Credit crunch, falling prices threaten ’stealth’ shale development
Posted on November 10th, 2008By Katie Howell
Greenwire: As natural gas prices skyrocketed this year and horizontal drilling techniques became mainstream, “stealth” shale reservoirs emerged as the saviors of the dwindling onshore U.S. natural gas industry.
But financing sources are drying up, and natural gas prices have fallen by nearly half from a high of $13.32 per thousand cubic feet in July, sparking concerns that the rapid development in the past year of shale plays like the Marcellus in Pennsylvania, West Virginia and New York and the Haynesville in northern Louisiana may stall out before the reservoirs’ full potential is realized.
“The economic forecast certainly does not bode well,” said Louis D’Amico, executive director of the Independent Oil and Gas Association of Pennsylvania. “Our industry will be impacted as much as any business industry in the U.S.”
The Barnett Shale in Texas, the grandfather of the current shale natural gas frenzy, was first tapped in the early 1980s and has been producing record amounts of natural gas from its compact, fine-grained rock for decades. Development of horizontal drilling and hydraulic fracturing technologies to break apart the compact rock and release hydrocarbons spurred development of the reservoir as well as development of similar plays like the Fayetteville in Arkansas and Woodford in Oklahoma.
Natural gas producers have long known about prolific reservoirs like the Marcellus and Haynesville, but gas-price economics did not make it profitable to explore the difficult-to-reach rock bodies. The Marcellus lies about 5,000 to 8,500 feet below the Appalachian Mountains. And to reach the Haynesville — positioned under relatively flat northern Louisiana — companies would have to drill down 10,500 to 13,500 feet.
Reports of a Haynesville well producing nearly 17 million cubic feet of gas per day and the Marcellus’ potential 50 trillion cubic feet total size signify their importance in the United States’ energy-security lineup, but with drilling costs sometimes topping $7 million per well, companies need the assurance of sustained high energy prices — and sufficient cash or credit access — to make exploration possible and profitable. Horizontal wells in the Marcellus cost about $3 million to $4 million each, but companies and drilling rig operators have to contend with the uneven terrain of Appalachia to reach drilling sites (Greenwire, May 5). Haynesville wells cost $6 million to $7 million, according to a July Deutsche Bank report.
“We’re seeing people back down on their initial planned development [in the Marcellus] because of the lack of financing, among other issues out there,” D’Amico said. “Companies are taking a conservative approach with their cash flows because they’re finding it difficult to borrow funds.”
Return on investment
Chesapeake Energy Corp. could be the company with the most to lose — or gain — from the effect of the financial crisis on stealth shale plays.
Chesapeake, an aggressive leaser in the stealth shales and granddaddies like the Barnett, Fayetteville and Woodford, was slammed by the sudden drop in natural gas prices and waning credit lines during the third quarter of this year. The company had little cash on hand to proceed with drilling operations on its extensive acreages, and the drop in prices meant ongoing production would provide smaller profit margins.
But Aubrey McClendon, Chesapeake’s co-founder and CEO — and consummate landman — said the Oklahoma City-based company is well positioned to weather the current financial storm.
“Chesapeake favors low prices. It’s great to stimulate long-term demand,” McClendon said in an Oct. 31 conference call with investors. “We have more than 12 [trillion cubic feet of natural gas equivalent] of proved reserves and many, many 10s of Tcfs of probable reserves that need to be consumed by somebody some day. Every two to three years, we need higher gas prices to get our hedging done.”
The past month has sent Chesapeake into a frenzy of selling assets and cutting expenditures to boost liquidity. The company has stemmed its practice of paying $25,000 an acre for lease bonuses in the Barnett and Haynesville, indicating that it will now pay no more than $5,000 an acre — if it leases at all. It sold 20 percent of its Haynesville acreage to Plains Exploration and Production Co. And the company is looking for a 25 percent joint venture partner for its Marcellus operations.
Don Briggs, president of the Louisiana Oil and Gas Association, noted the significant drop-off in active leasing in the Haynesville area. He said the financial crisis will likely have an effect on companies’ efforts to secure credit for exploration activities like shooting seismic surveys and that it could slow development of the play. But he remained optimistic that companies would not bail out of the Haynesville just yet.
“These companies have put in a big commitment to exploration based on the dollars they’ve spent on bonuses and leases,” Briggs said. “There’s a big commitment to drill those leases.”
Chesapeake agreed that it wanted a return on its investment in the Haynesville. But McClendon said during the Oct. 31 conference call that the company had decreased its capital expenditures by $4 billion for the rest of 2008 and had seen its number of operating rigs in all its fields drop from a high of 158 in August to 128 by the end of the year.
“I think … the credit crunch is probably playing a bigger role even than lower gas prices in affecting producers’ drilling plans,” McClendon said.
How low?
Experts’ estimates were varied on the absolute price threshold that would stall companies’ efforts in the stealth shales.
D’Amico said the current price of natural gas was probably not enough to sustain operations in the Marcellus. Natural gas for December delivery was trading at $7.15 per thousand cubic feet on the New York Mercantile Exchange as of press time today.
“Nobody’s getting rich at the current price in the Marcellus,” he said. “But that’s the same with any new play.”
Experts on the Haynesville operations predicted a slightly lower threshold price. Don Goddard, a professor at Louisiana State University’s Center for Energy Studies and the director of the Central Gulf Region Petroleum Technology Transfer Council, estimated that prices would only have to drop as low as $5.50 to $6 per thousand cubic feet before companies would start pulling out.
Briggs of the Louisiana Oil and Gas Association said he thought prices would have to drop even lower.
“If the bottom drops out of natural gas prices for some unforeseen reason, then we’re going to see a serious pullback. I think prices would have to drop as low as $4.50 to $5 [per thousand cubic feet] before people start looking at their home cards,” Briggs said.
All were quick to note, however, that lower prices could spur higher demand, which would drive prices back up again, indicating that any lull in Marcellus or Haynesville activity could be only temporary.
If prices remain low, Chesapeake sees an unlikely savior to the supply-demand balance — and by association, development of the stealth shale reservoirs — for natural gas: President-elect Barack Obama.
“We think [Obama’s win] could be very favorable for natural gas prices going forward,” Marc Rowland, Chesapeake’s executive vice president and chief financial officer, said during the Oct. 31 conference call. “We look forward … to four or eight years of federal policies that we think will impose some kind of carbon costs on fuels that we believe will be favorable for natural gas. And we also view that this administration will be very favorably inclined to try to do something about introducing natural gas into the transportation network in a more aggressive way.”