Wednesday, March 4, 2009

Are You Surprised?

The D/FW Airport is at odds with Chesapeake. The Airport believes that royalties are not being computed properly (are too low) and that hiring practices at Chesapeake have not lived up to the terms of the lease agreement. For more details read the article by Trebor Banstetter at the Star Telegram.

Are you surprised? I'm not. The oil and gas business has had a less than stellar record for fair and honest dealings. Why would they change now?

Shaving funds from royalties is not a new concept. The terms of most leases are unclear on exactly what prices are to be used in calculating royalties. They often use terms like "similar" or "comparable" that are subject to interpretation (and legal disputes). If you have a lease, what does it say (please post a comment)?

According to Trebor,

Under the lease, Chesapeake is required to pay a 25 percent royalty based on the highest market price paid for gas from a field comparable to D/FW, or based on the actual proceeds received from the gas sale, whichever is greater.

Note that Chesapeake and other developers do not have any trouble reporting the worth of their gas leases and proven reserves to shareholders based on Nymex prices but they don't want to use those prices in paying royalties. Wonder why? Could it be that they want to obfuscate royalties so that they can "adjust" them appropriately to "wellhead" prices that are difficult to pin down?

If they will shave royalties to huge mineral owners with deep pockets like the D/FW airport, what will they do to small property owners in residential areas? The development companies say, "just trust us." If you think they will be on your side, think again.

The state could protect mineral owners rights and insist that all royalty agreements be based on public commodity market prices, not on some black, off-the-record, closed-door market that is subject to relatively easy manipulation and "management." But, not unlike many issues, it takes time for the consensus to form and government officials to do the job for which they are elected.

So it is up to us. Public pressure is required to move the pendulum in the direction of the public good. You get what you bargain for ... not what you deserve. Let your city, county and state officials know how you feel.

I know it is not easy to make a change. I know it takes effort and persistence to pursue and communicate with lawmakers. However, if you want the public to be protected, it is time for action. No one else will do your part. If you do nothing, the developers just get richer and smile all the way to your bank to cash your check.


Sunday, March 1, 2009

Another Year and Counting

What a difference a year makes. The price of gas has fallen dramatically since last year at this time and interest in leasing and drilling has decreased with it.

Signing bonuses of $25K per acre and 25% royalties are no longer the norm in Tarrant County. Instead, $2k and 20% is the going rate. However, that may be a blessing. It will give us time to consider things and reduce the pressure to join the herd.

In fact, mineral owners may end up getting much more by just waiting. This is due to an interesting development in the way the RRC is handling "forced pooling." It may change but for now the new approach seems to be a significant benefit to the "holdouts" while also providing for the continuation of development that would otherwise be stiffled by the holdouts. According to an article in the Start Telegram --

Baen and John Barber, a Fort Worth lawyer working with a Fort Worth neighborhood group, pointed out that under the ruling, unleased property owners will likely be paid much more than their neighbors who signed leases.

In its order, the commission required two different payments to the unleased parties: One is a standard royalty payment equal to 20 percent of the value of production; the other is a 100 percent working interest on the other 80 percent of production. A working interest is paid only after the costs of drilling, operations and production are recouped, while the standard royalty is paid as soon as production begins.

Barber said he estimates that the Railroad Commission’s terms would produce a total royalty equal to 60 or 65 percent of the value of production.

That means that the holdouts will get a LOT more than those that signed a lease before drilling began. They will forgo the initial signing bonus of about $1000 for a 1/4 acre lot, but eventual royalties will increase from about $50,000 to about $150,000 over the life of the related wells.

That is much more in line with what I think would be a fair split of the value of gas in the area. If they would just offer a 50/50 split of production (50% royalty) and reasonable ($50,000 per acre) signing bonus, both the drillers and the owners would benefit equally. But as long as most owners will settle for less, the development companies, like Chesapeake and Devon, are obligated to maximize profits for their shareholders at the expense of the mineral owners.

I'm sorry if you already signed a lease and would like to get out of it but, for now, a contract is a contract and you got what you negotiated. It's too late unless the lease expires or is terminated per the terms of the lease agreement. But don't be too eager to sign an extension if it is offered in the future. If you do, you will only get the bonus and royalty in the agreement.


