Angling In The Fayetteville

As one of the frontrunners in what has become the success story of shale-gas plays across the U.S., northern Arkansas' Fayetteville shale continues to deliver big volumes of natural gas to its producing companies.

According to Lawrence Bengal, commissioner of the Arkansas Oil and Gas Commission, the play produced some 1.604 trillion cubic feet (Tcf) of gas from 2004 through 2010. Today, gross daily production tops 2 billion cubic feet (Bcf) per day.

Despite significant infrastructure investment and reasonably predictable well results, Fayetteville opportunities can still be reeled in, as evidenced by recent, major acreage acquisitions by some big entrants in the basin.

Sun shines on a pipeline right-of-way landscape in the Fayetteville shale. North Central Arkansas offers a variety of terrain challenges.

The Mississippian-age Fayetteville shale occurs in the Arkoma Basin and extends across northern Arkansas from the western edge of the state throughout the north-central region. The shale facies ranges from 50 to 500 feet in thickness and varies in depth from 1,500 to 6,500 feet. The deposit is bounded by the Pitkin limestone above and the Batesville sandstone below. It is the geologic equivalent of the now-famous Barnett shale in Texas.

However, the gas content of the Fayetteville (60 to 220 standard cubic feet per ton) is less than the Barnett (300 to 350 standard cubic feet per ton), which equates to lower original gas-in-place estimates and technically recoverable resources for the Fayetteville.

Nonetheless, Fayetteville development continued to attract shale players as they recognized parallels between this shale and the prolific Barnett. In time, lessons learned from the horizontal-drilling and hydraulic-fracturing techniques used in the Barnett made the Fayetteville similarly economic. The Fayetteville shale is now considered to be a world-class reservoir.

Yet, the Fayetteville doesn't get as much attention as it once did in the much-publicized overall shale-gas story, overshadowed as it is by the Texas Eagle Ford, the northeastern Marcellus and the new kid on the block, the Utica shale in Ohio.

Some say the lack of fanfare might be due to the fact that the Fayetteville became a shale-gas play before unconventional plays rocketed to fame. New fields in varying geographic areas were tapped in fairly rapid succession, with each being hyped as the greatest thing since televised bass-fishing tournaments.

Additionally, as gas prices continue to hover in the range of $3 to $5 per thousand cubic feet (Mcf) throughout most of the U.S., some operators have divested their Fayetteville gas assets and are going fishing elsewhere for liquids-rich deposits that add additional value due to climbing oil prices.

Big fish

Perhaps it was this decline of the producers' infatuation (i.e. investors' appetite) for the Fayetteville, or the acreage valuations were finally priced just right, or the play had finally been de-risked enough and had proven its worth according to a proprietary set of metrics, but, for whatever reason, the play won the attention of the big boys.

“I believe the recent major company investments in the play support our analysis that the Fayetteville shale is a world-class development project.” — John C. Gargani, vice president of midstream planning and commercial operations,

Enter ExxonMobil Corp., which made a significant statement about its desire to play the shale game in 2009. After looking at Devon Energy Corp., Chesapeake Energy Corp. and Petrohawk Energy Corp., among others, it acquired unconventional-resources player XTO Energy for a whopping $41 billion, the largest energy-related marriage since Exxon merged with Mobil in 1999.

Soon after, XTO expanded its Fayetteville shale position when it swooped in on big-time shale player Petrohawk Energy Corp.'s Fayetteville gas assets, located principally in Cleburne and Van Buren counties, Arkansas. XTO paid some $575 million for the deal, effective October 1, 2010. As a result, XTO gained the Hawk's estimated 299 Bcf proved reserves in the Fayetteville and agreed to buy its Fayetteville midstream assets for $75 million.

Conversely, Chesapeake announced early in February 2011 that it would sell its assets in the play. Weeks later, BHP Billiton Petroleum Ltd. stated its interest in Chesapeake's 487,000 net acres of leasehold and producing properties, and the story ended with a reported sales price of $4.75 billion cash for 10 trillion cubic feet of gas resources, 415 MMcf equivalent of gas production per day and midstream assets containing 420 miles of pipeline.

