The Prospects for Continued Expansion of Marcellus Drilling – Some Companies Cooling on Shale Gas Drilling

Will drilling in the Marcellus Shale, or other shale plays for that matter, continue its red-hot growth? The honest answer is, who knows? It depends on whether or not it’s profitable for energy companies to continue their shale gas drilling expansion. Right now, it appears that at least some companies are leaning away from further expansion in shale gas drilling because the commodity price of natural gas is low compared with oil. Many (most?) of the companies who drill for natural gas also drill for oil. If the price you get for gas is only barely covering your costs to drill, as it is right now for natural gas, you take a close look at the alternatives, like oil.

Some of the factors that will continue to affect the price of natural gas in the coming few years, and hence drillers’ willingness to drill:

  • The price of oil. The higher it goes, the more attractive it is to drill for it.
  • The number of coal-burning plants. A number of plants (which provide much of the electricity in the U.S.) are due to be retired or converted to natural gas. More demand for gas, higher prices for gas. Some alternative—either gas or nuclear—will have to replace coal long-term because demand for electricity ever increases.
  • Government regulation. Too little regulation and oversight of the industry is not good, but likewise, too much regulation, especially from the federal government, could lead to much higher costs for drillers, making natural gas drilling less attractive. Right now the specter of the EPA claiming it has a right to control drilling based on water issues hangs over the industry.
  • Lack of pipelines and storage. You’ve got to be able to get the gas from the well to market. Lack of infrastructure slows it down.
  • Increase in the number of natural gas-powered vehicles. If more cars and trucks are manufactured to run on natural gas, and if more “filling stations” appear, that will create more demand for natural gas and increase the price of it.

One phrase that is often used with relation to shale gas is that it is a “game changer.” No doubt there will be cycles where drillers will drill less at certain times, and more at other times, depending on the commodity price of natural gas. One thing is for sure: Shale gas drilling is here to stay for the next several generations.

Below is a press release from Energy Management Resources with their insights on natural gas prices and how those prices are affecting energy companies’ plans to drill.

EMR Press Release

Based on last months New York Mercantile Exchange (NYMEX), Natural Gas prices are holding between $4.20 to $4.30 per MMBtu. Many factors come into play with when pricing commodities on NYMEX; however, all eyes continue to focus on the game changer – Shale Gas. Energy Management Resources is seeing a lot of clients re-analyze their hedging strategies as a result.

Shale continues to take center stage, albeit with mixed opinions, as compared to previous robust projections. These mixed opinions are adding some volatility to the direction of natural gas prices. Yet, it looks like North American producers are scaling back due to economics.

Here are the some facts regarding the economics of shale gas:

  • There are 2,300 drilled but yet to be completed wells in the Haynesville, Marcellus, Eagle Ford and Barnett plays alone. As a result, producers have an inventory position whose cost structure will continue to put price caps on future price increases.
  • There are potential environmental hazards that can be associated with the process of drilling for shale gas. Consequently, larger investments may be needed to deal with any new regulatory oversight and unanticipated regulations.
  • Storage and pipeline capacity limits are being tested, as U.S. dry natural gas production is expected to grow by about 5.4 Bcf/d through 2015 from the 2010 average.

What some know about this game-changer is that the new drilling technologies that have proved so successful for natural gas may now provide an impact on the world oil supply. Oil brings much higher returns than gas, so many investors have already begun to pressure Boards of Directors about their investments. While debt rollovers, new equity offerings, and asset lease sales have financed the shale gas boom, disappointing cash flows are leading some investors to jump off the bandwagon. A thousand cubic feet (Mcf) of U.S. natural gas once sold for a tenth of the price of a barrel of oil, but now that spread has widened tremendously – One (1) Mcf of gas now sells for a twentieth, or less, of the price of a barrel of oil. Major shale producers see today’s gas prices making the economics of shale gas, as well as conventional gas, increasingly unprofitable. Weak cash flows have spurred investor concerns that these companies may no longer be able to meet wellhead break-even costs at those prices.

  • Chesapeake Energy Corporation announced they had decided to sell all of its Fayetteville Shale assets and its equity investments in Frac Tech Holdings, LLC and Chaparral Energy, Inc.
  • Chesapeake also announced ramped up investments at the Niobrara oil/shale formation, primarily an oil play, situated in northeastern Colorado and parts of Wyoming, Nebraska, and Kansas.
  • Voyager Oil & Gas has made similar investment decisions. It will reduce production in its Bakken shale formation and refocus on its Niobrara fields.
  • In response to deteriorating, if not negative profit margins, other shale gas producers are suddenly redeploying their rigs to drill for more lucrative oil. That includes the likes of Petrohawk Energy Corporation, EOG Resources, Forest Oil Corporation, and Quicksilver Resources.

Low natural gas prices are the result of many factors and the technology behind shale gas is seen as the central game changer, as it may assume a similar role in oil exploration. Although the potential environmental impacts of producing shale gas are being questioned, shale gas producers are redeploying their drilling dollars to oil targets searching for higher returns. According to Baker Hughes last week, the number of natural gas rigs operating in the US fell for a fifth consecutive week to a ten-month low. By shifting from gas to oil, the technology has lifted hopes of the first significant rise of onshore U.S. oil production in decades. In five to eight years, the technology could add a million barrels of oil a day to U.S. supplies.

Analysts stress the importance of this switch in exploration activity. Moving from shale gas to oil won’t be without consequences for future gas supply, as the effect of more rigs drilling for oil will have an impact gas prices. The oil exploration industry has already moved to riskier finds, such as Alberta tar sands and deep-water drilling. There probably isn’t a whole lot of “easy oil” left to find. Thus, the oil industry thinks it can benefit from the shale gas technology developed by its siblings in the natural gas sector.

*PRWeb/EMR (May 3, 2011) – Energy Management Resources Reports on the Volatility of Natural Gas Prices

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