When all is said and done, is a resource play profitable? This debate crops up all the time, especially regarding natural gas resource plays. We now have the lowest gas-rig count in years, so you might easily conclude the industry has decided where it comes down on this question.

E&P companies are furiously drilling in shale plays and reducing costs all the while, yet still, they won’t be cash-flow-positive until 2015 or 2016. Just today I was chatting with an industry veteran who mentioned that he hears from skeptical investors all the time lately on this topic. Yes, the industry has proven the plays work technically, and yes, thousands of locations are teed up. The midstream and rail sectors have proven they will move the product to markets—even beyond our borders.

Despite the astounding breadth of shale plays and rising production, we keep hearing from those in the know that most of the wells are not really profitable. No one dares say it too loudly though.

And yet, there are some “gassy” plays where you can print money in today’s price environment. “Many may be surprised to find that virtually every major natural gas play in the U.S. actually makes money at gas prices above $4 per Mcf (thousand cubic feet). More importantly, most can generate a decent rate of return at gas prices above $4.25.” So says Marshall Adkins, head of energy research at Raymond James & Associates in Houston, in a recent report.

The before-tax breakeven in one play is only 15 cents!

The firm studied 15 plays and sub-plays across the U.S., and compiled data from more than 50 majors and independents. By sub-plays, for example, Adkins includes the Marcellus Southwest Super-Rich, the Marcellus Southwest Wet Gas, the Marcellus Southwest Dry Gas and the Marcellus Northeast Dry Gas areas. By the way, these sub-plays each break even at $2.50 or less—but, only if you count the actual drilling and completion costs.

And there is the big If.

Every E&P company touts good returns, and every skeptical investor can make a counter claim, because everybody uses different metrics. Is the return five-to-one? Six-to-one? Is it worth it to drill three dozen wells if the return is only two-to-one?

If we include the cost of corporate overhead and acreage, and the acreage was acquired during the leasing frenzy, you can pretty much throw any and all numbers out the window. The classic apples-and-oranges comparison comes to mind. Let’s not bother to mention the cost of capital, it being so low.

To avoid unfair comparisons, Raymond James focused on only one metric that it claims should be consistent among E&P companies: the marginal-cost breakeven price (before income taxes). This ignores sunk costs like overhead and land, but includes completed well costs, lifting costs or lease operating expenses, and royalties and production taxes.

“In other words, we are looking at the breakeven price needed to drill a well based on the incremental costs incurred from here on (subject to changes in technology and service costs),” the firm said.

Full-cycle costs are supposedly a better metric, but each company looks different under that microscope: It depends on when it bought the acreage and at what price versus competitors, whether it has a joint venture providing essentially free capital, whether it is punching holes to hold leases—and whether it turns out the company is drilling in the sweet spots or outside those.

Adkins points out that the ultimate decision to drill or not drill is so company-specific as to not be worth analyzing in this case.

Naturally, E&P firms are focusing mostly on wet-gas and liquids plays, and rightly so, for the returns there are superior to those of drygas plays. Adkins calculates the breakeven price in the Arkoma Woodford is $5 at current costs, the highest such breakeven in the study. In the Barnett dry-gas area, it is $4. In the Haynesville Core (Louisiana side), it is between $3.50 and $4.

The best play? The Marcellus Southwest Super-Rich wins hands down, with a breakeven cost of a mere 15 cents an Mcf! Next best is the Eagle Ford wet-gas window at just under $1 an Mcf.

In all the plays studied, the boost from natural gas liquids production is critical to profit margins.

“Drilling activity is likely to track industry cash flows up and down, rather than turn on or off when you cross a breakeven threshold for any given area,” Adkins concludes.

Two big events are coming this fall that are favorites of mine. First up is our 11th annual A&D Strategies and Opportunities Conference, in Dallas on September 5. It is preceded by the very popular Deal Lab workshop, to which we have added some intriguing twists this year. Second is our DUG Eagle Ford Conference and Exhibition, in San Antonio again on September 18 and 19. Be sure to register.

Comments