Tuesday, September 16, 2008

Interesting Morningstar Article

In my previous post, I referenced an article on Morningstar.com (link to article) that offered some interesting insight and analysis of the perceived upcoming oversupply in the natural gas industry. I recommend reading the article (it's not too long) because it makes some great points about the gas industry and the Haynesville Play.

Perhaps the most interesting section is the discussion of Haynesville. Because there has been such a land rush in the Haynesville Play, the gas companies are under huge pressure to drill. They amount of land leased is tremendous - Chesapeake has leased over 550,000 acres (not counting what it has put in joint ventures to calculate its "net leased" land) - and most of the leases are for three years (some are three with a two year option). This creates a need to drill and produce on the land to be able to hold the lease before it expires. They are hell-bent to get the leases HBP (held by production) so they can suck it dry over time.

This rush to drill by multiple companies has caused huge strains on the drilling infrastructure - drilling rigs, parts and supplies, pipeline capacity and personnel. There is only so much infrastructure out there and if the production out of Haynesville is going to be as big as expected, it's going to be stuck in the ground without huge expansion of the above ground resources. Don't forget that there are other plays demanding these resources, including Barnett, Marcellus, Fayetteville and Woodford. Chesapeake is on record having said that they have been building new rigs over the past couple of years for this very reason, but what about the other guys?

Another consideration related to the constrained resources is the monetary capital required to do all of this drilling in a short period of time. The exploration companies have spent the summer selling equity, raising debt, selling assets and entering into joint venture agreements to the point that they are maxing out their availability. Wall Street sees this and is spooked. In its infinite short-sightedness, Wall Street is punishing the natural gas companies badly. All of those investors who bought new shares over the past few months have to be sweating as they watch their investments sink (in the short term, at least).

On top of these constraints, the gas companies watched the price of natural gas plummet over the past two months. The gas futures price today ($7.20 at this moment) is approximately half of what it was in mid-July. At some point expensive horizontal drilling becomes uneconomical if the sales price is too low. Let's hope smart companies locked in future gas deliveries when the prices were in the double digits.

It's going to be an interesting time in the Haynesville Play for the next year (actually next three years) to see how the exploration companies behave. With the various constraints I've mentioned above, they are in a box right now, and it seems the only way out is to "drill, baby, drill!"

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