"The Fayetteville shale is a world-class onshore natural gas resource," said J. Michael Yeager, chief executive of BHP Billiton Petroleum, in announcing the transaction. "It provides access to a competitive long-life resource basin that benefits from our ability to invest through the economic cycles." BHP promised it would spend $1 billion annually there during the next decade.

Overall, the market approved. Wells Fargo analysts put the deal's metrics at $9,036 per Mcf equivalent per day, or $1.52 per Mcf equivalent for the proved reserves. On an acreage basis, the deal brought an "attractive price" of $7,700 per acre, said the analysts.

With such heavy lifters coming into the play, producers and investors are beginning to take a second look at the venerable gas resource, and as well they should. And as the big players and perhaps more new entrants vie for acreage, midstream companies are ready and willing to build, operate and maintain the needed infrastructure to handle the gas and get it to market.

Crestwood Midstream Partners LP’s largest group of systems is the Twin Groves (assets pictured here), Prairie Creek and Woolly Hollow systems in Conway and Faulkner counties, which extend east to west across the play’s trend. Crestwood’s managers refer to the group as the TPW area.

Play founder

Going back to the beginning of the play, Houston-based Southwestern Energy Co. initially recognized the economic viability of the Fayetteville in 2004 before ultimately establishing itself as the first operator in the shale resource.

The company continues to drill and produce Fayetteville shale gas as the biggest producer in the play. Its Fayetteville leasehold tops out at 915,884 net acres, and production for 2010 tallied some 350.2 Bcf net, up from 243.5 Bcf in 2009, according to financial and operating results for fourth-quarter and the year-end December 31, 2010. This represented a big chunk of Southwestern's total gas and oil production of 404.7 Bcf equivalent in 2010, up 35% compared to 300.4 per Bcf equivalent in 2009.

The company's average realized gas price was $4.64 per Mcf, including the effect of hedges, in 2010, compared to $5.30 per Mcf in 2009. At year-end 2010, Southwestern had spudded a total 2,001 operated wells in the Fayetteville since the play commenced in 2004. A total 1,820 operated wells had been drilled. Pretty good odds.

In a recent research report, Nicholas Pope, an analyst with Dahlman Rose & Co., forecast what Southwestern will need to spend, and the drilling rate it will need to maintain, to replace production declines in the Fayetteville. "Each month, we are assuming Fayetteville shale production will decline at a rate of 1.5% per month," he said. "Based on the current gross production rate of 1,500 MMcf per day, production will likely drop by 27 MMcf daily over a month, which needs to be replaced with newly drilled wells in the same month to keep production flat."

According to Pope, the company is seeing average 30-day rates of between 2.4-and 2.5 MMcf daily. Southwestern will need to add 22.5 wells per month to replace this production if the wells come online at the midpoint of the month. The wells are currently costing $2.8 million per well, so the company will need to spend $63 million per month to replace declining production, and drill about 270 wells, spending about $700 million in 2012.

On April 1, 2011, Crestwood Midstream Partners LP entered the Fayetteville play in a big way when it acquired several midstream systems in the Fayetteville from Frontier Gas Services LLC.

Midstream business

Meanwhile, Southwestern Energy' s production, through its SEECO subsidiary, continues to grow, as demonstrated by the recently announced second-quarter results. And along with production, the company values its very robust midstream business.

"Including volumes from other producers, Southwestern is currently gathering approximately 2.0 Bcf per day," says John C. Gargani, vice president of midstream planning and commercial operations.

"This is up from 1.8 Bcf per day at the end 2010, 1.3 Bcf per day at the end of 2009, and 0.8 Bcf per day at the end of 2008. I expect to see increased activity in the rest of the play as a result of the consolidations of producing assets over the last couple of years by major energy companies."

Gargani sees more opportunities here, including continued expansion of drilling into previously undrilled sections as well as in-fill and pad drilling in sections with established production. Also, increased activity resulting from recent consolidation activities in the Fayetteville shale is expected to result in increased gathering opportunities.

“We are laying pipe out in the Fayetteville as we speak. It’s still a growing, active area, so we are building several more pipeline segments, particularly in the TPW area, right now.” — Joel Moxley, senior vice president and chief operating officer, Crestwood Midstream Partners LP

But the play is not without its challenges. "Obviously, improvement in gas prices could result in accelerated drilling in the play," he says. "And there continues to be increased regulation of our operations. We have taken a proactive approach on this by working together with the governmental agencies, as well as other stakeholders, to develop an appropriate framework."