Wednesday, April 2, 2008

So Where Is This Going?

Some claim they can tell the future but nobody really knows unless they are working with a very predictable process.

For example, the engineers I worked with at Lockheed knew exactly what the THAAD missile (in the picture here) was going to do. The "cork screw" maneuver was required to adjust energy during the flight. It was planned and the missile continued on it's trajectory to a perfect intercept of the target.

Note that if it didn't do exactly what was planned and predicted, the Range Safety Officer would have destroyed the bird shortly after launch. So even very complex situations, with the right information and analysis, can be predicted accurately.

When it comes to the Barnett Shale, many observers can see the momentum building and know that change is on the way but accurate predictions are difficult. Never the less, let's take a look at what has happened in recent years in the Barnett shale field and see if you agree with me about some aspects of the future. If I'm right, it could put tens or perhaps even hundreds of thousands of ADDITIONAL dollars in your pocket.

Until a few years ago, few had even heard of the Barnett Shale. As early as last spring, properties in Tarrant County were sold with little consideration of mineral rights. I know because, unfortunately, I sold one and never thought of withholding a share of the minerals. And it was never mentioned by my agent.

Three years ago, a few leases were being made in Tarrant County but mostly in the northwest quadrant. D/FW Airport was just being leased by Chesapeake.

Now, drilling permits issued in the 18 county Newark (Barnett Shale) Field in 2005 through 2007 rose from about 1100 to over 3600. Gas production rose from 501 to 768 BCF over the same period. (Ref a)

Leasing bonuses are hard to pin down but I believe they have increased from under $500 per acre to over $15,000 per acre during the same 3 years. If you have specific examples during 2005 and 2006, please let me know. But the best I can tell, only a few insiders knew what was happening three years ago. Little was mentioned in the news paper and blogs were not common.

Now it is different. The Barnett Shale headlines and several articles appear in the Star Telegram each week. Leasing agents and land men are busy. Property owner groups and blogs about the Barnett Shale field are plentiful and expanding.

And all this activity is clearly appropriate. It starts with a natural gas resource with the potential of over $1 million per acre almost anywhere you drill in Tarrant county. No wonder the bonuses are now over $25,000 per acre. That is less than 3% of the potential production.

And if bonuses have risen from under $2500 per acre to over $25,000 per acre in one year, what will they be by the end of the year? Again no one really knows where bonuses and royalties will evolve but my guess, based on the momentum I see, is that they are not going down. Drilling and production technology is well understood in the industry.

For example, a developer like XTO or CHK or DVN can drill wells for about $3 million each (possibly less) and produce over $15 million of clear profit per well AFTER all drilling and royalty expenses are paid. Why wouldn't they pay a little more for leases, particularly if other operators take note of the potential profit and decide to compete?

I'm not saying the risk in the oil and gas business is nil or that the work is as easy as changing a light bulb or watching grass grow. But I am saying it is not rocket science either. Workers are skilled but I doubt they are more skilled or hard working than many farmers, construction workers, railroad workers or manufacturing workers.

While some scientists and engineers are required, do exploration and development companies have tens of thousands of degreed engineers like Lockheed Martin or Boeing? Are work tolerances measured in a few nanometers like they are at TI or Intel?

Also note that the cost of capital equipment is high in the drilling business but it pales in comparison to that in many industries. For example, a new National Oil Well Varco Flex Rig is under $15 million while American Airlines routinely pays over $150 million for new airplanes. Airports frequently cost several billion to build. Intel manufacturing plants are in the billions but are only good for a few years until their technology becomes obsolete. Even the vaunted new Cowboy Stadium was about $1 billion and it sits empty and unused most of the time.

And the risk of drilling a bad well in Tarrant county is not zero but it appears to be much less than 10%. So is it so unreasonable that bonuses could increase? Could they ultimately rise to over $50k per acre (about $1 million per 20-acre well)? Could royalties rise from the current 25% level to 30% or even 50% ($6 to $10 million per well) and still result in healthy profits for developers like XTO?

