Gas from shale has rapidly transformed every aspect of the North American market, and the industry is grappling with the profound implications of this change. Truly, the way forward is across new and uncertain ground.

“No doubt, we have witnessed a paradigm shift in the North American gas markets through 2009,” said Jen Snyder, principal analyst for Edinburgh-based Wood Mackenzie, at Hart Energy Publishing’s Developing Unconventional Gas (DUG) 2010 conference held in Fort Worth in late March.

Glimmers of this shift appeared in 2007 and 2008, as U.S. production turned a corner. “Between January 2007 and December 2008, we grew North American supply by about 8 billion cubic feet (Bcf) per day,” she said. The most significant change occurred in 2009, however, when the industry demonstrated that supply levels could be maintained in the face of sharply lower rig counts.

Supply came on strongly, thanks to both high-productivity shale wells and the extension of shale-well technology to such tight-gas plays as the Granite Wash in the Texas Panhandle and western Oklahoma.

Simultaneously, the industry has successfully driven down the cost of producing shale gas. For example, in Arkansas’ Fayetteville shale, Southwestern Energy Co. has been able to move breakeven prices from about $5 per thousand cubic feet (Mcf) in 2006-2007 to some $3.50 per thousand in 2009.

“This is an impressive improvement on its own,” said Snyder. “But it’s actually more impressive when you consider the fact that the costs of virtually everything across the energy value chain were going up in 2007 and 2008.”

The Houston-based independent achieved this result using a number of strategies, including the adoption of longer laterals and pad drilling, which improved initial potentials and substantially cut drilling times, respectively.

Better wells and lower costs have moved shale plays that were once somewhat marginal squarely into the foundation of the North American supply stack, and shale gas now ranks among the most economic of all gas.

“The Barnett, Marcellus and Montney are among the six best plays across the continent on a breakeven cost basis,” said Snyder. The Fayetteville, Haynesville, Woodford and Eagle Ford plays are also legitimately competitive.

Indeed, because many plays are economic even at prevailing prices, shale-gas supplies will surge in the next few years. “Our expectation is that shale-gas volumes will increase from current levels of around 9 Bcf per day to around 17 Bcf a day by 2015 and all the way up to 25 Bcf a day by 2020.”

There’s no doubt a wave of shale-gas supply is coming, whether the market is ready for it or not, she said. “We think that the challenge of a relatively weak market for North American gas is going to be in place for the next two years. The winners will be the best, lowest-cost shale plays.”

Equity Repercussions

Traveling farther down that path, shale gas is a case of creative destruction in the oil patch. That’s the opinion of Michael Hall, vice president, Wells Fargo Securities LLC, Denver.

The economic theory of creative destruction, advanced by the Austrian economist Joseph Schumpeter, holds that technology and innovation can destroy the value of established market leaders.

“Applied to the oil patch, horizontal drilling combined with extensive multistage frac treatments has, to some extent, destroyed the value of remaining conventional gas supply,” said Hall, also speaking at DUG 2010.

“The shales are highly economic and increasingly prolific sources of gas.”

So much gas is coming from shales that the breakeven cost of supply across the entire U.S. market is coming down. This year, shale gas comprises some 18% of domestic supply; by 2014 it will account for 29%. At present, the overall production cost for all sources of gas—conventional, nonshale unconventional, shales, Canadian imports and liquefied natural gas (LNG)—is currently $6.48 per Mcf. By 2014, the mighty influx of shale gas could drive overall costs down to $5.95 per thousand.

“The shales have brought deflation to the supply stack, and as they become a larger and larger source of U.S. supply, we see expensive, higher-cost gas being priced out of the market,” said Hall.

Rig counts tell the tale of current economics: the Marcellus, Haynesville and Eagle Ford plays all are hosting record levels of active rigs. While lease commitments account for some of this activity, it is also consistent with economic thresholds across the plays.

Wells Fargo forecasts that shale production has the potential to grow from present levels to some 20 Bcf per day in 2014, an even more aggressive scenario than that envisioned by Wood Mackenzie’s Snyder.

Lots of uncertainty remains, naturally, and possible constraints include the availability of adequate drilling rigs, completion services and midstream facilities.

Nonetheless, the building blocks of this projected growth are the Woodford, Marcellus, Eagle Ford and, most particularly, the Haynes­ville plays. Barnett production may drop slightly, and Fayetteville gas volumes will likely be fairly flat, but the other shales should contribute much more.

Prospective growth from the Haynesville blows all other shales away. From 2009 levels of 1.65 Bcf a day, this shale could deliver 6.75 Bcf a day in 2014. “That’s about the amount of production from all shales in the U.S. in 2008, so it’s a massive amount of production coming on line,” said Hall.

The startling growth in shale-gas production is already ushering in the commodity producers’ dilemma: Increased productivity allows an increase in volumes, which kills pricing.

Going forward, companies must focus on keeping costs down and raising volumes faster than prices decline, says Hall. Plainly, shale gas has added a layer of deflation to the U.S. supply stack.

In the equity markets, that translates to shorter stock cycles and a range-bound environment for natural gas producers, said Hall. “Don’t expect that secular bull market of the last decade to come back anytime soon.”

A&D Impacts

The oil and gas transaction market has also been profoundly affected by the shales, said Ward Polzin, managing director, Tudor, Pickering, Holt & Co., at DUG 2010.

In 2007, shale deals began to populate the market, and by 2009 they accounted for more volume than nonshale deals. “We now have a shale market that is equal to or greater than the rest of the market,” Polzin said.

Today, 55% to 60% of deal volumes have a shale orientation, and half the number of deals done are shale. There is a discrepancy between volume and number because shale deals are generally larger, he noted.

Significantly, the new tranche of shale deals is coming from every shale basin. “There’s not one shale dominating the volume. There’s a buyer in every one of those positions, and a deal to be done in every shale basin.”

The rise of the shale joint venture (JV) is another notable development. Some $15 billion worth of shale JVs have been consummated during the past few years, and this trend is increasing. “We are seeing two to three significant-sized JVs being announced every quarter,” he said.

JVs fit well in today’s market: Buyers like the repeatability and scale of the shale joint efforts, and sellers like the ability to hold on to large land positions, retain operations and accelerate value. A typical deal might call for a third in up-front cash and two-thirds as a drill carry.

Furthermore, shales have a broad appeal. Companies from across the industry spectrum—from private equity to foreign buyers to large and small independents—are acquiring and building shale positions.
Truly, the shales are the place to be. Even in today’s tough environment, growing rig counts provide direct evidence of money being spent preferentially in the shales, noted Polzin. “It’s where the rubber meets the road.”

Welcome to the future. It doesn’t look anything like the past.

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