Yet, as a result of the industry's success in developing long-term gas supply from shale reservoirs, the dynamics of the U.S. gas market are changing and "we need stay on top of this and react accordingly," he says.

Today, Southwestern owns and operates extensive midstream facilities throughout the play. Currently, it gathers some 2 Bcf per day through about 1,700 miles of gathering lines.

"Our gathering system includes poly lines from the wellheads to the suction of our compressor stations and steel lines from the discharge of our compressor stations to the interstate pipelines," says Gargani. "We have over 500,000 horsepower of natural gas-fired compression in operation. Most of our new compression has been standardized to Caterpillar-Ariel packages including Caterpillar's 3606 engines. This gathering system is connected to five different interstate pipelines that give the gas gathered on our system access to a wide variety of markets and liquid sales points."

Going forward, Southwestern plans to grow its operations in the Fayetteville shale as more wells are drilled and put on production.

"This includes both our SEECO operated wells as well as some third-party production that we also are gathering," he explains. "Our growth model has been to grow the system organically. I expect this to continue to be the primary means by which we expand our presence in the Fayetteville shale, but we would pursue appropriate acquisition opportunities that complement our existing operations."

Overall, Fayetteville shale production continues to perform "very well" with production on Southwestern's gathering system alone, reaching some 2 Bcf per day, he says. "The recent major company investments in the play support our analysis that the Fayetteville shale is a world class development project."

And other area midstream players agree. On April 1, 2011, Crestwood Midstream Partners LP entered the Fayetteville play in a big way when it acquired several midstream systems in the Fayetteville from Frontier Gas Services LLC for $338 million, which included assets in the Granite Wash play in the Texas Panhandle.

New deal

Crestwood LP financed the purchase through a $153 million private placement of 6.2 million Class C units as well as $200 million of 7.75% senior notes that mature in 2019.

The Fayetteville assets include 39 miles of high-pressure and 88 miles of low-pressure gathering lines that provide services under fixed-fee, long-term contracts. The 127-mile system is capable of moving some 510 million cubic feet (MMcf) of gas per day. Also included in the deal were treating facilities with a capacity of about 165 MMcf per day and 35,000 horsepower of compression. The systems interconnect with multiple interstate pipelines.

Specifically, Crestwood's holdings in the Fayetteville shale can be broken down into five named areas. Its large systems are the Twin Groves, Prairie Creek and Woolly Hollow systems in Conway and Faulkner counties, which extend east to west across the play's trend. Crestwood's managers refer to the group as the TPW area. To the east, in White County, is the Rose Bud system and to the north, in Van Buren County, is the Wilson Creek gathering system.

"These systems are constantly evolving," says Joel Moxley, senior vice president and chief operating officer, who describes the play as being in the early-adolescence stage with many more wells to be drilled and more infrastructure to be built. Although it's no longer a new play, such as the Utica shale of Ohio, there is still plenty of work to be done by upstream and midstream operators.

"We are laying pipe out in the Fayetteville as we speak," says Moxley. "It's still a growing, active area, so we are building several more pipeline segments, particularly in the TPW area, right now."

Crestwood's build-outs are driven by its relationship with BHP Billiton. "We have a large block of acreage, about 100,000 acres, dedicated to us in the TPW area by a joint venture between BHP Billiton and BP America, in which BHP is the operator. So that is where our emphasis is, to support BHP's drilling program in the area," explains Moxley.

In March 2011, Chesapeake Energy Corp. sold its Fayetteville shale assets to BHP. The sale included acreage, production and about 420 miles of pipeline. As part of the transaction, Chesapeake agreed to provide technical and business services for up to one year. Following the acquisition in the Fayetteville, BHP more recently announced a $12-billion acquisition of Petrohawk Energy Corp. which will greatly expand its presence in the U.S. natural gas market.

"We are still getting to know BHP," he says. "When BHP bought the Chesapeake acreage in the Fayetteville, it came without the Chesapeake staff in Oklahoma City that was managing the assets. BHP is still relying on those folks to operate the Fayetteville area, so we have continued to work with the Chesapeake people, for the most part during this interim period as BHP gets their permanent staff in place."

