies, "There's plenty of room for more people without driving lease prices up. There are a lot of places to go in Kansas."