Wednesday, April 15, 2009

True Haynesville Well Economics Worse Than Reported?

First let me say that I'm a generalist and am no expert on the oil and gas industry. There are plenty of folks out there with highly specialized backgrounds in engineering and oil and gas finance who can talk about this stuff with a much higher degree of accuracy. I've read a couple of accounts recently (#1: Arthur Berman, #2: Keith Schaefer in the form of lengthy blog posts) that suggest the gas drillers in the Haynesville Shale are not correctly accounting for the true costs of drilling a well in their rosy press releases about their Haynesville successes.

On the surface, I agree with some of the points made (i.e. fully accounting for the acquisition of the land) and disagree with others (i.e. amortizing the cost of debt in individual well costs), but I'm sure there is a large degree of truth in these analyses. But it is important to note that these analysts are looking at the companies from the outside-in and don't have all of the information the producers have (i.e. real time production information and individual well decline curves), and sometimes analysts place a higher value on reporting something before the crowd or being controversial than they do on being 100% right (they're selling something too!).

Quibbles aside, there is a growing chorus of voices that suggest the economics of the Haynesville Shale may not be as rosy at current prices as we're being led to believe. This isn't a huge surprise. It is well known that these horizontal wells are expensive, and the leasing frenzy created some very high lease costs for producers. Because companies are under the gun to drill on the leases because they only have 3-5 years to hold the leases by production, the price of natural gas isn't going to be the ultimate determination of whether or not they drill.

The underlying suggestion (and statement by some) is that producers are putting out rosy numbers to boost their stock prices. There is a problem here: if this is true and the economics are false, these companies would have their shorts sued off by angry investors. There is certainly a precedent for this and there are entire law firms that do nothing but handle investor class action suits. These companies are smarter than this. Aren't they? OR do they know they are drilling non-economic wells for the purpose of holding leases by production but are producing glowing reports of successes so the stock market doesn't kill them while the price of gas is so low? Ultimately it is good in the long run for a company to spend now to hold the lease rather than lose it because they are too afraid of stock market analysts. OR are these wells actually economically successful and this is a smokescreen by individuals who have a bully pulpit on the Internet? I don't know.

Another bottom line conclusion: this might be a cautionary note for people who are still on the fence about leasing and are on the verge of getting "force pooled." If the returns are not going to surpass the costs, these land owners will get nothing, while the people who did sign leases will at least get their royalty percentage. Royalties are paid upfront. Those who are force pooled get paid on the back end, and if the well is not a money maker the back end is just that.

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