The Barnett Shale: A Reference to Future Urban Drilling Plays

posted by Matt Bodley on September 22, 2009

The Barnett Shale play has been an interesting ride for me.  I have had the fortunate opportunity to work during its climb, at its peak and where it presently rests.  Working the play during and after its peak gave me a chance to observe oil and gas businesses’ successes and downfalls.         

You could see the successes on the rise as the high bonuses being paid allowed for monstrous acquisitions in very short periods of time. I would say that the peak of these high bonuses lasted for about 6 months; March, 2008 thru August, 2008.  During this time natural gas prices were hovering around some of its highest levels at $14/MCF.         

While natural gas prices were on the rise, the lease acquisition process progressed, and more and more neighborhoods that were being affected by “urban drilling” were becoming pretty savvy in their negotiations. Neighborhoods were forming sizable associations based on geographical areas such as where a rig was going to go, where companies were taking leases, etc.  Their common philosophy was, “you lease all of us or you lease none of us.“  Because of the acreage sizes these associations were putting together, production companies saw a great opportunity to lease enough acreage for a good sized drilling unit within a few months, as opposed to taking leases one by one which could take a year or two to develop a similar sized unit.  This opportunity created a flurry of competition which only helped the associations’ leverage.  Bids were being accepted in some areas of Tarrant County at $27,000, the highest I ever dealt with and, a historical amount per acre.         

Signing big neighborhood associations opened a door for acquisition companies to make a splash in the highest bidder’s area. In essence, acquisition companies had no interest in production but saw an opportunity to flip leases. If a neighborhood agreed to a deal where everyone in the association got $25,000/acre, an acquisition company would go door to door looking for those that hadn’t signed a lease, offer $26,000/acre, and hope to acquire as many leases as possible. Assuming the operator held a large majority of the leasehold (which if they won the association’s bid, they did), they would then have to buy the acquisition company’s leases in order to produce the unit. Many acquisition companies did very well working that angle of the business.         

Then, in September and October of 2008, the country experienced a huge economic meltdown. The banking and financial sectors became unwilling or unable to provide credit to corporations, including oil and gas. Capital evaporated, and the price of natural gas dropped and dropped, and we have seen little progress since.  Some companies have decided to stop drilling altogether until natural gas prices rise.  This has left a lot of the acquisition companies looking to flip their leases in a very bad position.  Now, they hold a lease they paid $26,000/acre for and can’t sell it for anywhere close to that and, if they are in an area where a production company decided to stop drilling altogether, they will never see any kind of return.         

On the other hand, the downturn didn’t affect businesses to that extent. Wisely, some production companies had the foresight to hedge their natural gas prices; usually 24 month contracts at varying rates depending on when they entered the agreement. This limited their profit margins when natural gas was at $14/MCF but more importantly has allowed them to lessen the impact of falling natural gas prices.  Good call to those guys as natural gas prices have been bouncing between $2.50 and $3.80 per MCF.         

It’s been interesting to see the strategies, both successful and not, develop during the Barnett Shale play.  This play has set a decent precedent to “urban drilling” and, I think, will be referred to in the future for what and what not to do.

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