World-class resource

Despite all the excitement and rush to liquids in plays such as the Eagle Ford and Utica shales, the Fayetteville has great growth potential, says Moxley.

"It's a world-class resource, as evidenced by BHP, which is a large, multi-national mining and minerals company, paying $4.7 billion to Chesapeake to buy into the play. That is a huge validation of the long-term viability of the Fayetteville shale, as was ExxonMobil's XTO Energy's $650 million acquisition of Petrohawk acreage in December 2010. Having two sophisticated companies like ExxonMobil and BHP make acquisitions in the Fayetteville is a real stamp of approval."

For the most part, the downstream infrastructure is fairly adequate for the play, other than individual gathering systems to support drilling.

"We are still laying lines and setting compressors and undertaking those types of activities, but once the gas goes from our systems into the take-away lines, like Fayetteville Express that is owned by Kinder Morgan Energy Partners and Energy Transfer Partners, or into Boardwalk Pipeline Partners' Fayetteville lateral, there is plenty of take-away capacity on those lines," says Moxley.

"There is still plenty of gathering infrastructure to be built, getting back to the drilling pads and tying into those main lines, but that will happen in time as the play develops and these guys drill out their acreage."

Yet, the play doesn't come without its challenges, and, as in other plays, the major challenge is the price of natural gas. The Fayetteville shale produces dry gas, and must make its mark without the added value of crude oil or natural gas liquids found in other plays.

"The good news is that there is still a lot of gas in place, and the wells are not as expensive as in some of the other areas," he says. "It's a challenge for the producers now to compete for development dollars and getting a strong enough gas market for the volumes to continue to ramp up."

Next step change

The next big step change for the Fayetteville will be producers drilling multiple wells per drill pad, says Moxley. For now, most of the producers are drilling one well per pad.

"BHP is just now talking about multi-well pads later this year," explains Moxley. "They will begin by drilling multiple wells per pad, then coming back later and completing them all at one time, which will ultimately drive down finding and development costs."

As production increases, more CO2 treating capacity will be required, along with additional gathering capabilities.

"There is not a lot of CO2 in this gas," he says. "But as the volumes grow, we'll need more treating capacity installed along with additional compression and pipelines."

Going forward, Crestwood plans to continue to grow in the Fayetteville for some time to come. "It's a good state in which to do business, and the people have been great to work with so far," Moxley says.

Interstate midstream activities

Interstate midstream operators include Boardwalk Pipeline Partners LP, which built two laterals to transport gas from the Fayetteville shale area to markets directly and indirectly served by their existing interstate pipelines.

The 165-mile, 36-inch Fayetteville lateral reportedly has a peak day capacity of 1.3 Bcf. Peak day capacity for the 95-mile, 36-inch Greenville lateral is said to be about 1 Bcf. The Greenville lateral will enable customers to access additional markets, mainly in the Midwest, Northeast and Southeast.

As well, Kinder Morgan Energy Partners LP and Energy Transfer Partners LP have completed their 50-50 joint venture, Fayetteville Express Pipeline LLC, a 187-mile line to move shale gas to market. It originates in Conway County, Arkansas, and ends at the interconnect with Trunkline Gas Co. in Quitman County, Mississippi. With an initial capacity of 2 Bcf per day, FEP has already secured binding, 10-year commitments totaling 1.575 million dekatherms per day, including 1.2 million per day from Southwestern Energy.

Elsewhere, Ozark Gas Transmission (OGT), owned by Spectra Energy Partners LP, is in Oklahoma, Arkansas and Missouri. Operated by Spectra Energy Transmission, it has four compressor stations and a system capacity of 500 MMcf per day, according to Hart Energy Mapping and Data Services. It has 565 miles in length and interconnects with Spectra Energy Corp.'s Texas Eastern Transmission system, Mississippi River Transmission (Centerpoint), Texas Gas (Boardwalk) and NGPL (Operated by Kinder Morgan). OGT accesses the Fayetteville shale and the conventional Arkoma Basin.

Spectra Energy Partners acquired OGT in the second quarter of 2009 from Atlas Pipeline Partners LP, for $300 million. (For more on Atlas, see "The Emerging Cana-Woodford" in this issue.) The deal also included the 365-mile Ozark Gas Gathering system, which feeds into the OGT system.