November 23, 2009

Economic Reasons to Delay Marcellus Shale Drilling

Most of the discussion about gas drilling in the Marcellus Shale has turned on environmental questions - will it poison our water, irradiate the area, destroy our roads, and generally prove difficult to fix? All of these are important questions, but they've mostly been contrasted with rosy pictures of large royalty payments to landowners and economic benefits for municipalities.

I'd like to suggest to landowners and municipalities that being in a hurry may not be to our advantage. Yes, of course people prefer their money now, and often place a significant premium on cash up front. At the same time, though, drilling as quickly as possible also may bring a lot less return.

The Marcellus Shale wells are not the usual natural gas wells that reach down into permeable sandstone and give gas a simple path to the surface. Drilled into less permeable shale, they need to expand horizontally to create more pathways for gas. This is typically done with water and a variety of additives, and is called hydrofracturing, or just "fracking".

This process creates most of the controversy around gas drilling, as it uses huge amounts of water, adds chemicals to the water, extracts the water from the ground, and then has to dump that water somewhere. The process of blasting water through the ground isn't exactly precise, either, and seeing what's happening thousands of feet down is difficult.

From a mining perspective, though, the problem with fracking isn't environmental - it's simply that it's expensive. Having to frack a well once is natural to shale production, and the story we've been hearing locally about Marcellus fracking, but it also seems that as production declines on a well, it may be worth fracking again and again:

"They have fantastic initial rates, but the question is whether the (rate of production) persists as they say." For example, he says, in deep shale formations "the rock collapses as gas is produced, and crushes the proppant. And as the fractures are drained you have to frac and frac and frac."

The question of the rate of decline on shale well production has created some explosions in the energy community recently, with World Oil magazine canning a column and then canning its editor for not being enthusiastic enough about canning the column, which a few gas companies weren't happy about. (For more detail on that, see the columnist's web site, with a letter from the editor.)

For energy companies, the scary questions are the size of their recoverable reserves and the cost of extracting that gas, which largely determine the value of their companies.

For landowners looking forward to what they'd hoped would be long-term income, the scary questions are how long their well will actually stay in production, and what they'll get for income. A shorter production window of just a few years makes the value of the well much more vulnerable to fluctuations in natural gas prices. Right now, prices are historically low, and likely to stay that way for a few years at least, until the economy recovers and natural gas becomes a more important component of energy generation.

Landowners, of course, have no control over when the gas comes out of the ground and for what price it's sold. Their lease agreements ensure that they'll get a share of the revenue, as it's a royalty-based system. Energy companies would of course like to get the highest possible return on their wells, but they have a lot of other factors they consider beyond the current price of gas and the return to the landowner.

They have a business to sustain, customers to supply, stock prices to watch, and while they certainly hope for high prices, they'll sell what they have to, without much worry about the people from whom they leased rights.

To the extent that municipalities and especially the State of New York stand to benefit from these revenues, they have a similar interest in waiting. Yes, of course New York is desperate for revenues, and may have a much more severe hunger for short-term fixes than landowners - but that doesn't mean the quest for a few more years of stopgap revenue is a great idea.

Whatever the pros and cons of drilling, a short potential lifespan for these wells and a crashed-out natural gas market that's likely to stay that way for a few years make a lousy combination. Even proponents of drilling should take a hard look and ask: why rush?

Posted by simon at November 23, 2009 8:25 AM in
Note on photos


Brian Weis said:

I think you raise an exceptional point. I was at the recent hearing at the State theater and I don't recall anyone bringing up this argument. It would be nice to see a more "Wait and see Approach" it seems to me we have not much to lose from waiting, and the reasons to wait are many.

Thomas Shelley said:

Simon--This is a very well thought out position. I think the Multinationals' "rush" is to set precedent (establish territoriality and the hold of the technocracy, to defeat the strengthening of environmental regulations) and to make it look (at least) to their stockholders like they are doing something. I'm certain they are under a lot of pressure to "do something" after the expectations generated by their prospecti over the past few years of puffing up their stockholders. Tom

One key piece of the "production" pie that you've failed to touch on is that if a well is successfully producing, that creates a binding production agreement that can lock leaseholders into an otherwise "shorter" lease for years on end. So, more production is not necessarily a good thing, because that means the industry will be here for years to come, extending the leases for as long as they can.

Jason said:,_i_email=y.html

Above is a link to a financial times article that raises similar questions about the economics of the Marcellus. Bottom line, these wells are money pits and unless the price of gas rises and the well production reaches the extra rosy predictions, the wells may not be the moneymakers these companies hope them to be.

This doesn't even account for the remediation costs for the land after the well is dry and the water retention ponds (and their waste) have to be dealt with.