I'm sure neither Devon nor XTO would ever admit it but within a year or so, some Tarrant county property owners may be offered the illusive 50/50 deal. What do I mean by that? I mean that, based on the building momentum of activity, it would be fare to all concerned if signing bonuses on a 3-year lease exceed $50k per acre and royalties reach 50% of gross production.

In fact as far as I am concerned, anything less is a gift to the economy that has handed us gasoline rapidly approaching $4 per gallon and average electricity bills approaching $300 per month. And Chesapeake has proven they can figure out how to spend the money from our gas.

Please lease your land for what ever deal you think is fare. If you want to "donate" most of your gas to the developers, I'm sure Aubrey and Bob will really appreciate the growth in their already amazing net worth. (Click the names to see what I mean.)

But if you want a more significant share of the benefits from YOUR gas, it will take some effort. It won't just happen. You will have to get organized, develop a plan, stand up and demand

50/50 or Bust !!



Ref a: Newark East Statistics 2008

Wednesday, March 26, 2008

Peaking At Chesapeake

According to Chesapeake's March 2008 Investor Presentation (click sample slide above) the Barnett Shale is the nations best resource play and is increasing production and reserves rapidly as Chesapeake ramps up drilling to prove reserves. But there is more to the story .... Could Chesapeake's interest be waning? What happens when another cute girl walks by and looks interested?

According to Chesapeake's CEO, Aubrey K. McClendon, during his 3/25/08 conference call, the Barnett Shale has the highest rate of return on capital investment of any of Chesapeake's three major drilling areas. To make sure that they hold their leases, which are becoming much more expensive to acquire due to increased competition, Chesapeake is increasing their rig count in the Fort Worth area from 40 to 45 rigs.

However, Chesapeake's CEO went on to announce (quite reluctantly due to the desire to maintain competitive security) a new shale discovery in Louisiana that he believes is even more important than the Barnett Shale. Mr. McClendon indicated that the Haynesville Shale in northern Louisiana is ... "the most important operational announcement in Chesapeake's 19 year history." With 200,000 acres leased and a goal of 500,000 acres in the next few years, this field could increase net-to-Chesapeake potential reserves by up to 20 TCFE ($200 Billion at $10/MCFE). This compares to 260,000 net acres in the Barnett Shale with about 8 TCFE in reserves. Further detail about the Chesapeake announcement is also available in the Fort Worth Star Telegram article by Maria Perotin entitled "Chesapeake discovers Louisiana gas field."

Details of the discovery were limited during the call since they are competitive sensitive. However, drilling and development net costs for the new area should be similar to the $2/MCFE that is typical of the Barnett and other prime areas being developed by Chesapeake.

In a related article the magnitude of these estimates from Chesapeake were corroborated by Cubic Energy, a competitor in the Haynesville area. In this article Cubic claims their reservoir engineering estimates indicate gas reserves for the Bossier/Haynesville shale ranges from 217 to 245 BCF/section. That is about 40% greater than the reserve estimated by XTO (160 BCF/section) for the Barnett shale of Tarrant County.

So what does this mean for the mineral owners in the Barnett Shale? Could this mean that Chesapeake will be distracted by a new opportunity? Will already strained drilling programs and dollars be diverted to other opportunities? Will this further delay the required intensive development of Fort Worth minerals (except the minimum required to hold them by production)?

Such distractions could significantly limit the royalty stream paid on leases in the Barnett Shale for many years. So if you have leased a quarter acre to Chesapeake, you might well forget about receiving any royalties above $500 per year for many years to come. Chesapeake may be "too busy" if their interest in the Barnett Shale has peaked and they are "moving on" to prettier plays where they can focus on higher returns for shareholders.


Monday, March 17, 2008

Sunlight Insight ...

As I continue to research the natural gas situation, I came across some info of a different sort. I thought these findings might be worth sharing. Sorry if this old engineer bores you to tears.

First, according to the DoE Energy Information Administration, the U.S. uses about 100 quads of energy each year (includes oil, natural gas, coal, nuclear, wind, solar, hydro, etc.). A quad is a quadrillion BTUs.

I would not be surprised if about half of that energy is waisted with low efficiency systems that could and should be replaced or upgraded. We need newer high efficiency appliances, insulation, transformers, engines, transmission lines, etc. as much as we need more energy.

