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Gas, Gas Everywhere

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September 10, 2008, 4:59PM EST

Gas, Gas Everywhere

Billions are being pumped into new U.S. natural gas exploration, leading to a jump in production, lower prices, and a lot of rich Texans

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Click here to find out more!In the oil patch, they are calling it the “shale sweepstakes”—a fevered rush to purchase drilling rights to natural gas that lies deep in deposits of shale rock. Output from these fields has been on a rocket ride for the past four years. It is the reason why natural gas production overall in the U.S. is expected to jump 8% in 2008, after nearly a decade of no growth.

This is good news for consumers who’ll be turning up their gas furnaces this winter. Natural gas prices have fallen 50%—much steeper than oil—in the past two months, to a recent $7 per 1,000 cubic feet. All the new shale development could keep a lid on natural gas prices for years to come. The oil companies, says Ed Siefert, president of market researcher RigData, “are all spending money like drunken sailors.”

The shale business has gotten so big that some of the earlier players are starting to cash out, and the major oil companies are diving in. On Sept. 2, BP (BP) announced it was buying a 25% interest in Chesapeake Energy’s (CHK) shale fields in Arkansas for $1.9 billion. A month earlier the company paid $1.7 billion for Chesapeake’s Oklahoma shale properties. On Aug. 28, Royal Dutch Shell (RDSA) closed on the $5.7 billion acquisition of Duvernay Oil, which holds similar prospects in Canada.

BACKYARD RIGS

The birthplace of the boom is Fort Worth, home to the giant Barnett Shale field. Believed to be the largest new onshore natural gas field in the U.S., production there has quadrupled, to more than 1 trillion cubic feet a year, since 2003. That’s about 5% of total U.S. consumption. The development has changed the face of the city, with rigs popping up on almost any spare land and oil-company brokers knocking on doors of suburban homeowners asking them for leases to drill on their property.

Prices for such contracts have soared over the past four years, from signing bonuses of as little as $500 an acre and a 12% ongoing royalty to $25,000 an acre and a 25% cut of production says Timothy Malone, an oil and gas attorney with Whitaker, Chalk, Swindle, & Sawyer in Fort Worth. Says Andrew Segal, a real estate investor who recently sold rights for seven figures to drill under a shopping mall and raw land that he owns: “All of a sudden, you know how those Arab sheikhs feel when they go shopping in London.”

The benefits aren’t only going to landowners. In just the past year, employment in the oil and gas industry in Fort Worth has jumped by 50%, to more than 83,000 people, according to the Perryman Group, an economic consulting firm.

Businesspeople of all kinds are jumping on the opportunity. Texas Sports Sands used to supply sand to golf courses, but after being approached last year by several oil companies, the firm now sells the sand to oil field operators who use it to complete wells. The company recently changed its name to the more industrial sounding Superior Silica Sands.

HORIZONTAL DRILLING

The natural gas has always been there. But only in the past decade have oil men been using modern tools to extract it. One of the chief innovations is horizontal drilling, which allows crews to drill in several directions for not much more than the cost of one well. After drilling, oil-field workers pump water at high pressure into the ground to fracture the rock and release the gas.

Oil companies are now taking the techniques they learned in Fort Worth to shale fields in areas ranging from North Dakota to Arkansas. Among the hottest new fields is the Marcellus Shale, which stretches across West Virginia and Pennsylvania. This is the same land that Colonel Edwin Drake was drilling when he discovered America’s first oil field in Titusville, Pa., in 1859. Back then he was looking for oil. And today the cost of entry is much higher. In April, Fort Worth’s XTO Energy (XTO) acquired drilling rights on 142,000 Marcellus Shale acres for $600 million, believed to be a record price for the field.

With acquisition costs escalating, producers are taking diverging paths. XTO, the third-largest producer in the Barnett Shale, continues to be an aggressive buyer. It has closed on some $10 billion in assets so far this year, much of it new shale fields. Rival EOG Resources (EOG), formerly known as Enron Oil & Gas, is taking a more cautious approach. Chief Executive Mark Papa told investors at a conference on Sept. 2 that he won’t be making any large acquisitions. Instead, he’s selling a larger share of his production in the futures market, to lock in prices, and keeping debt low.

Papa said many of the new shale fields won’t be profitable if natural gas prices dip below current levels. “We’ve been boring and consistent, and we’re going to be even more boring and consistent,” he said.

Palmeri is a senior correspondent in BusinessWeek‘s Los Angeles bureau.

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