Marcellus Shale About to Take Off On One Sweet Ride
Greetings from my place in the Bahamas – my base of operations for the next few weeks. I have some upcoming meetings here and will be bringing you along. But today, I want to talk about a major meeting that already took place…
Last week, I attended a significant two-day session at Duquesne University in Pittsburgh. The Pennsylvania Environmental Council (PEC) brought together specialists from around the country to address the state’s Marcellus Shale Play (MSP). Our job was to brainstorm some recommendations for revising drilling regulations – then send them along to the state government in Harrisburg.
At stake is the future of a huge source of unconventional natural gas, enough to supply the entire country for 15 years (or Pennsylvania alone for the next couple of centuries). There is considerable interest throughout North America, Europe, and Asia. Everyone’s waiting to see whether Pennsylvania can come up with a workable solution… because it could just revolutionize gas production worldwide.
In the process, a number of new opportunities will be opening for the average investor in what will become an important energy investment option over the next decade. I have already talked about the importance of the MSP (“Marcellus Shale Gas: The Energy Sector’s Next Major Profit Play,” October 30th, 2009) . However, much has changed in the past six months since then.
And it’s tremendously exciting stuff.
The Latest News from Marcellus
Much of it is positive: the volume of natural gas expected from the MSP has increased considerably. Early projections were generous; they calculated the volume of known shale (the rock itself) and then applied percentages of extracted gas from the Barnett – the Texas deposit that is currently the largest producer of shale gas in the country.
But then drilling results started coming in… higher pressure, greater extracted volume, and deeper pay zones (the area in the rock where the gas actually resides) than anticipated. Oh yes, and one other result of note – a 100% hit rate – no dry holes. The number of wells will increase dramatically. From the about 620 currently drilled, the total will reach the thousands by the end of this year – I am estimating as many as 8,000 – and the tens of thousands within the next 12 months.
Some experts are now suggesting that the technically available MSP gas amounts to between 300 and 500 trillion cubic feet (tcf). To put that in perspective, the entire U.S. demand in 2010 will be about 23 to 24 tcf. Without a doubt, the MSP could be a game-changer of the first magnitude as we look for genuinely domestic sources of energy.
The Energy Policy Research Group (EPRG) I direct at Duquesne periodically provides MSP updates. My grad students crunch the numbers, and we apply them to an ongoing rolling projection (an approach that adds the latest data while eliminating the earliest). We relate figures representing supply, demand, price dimensions, and expected usage levels in various economic sectors to the number of drilling applications, wells actually begun, and production volumes. Other indicators we track include variations in the width of the pay zones, the depth of the shale itself, and pipeline capacities. As a result, the approach allows us to come up with an aggregate MSP market view.
Here are the latest EPRG estimates…
As of May 10th, 2010, we project 275 tcf of technically available gas and 87 to 90 tcf of actually extracted gas over the next 10 years. The first figure is a bit lower than what others have projected. But taking initial production volume realized as typical of later wells is a very risky proposition, so we still await clear indications that similar drilling results can emerge from other sections of the MSP. Our figure is probably a floor estimate, with actual being somewhat higher. As the number of wells drilled and regions of the MSP in which that drilling is taking place both grow, we should expect to see the volume estimates from various sources converge.
The second figure, actual extracted gas, is far more important. The amount of gas possible is not the decisive factor. The amount that the market will allow lifted, however, is. Supply, demand, and pricing constitute the elements that determine the actual gas volume extracted. I expect this figure of actual expected extracted gas will also rise as we get into accelerating drilling sequences. Yet that, too, remains to be seen. While the rolling averages continue to increase here as well, we await a full return of the gas demand taken out of the market by the global financial slowdown.
Now, this is where the primary MSP competitive advantage kicks in.
Much of the MSP now appears to support a drilling environment in which wells will be profitable at around $3.60 per Nymex contract (1,000 cf at Henry Hub, the primary pricing location for natural gas consignments), with some current wells coming into profit as low as $2.20.
Given the current gas glut in the U.S., there are concerns that additional supply coming on-line will simply create problems.
Yet my view of what will happen is somewhat different: Additional cheaper gas will displace more expensive traditional production. In effect, therefore, MSP volume will move into the network at the expense of more costly sources, creating a significant investment opportunity in both the operating companies and suppliers targeting the MSP.
The Question Polarizing Marcellus
These were some of the pressures urging a rapid drilling program upon the PEC assembly. The argument is rather straightforward: There is a great economic advantage to expedited development, and it could make the entire Northeast energy-rich – a boon to a region usually under siege to save jobs and tax base.
But there is a negative side to developing Marcellus, too.
Liberating the gas from inside rock requires a process called hydrofracing (pronounced “fracking”) that uses large volumes of high-pressure water to break open the shale. Toxins contaminate the flowback (the water that returns to the surface with the gas)… along with hydrocarbons and chemicals used in the fracing process.
This is a major environmental worry, but it is hardly the only one. Several problems counsel the state government to slow the process of providing drilling permits, at least until there have been adequate impact studies.
Other concerns include where operating companies will source the water for the process (presenting a possible major competitor to agriculture, industry, and municipalities)… whether water supplies will be safe from gas seepage… how the flowback will be processed and disposed… and whether fracing will present problems for coal mine subsidence or even create seismic events.
These two distinct movements – one demanding quick drilling, the other (equally strong) in favor of delaying drilling – have polarized the discussion and provided very charged positions in the MSP debate.
The point of the PEC meeting was to find a doable approach that allows both sides adequate assurance. Over the next several weeks, discussions in Harrisburg will determine whether that was achieved.
If residents end up having to choose between keeping warm in the winter, or drinking clean water… then everybody loses.
MSP Production Will Continue – What’s at Issue Is the Pace of That Development
With Pennsylvania now certain to introduce a severance tax on shale gas production, the state government has an active interest in resolving the differences between producers and environmentalists. The weight of public opinion, especially in those sections of the state primarily affected by the drilling, also has a strong presence in an election year.
The most likely (and obvious) outcome involves increasing drilling while providing sufficient environmental services to offset the negative results. Given what is happening on both fronts, I am confident this will happen.
And that is good news for you. Because in addition to the opportunities emerging among the 50+ publicly-traded operating companies drilling in the MSP… enticing investment options will start to appear with service providers in water treatment, drilling, environmental support, planning and logistics, energy management, and a host of other areas.
Since I advise both operators and environmental service components in the MSP, I believe these issues will be resolved in short order, and the gas will really start to flow. Once MSP production begins in earnest, I will provide suggestions on how to get into the action.
This is going to be one sweet ride.