Second, the energy deposited on the lower 48 states by the sun each year is about 100,000 quads. Thus we have a free source of energy that exceeds our needs by a factor of 1000 but we just don't yet know how to use it very effectively.

Third, agriculture on prime heartland is able to convert at most about 1/2 of one percent of the sunlight on a given acre into raw biomass feed stock (cellulose, sugars, starches, oils, etc.) each year. By the time the biomass is refined into more usable forms like ethanol or butanol, only about 1/10th of one percent of the original sunlight energy is captured in usable liquid hydrocarbon "fuel."

That implies that if the ENTIRE United States were planted in corn that is converted to ethanol or other biofuels, we would just barely be able to provide the energy required; i.e., 100 quads. Unfortunately, some land is not suitable for agriculture (rocky soil, mountains, deserts, lakes, cities, etc.) and some is needed for food production, timber production, recreation, living space and other uses.

Thus it seems that we MUST do something to increase the efficiency of solar conversion if we are to have an economy that is sustainable in the long term and if we want to mitigate any negative effects of both the carbon load of fossil fuel utilization and the waste products (or worse nuclear, thermonuclear and dirty bombs) from nuclear power generation.

I find confusing the current emphasis on government subsidies for biofuels and related research. Surely someone at the DoE is aware of these fundamental limitations and has made Congress aware of them too. However, I hear little of this from ADM or the farm lobbies or the major networks or anyone else with significant influence.

In short, biofuel is very unlikely to be able to meet the need and fossil fuels eventually run out. That leaves solar (and its direct derivatives wind and hydro) and nuclear as potentially sustainable sources (and solar IS nuclear without the radioactive waste).

Am I missing something or should Congress (and they are OUR designated decision makers) focus its attention (research, regulation, tax policy, etc.) on the development of 1) improved efficiency energy loads and 2) improved efficiency solar sources as the primary energy policy objectives for the next decade?

Saturday, March 15, 2008

What's The Deal?

OK folks, I think I understand the situation. The big oil and gas operators have figured out that there is a lot of money to be made in Tarrant County if they can get minerals leased before the competition beats them to the punch and before property owners figure out how to organize and demand a more significant share of the proceeds.

They have drilled a few wells and found that the Barnett Shale gas reserve is real ... VERY REAL. They also found that property owners don't know what's going on and don't have time to figure it out and get organized. They found the average drilling unit can produce $20 to $30 million in gas per well drilled. They know how to complete wells for under $5 million per well (perhaps as little as $2 million). They have demonstrated a 90% or so success rate. Thus they expect to book about 50% of the proceeds from a well after all royalties and expenses. They found that government officials at the city, county and state level are not yet aware of any significant new environmental, property value or explosion hazard risks to their constituents from urban drilling. They have the know how, regulatory environment, political clout and legal position to control the gas production once the leases are signed and drilling is begun. Their initial well investment is quite small and the production of early wells will pay for the rest of the development process. Return on their INITIAL investment to lease and drill the first wells is HUGE (easily 10,000% or more).

Folks, as I see it, we only have two choices.

  1. organize a little and sign the best lease deal that community volunteers can negotiate or

  2. organize enough to produce the minerals ourselves.

The first option will result in a 50 or 60 year process that will pay the average 1/4th acre lot owner about $50,000 or $60,000 over the life of production. Those payments will come as an initial signing bonus of a few thousand followed by royalties averaging about $75 per month (current dollars) for 60 years. That is not a bad return for a minimum investment of time and no money invested up front. That is the option most are choosing at this time.

The second option offers the opportunity to enjoy a quicker return and a larger return but requires a little more effort up front and a modest investment not required by option 1. If enough 1/4th-acre owners put their land and resources together, the development time could be reduced to under 5 years (compared to 30 or 40 years for option 1) and the total production share could rise to $120,000 to $180,000 (a factor of 2 to 3 more than option 1). The initial investment required to get the additional $60 to $120 thousand can likely be held to under $5,000 to seed the production process (perhaps a little as $2000).

