West and Clear’s 2008 in review #2: Barnett Shale bust?

by Steve Smith of West and Clear

For much of the year, as every Chesapeake Energy advertisement reminded us in newspapers, billboards, buses, TV commercials and pretty much everything else they could throw money at, the Barnett Shale “inoculated” the local economy against recession. The fact that housing prices didn’t go crazy over the past couple of years the way they did in San Diego, Las Vegas and Miami? Nothing to do with it.

Today, not so much.

Of course, we all remember that inoculation is when you get a shot of something bad, like the flu, that boost your immunity to a specific malady. Well, I say “we,” but I should exclude the people at Chesapeake who concocted the analogy. So the Barnett Shale is the inoculation – does that mean it’s bad thing?

But just as you sometimes have flu shot and still get the flu, a hefty dose of Barnett Shale didn’t prevent Fort Worth from catching the recession after all.

Gone are the heady days of, say, five or six months ago when signing bonuses per acre had ballooned to $30,000 per acre. Of course, that was when natural gas prices were at around $12 per mcf (per one thousand cubic feet). About the same time the stock market imploded back in September, natural gas prices went south, too. The price of natural gas is now under $6/mcf and is expected to stay there throughout 2009 by the U.S. Department of Energy, which also expect those prices to remain in the $5 to $6 range until 2012. For the remainder of the projection period (thorough 2030), the DOE expects prices to increase virtually every year, to reach $8.39 per mcf in 2030.

Gone also are the days when Chesapeake could access the credit market to finance their massive debt to pay for operations, Shale.TVs and Pier One buildings. Chesapeake has had to do quite a bit of belt tightening and suppressing of their urge to splurge. Can they continue? One industry analyst points out that “cash flow from operations and revolving bank credit lines have historically been insufficient to fund all of Chesapeake’s annual expenditures.” Can Chesapeake change its ways?

Of course, not every producer spends like a drunk sailor on shore leave. For example, Devon Energy is well-known in the industry for financing operations most if not all of its operations out of existing cash flow. But does the collapse in natural gas prices mean that the Barnett Shale is dead? Not hardly.

One thing I’ve always wondered how is how much it actually costs to produce gas in the Barnett Shale. My theory was that it was quite expensive — around $4/mcf –- and the plunge in prices were going to jeopardize the viability of shale plays here and elsewhere.

Then I read this report out of West Virginia that puts the cost at less than $2/mcf. It’s a good read, even if I’m not as bullish about Chesapeake as this writer is.

Still, I found it hard to believe that the production costs could be less than $2/mcf. So I did a little more snooping and found a local source who provided a lengthy analysis of cost figures for producers in the Barnett Shale that put the cost of production at $1.59/mcf.

That’s right. About a buck and a half. Even with gas trading between $5 and $6/mcf, a lot of upside still exists for producers. So even though producers are sure to warn us that they need to keep bonuses low and have little oversight if we want to nurture the great gift that is the Barnett Shale, don’t be fooled. Business for most will continue quite nicely.

In other Barnett Shale developments this year:

* Gas Drilling Task Force: Remarkably, the results of the Task Force were even worse than expected.

* Eminent Domain Abuse: From Westcliff to Carter Avenue, Fort Worth learned how much power the industry really has.

* Eighth Avenue Showdown: On the other hand, Chesapeake Energy finds out that they are not 10-feet tall, invisible and bulletproof when their request for a high-impact permit was denied.

* TCU gas well on hold: In the wake of the Eighth Avenue decision and the collapse of natural gas prices, Chesapeake taps the brakes a little.