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