Current owners can lease their mineral estates to the big operators for a "share" of the production or they can tend their own garden, plant some seed and harvest a bumper crop themselves. It depends on whether one wants to be a "share cropper" or an independent farmer.

In either case the upfront costs will be paid. Like the farmer must pay for the seed and the cost of the tractor and the cost of the fuel to operate the tractor and the cost of hired labor, such costs will be deducted from the production proceeds. The only difference is that, in one case, most of the profits are enjoyed by the stock holders of the operators, in the other, they are enjoyed by the mineral owner. It is your choice.

To leave a comment about what you want to do, click on the word "comment" below. To email this article to a friend, click on the envelope icon below. If we are ever to get organized, we must take action and get involved. It starts today ... it starts with you.


Friday, March 14, 2008

Howdy Neighbor! ... Cont'd

Billy K. Lemons is a professional oil and gas consultant at Resource Analyt(SM) & Management Group. I appreciated that he took time to comment and clarify some issues on my previous post by the same title. As you will see he is very thorough and precise in his answer to my question.

Question: Is it true that if a pipeline company has acquired an easement from a landowner, either by voluntary conveyance or involuntary conveyance (through condemnation), the pipeline company can place pipelines and other facilities, such as above-ground facilities, on the easement property without the consent of adjoining or neighboring landowners?

Answer: That may be a legal question that an attorney is more qualified to answer. But speaking as a landman in an educational way only, I’d say that the answer is generally, "Yes." Under typical circumstances, the pipeline company needs no approval of adjoining or neighboring landowners to exercise its rights acquired under the easement conveyance.

When a pipeline company acquires an easement on or across a piece of property, it acquires rights in that property, a portion of that bundle of rights referred to as real estate. It is free to exercise whatever legitimate rights it acquired under the conveyance, subject to: 1) the terms and conditions of the conveyance; 2) any superior rights owned by others in that same piece of property; 3) federal, state and local law; and perhaps 4) any restrictive covenants covering the property.

Under the typical “standard” right-of-way easement agreements that pipeline companies convince most surface owners to sign, the pipeline company has rights of ingress and egress across the entire property that is subject to the easement, and it has the right to exercise those rights at any time without any prior or contemporaneous notice to the surface owner. The recording of the easement conveyance in the official public records of the county where the land is located is notice enough. If you own the land upon which the easement is located, the company operating under such a standard easement can come and go in your backyard, or whatever, whenever it wants and not even show you the courtesy of first knocking on your door, much less your neighbor’s door.

Also under the typical standard pipeline easement agreement, the company has the right to install “surface facilities,” which can be any kind of above-ground system of pipes, values, gages, etc., without need for any further authorization from or notice to the owner of the property, much less the owner’s neighbors. But again, such things are subject to the terms and conditions of the easement conveyance, to federal, state and local law, and perhaps to any restrictive covenants covering the property.

So typically, if a pipeline company sticks some big, ugly gathering system facilities across the street from your house, you generally have nothing to say about it unless it’s in violation of law or is a bona fide nuisance of some sort.

The pipeline easement agreements we use with our clients in selling right-of-way and easement to pipeline companies are much more restrictive than the standard easement. Plus, we have two versions, one which excludes the right to install surface facilities (the version we use most), and another that includes rights to install specific, restricted surface facilities. In my view, one should never sign any standard or other easement presented to him by the pipeline company, unless for some reason he just has to. (Never believe the pipeline company when they tell you that you have to do this or do that. Always seek qualified outside counsel.) Neither should one ever accept the purchase price originally offered. It is always low-ball. Most any landowner gets burned badly who tries to represent himself in negotiations for pipeline rights-of-way and easements.

It seems to me that to protect yourself and your neighbors from unsightly pipeline facilities, your best bet it through better local ordinances. If the damage has already been done and the facilities are a bona fide nuisance of some sort, the courts may be your only recourse.

If a problem exists or is apparently forthcoming, the best advice I could give would be to take the matter up with your local real estate attorney. He or she can better advise you of your options.

Billy K. Lemons
Principal Consultant
Resource Analyt & Management Group
P. O. Box 632507
Nacogdoches, Texas 75963
936-569-7228 Office
936-569-7220 Facsimile