If there’s a notion out there of wildcatters hopping from town to town, striking it rich on an oil and gas well and moving on to the next great thing, it isn’t so today. Not with shale. This, companies say, is a long-term game.
It has to be so for the economics to make sense, as companies struggle with low commodity prices and high capital costs. It’s why some of the most prolific producers in the Marcellus Shale are still spending more than they take in, nearly a decade into the shale game in Pennsylvania.
“As we look at 2015 and we look at capital allocation — what our budget could potentially be — and how that sits with respect to cash flow, the most important thing to me is how do we create the greatest amount of value long-term,” Doug Lawler, CEO of Tulsa-based Chesapeake Energy Corp. told analysts last week.
Chesapeake is among the top producers in the Marcellus. It has struggled financially from the financial consequences of a massive land grab here and in other shale plays, and since Mr. Lawler’s arrival at the helm in June 2013 the company has scaled back its ambitions and capital budget. But it continues to grow production through what many companies and analysts regard as a down period for oil and gas. The prices of these commodities — especially in the Appalachian region where pipeline capacity isn’t keeping up with the glut in production — have suffered and so have companies’ returns.
But, as Nick DeIuliis, CEO of Consol Energy Inc., put it, the Cecil-based energy company isn’t making decisions on today’s prices but on future trends.
“As long as our cost structure creates margins above the cost of capital, we’re going to continue drilling,” he said. “That’s not necessarily going to be the case for all producers out there.”
For Consol, it costs $2.69 to extract a thousand cubic feet (Mcf) of gas. Its margin last quarter, factoring in the price of gas and all the company’s expenses, was 89 cents per Mcf.
That explains why DeIuliis, who likes to say that “the only cure for low prices is low prices” — presumably, drilling will slow in response, tamping down supply and raising demand and prices — isn’t slamming on the breaks in his company’s shale development program despite regional gas prices hovering below $3 per Mcf.
Daniel Pratt, direct of energy company transaction research at IHS, wrote in a recent report that worldwide, exploration and production margins have tightened significantly while capital investment in 2013 totaled more than $720 billion, an 18 percent increase over the prior year.
“Margin squeeze remains a significant challenge for upstream energy companies because capital spending continues to rise rapidly, despite the recent weakening in per-unit profitability and the longer-term trend of deteriorating returns,” said Mr. Pratt said in a statement.
Several companies operating in the Marcellus that reported earnings over the past few weeks tempered their programs here in response to that dynamic.
“Our big view is that it will probably take two years or three years before we re-implement an active program in Appalachia,” said Harold Hickey, EXCO Resources’ president and chief operating officer.
Texas-based EXCO has about 161,000 acres prospective for the Marcellus Shale, but it only expects to drill a handful of wells here next year.
“We have some 2,000 locations that can light up when our prices increase again,” Mr. Hickey said. “So excited about the opportunity. It’s just not going to happen over the next couple of years. There are better opportunities in the portfolio.”
Capital is tight for exploration and production, both within companies where different business segments are competing for shorter dollars, and outside where markets are nervously awaiting a return to higher commodity prices.
“Not long ago, you could get access to capital by quoting acreage in Pennsylvania and (an initial production) rate,” Mr. DeIuliis told analysts in October. “Suddenly, those days are gone. Who’s going to thrive, and who’s going to struggle?”
When an analyst asked him what it would take to curb the company’s ambitious plan of 30 percent annual production growth, Mr. DeIuliis said that would require a change in the forward price curve for a sustained period of time, not the current price. And he doesn’t see that happening.
Neither do Jason Stevens, director of energy research, and David McColl, equity analyst at Morningstar, who published an optimistic long-term outlook for the industry last month.
“Despite softening demand, surging production, and weakening prices,” they wrote, “we still expect long-term gas prices in the United States to strengthen above $5/Mcf.”
Last week, State College-based Rex Energy Corp. framed its yet unconsummated search for a development partner for a newly acquired chunk of the Marcellus in Pennsylvania as a sign of long-term optimism.
“One thing that we’ve noticed in the market (is) that most of the people we’re speaking with have (a) much longer term horizon than the next six to 12 months,” said CEO Thomas Stabley. “So they understand the dynamics of what’s happening in Appalachian and see a better opportunity as we go forward.”