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Fayetteville Shale approaches crossroad

by Alison Sider | September 5, 2010 at 5:39 a.m.

— Natural gas production in Arkansas’ Fayetteville Shale has grown steadily during the five years of extraction, and so far 2010 does not look to be an exception.

The volume of natural gas produced in the shale formation in north-central Arkansas increased from 2.4billion cubic feet in 2005 to more than 500 billion cubic feet in 2009. And this year’s production is on track to top 2009, with more than 300 billion cubic feet produced in the first six months of the year.

But with falling gas prices and exploration in shale formations around the nation promising higher returns,the Fayetteville Shale “play” is approaching a crossroad.

The per-well production has fallen by nearly half - from about 250 million cubic feet per well in 2009 to about 125 million cubic feet in the first half of 2010.

When production started in 2004, the number of rigs was in the single digits, but with 38 rigs operating in the state last week, activity is far off the peak of 59 rigs in 2008, according to Houston based oil-field services company, Baker Hughes.

James Williams of WTRG Economics in Russellville said that on average nationally a rig drills a well about every two weeks.

In September 2005, during the early days of production in the Fayetteville Shale, natural gas sold for $11.70 per million British thermal units on the New York Mercantile Exchange, Williams said. By 2007, the price had fallen to less than half that, and was at just over $2 in 2009. Though prices have recovered somewhat, they have not returned to 2005 levels, in part due to an increase in supply brought by exploitation of shale gas, and in part due to the weak economy, Williams said.

Friday, the cost of a futures contract for natural gas delivery in October was $3.92 per million BTUs. Williams said he expected gas prices to pass $7 per million BTUs this winter, but that prices would stay relatively low for some time.

This means companies have to make choices between the Fayetteville Shale and other gas fields, as well as other energy sources.

“A lot of the companies involved in these plays are smaller ‘independents,’ as opposed to majors. So cash flow is so much more important to them,” said Phil Weiss, an analyst at Argus Research Co. in New York who covers Chesapeake Energy, the second-largest operator in the Fayetteville Shale.

Chesapeake’s strategy reflects doubt that natural gas prices will rebound soon enough to make shale gas as profitable as many once thought it would be. The company is backing away from drilling in shale in favor of exploring unconventional oil and liquid natural gas resources.

In its 2008 annual report, Chesapeake said that it planned to keep 20 drilling rigs operating throughout most of 2009 and 2010 in the Fayetteville Shale. But Chesapeake now has just eight rigs operating in the shale, and in an Aug. 2 conference call, Chief Executive Aubrey McClendon said the company is “comfortable” reducing drilling further if natural gas prices continue to fall.

Fayetteville Shale is old news to some.

Petrohawk Energy Corp., which, along with its subsidiaries, is the fourth-largest producer in the Fayetteville Shale, announced recently that it plans to sell its assets there to focus on other shale plays, such as the Eagle Ford in Louisiana.

“Natural gas prices have significantly declined, and so from a capital allocation standpoint, your capital is allocated a little more carefully,” said Joan Dunlap, the vice president for investor relations at Petrohawk.

Petrohawk once had 11 rigs running in the Fayetteville Shale. Now it has just one.

In 2010, the Haynesville Shale in northwest Louisiana and East Texas Eagle Ford Shale in southern Texas are projected to receive 92 percent of Petrohawk’s $1.35 billion in capital expenditures. The Fayetteville Shale accounted for just 6 percent, or $81 million.

Robert King, an analyst with the U.S. Department of Energy’s Energy Information Administration, said the move is not uncommon.

“Obviously the interest has turned away from the Fayetteville and toward the Marcellus and the Haynesville,” he said. The Marcellus Shale is located in New York and Pennsylvania. “The Haynesville, over the last year or so, has lit up, in part because some people were getting some very large initial production wells - larger than the initial production people were getting in the Fayetteville.”

After five years of production, the Fayetteville Shale is less risky, but it does not provide the same high returns that Petrohawk can get as an early entrant into other, potentially larger shale fields. Dunlap said the Fayetteville Shale is a good asset for a company looking for a “stable return.”

“You know where good areas to drill are, you know you can get consistent results, you know you have enough well history to predict cash flow from the drilling activities,” she said.

Because of its relative maturity compared with other shale fields that are just being explored now, the pace of drilling in the Fayetteville Shale may begin to slow down. A provision in standard lease agreements allows operators to hold a lease indefinitely as long as paying quantities of gas have been produced.

In practice, this often means companies drill with greater urgency in the first few years a shale is in production, to lock leases into “held by production” status, Weiss said.

But in the Fayetteville Shale, Weiss said, “[companies] have done the drilling that’s needed to protect their leases,” and are now focusing on drilling in more recently discovered shales.

This does not necessarily mean production will drop off as sharply as drilling. For example, because Petrohawk participates in wells with other companies, including Southwestern Energy, which is maintaining high levels of activity in the shale, Petrohawk’s production has not declined significantly even as it scales back its drilling in the Fayetteville Shale.

And some companies are still emphasizing shale gas in general, and the Fayetteville Shale in particular.

The shale is still the primary area of focus for Southwestern Energy, whose subsidiary, SEECO, is by far the largest operator in the Fayetteville Shale. Wells operated by SEECO yield nearly two-thirds of the gas produced there, though other companies may also participate in these wells. In its 2009 annual report, the company said it planned to invest $1.2 billion in the Fayetteville Shale in 2010, and to participate in up to 680 wells, up from the 570 it participated in 2009.

Southwestern has 24 drilling rigs operating in the Fayetteville Shale, according to its second-quarter report.

In July, Exxon Mobil Corp. Vice President David Rosenthal told investors in an earnings conference call that the company planned to increase drilling activity in unconventional acreage positions owned by XTO.

XTO is the third-largest producer in the Fayetteville Shale.

“We are really starting to see the benefits of combining the two organizations, and getting after this, this massive, high-quality portfolio of unconventional acreage that we have to deal with,” Rosenthal said.

Business, Pages 69 on 09/05/2010

Print Headline: Fayetteville Shale approaches crossroad


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