DUG 2011: E&Ps now in an economic sweet spot

Are current economics, both in terms of unconventional development and on a global, macroeconomic scale, supportive to domestic oil and gas players? Undoubtedly so, was the consensus of several experts speaking on April 19 to 2,500 attendees at Hart Energy's sixth annual Developing Unconventional Gas (DUG) Conference and Exhibition in Fort Worth, Texas.

Consider that capital markets are "wide open," and rates "have never looked better," noted Steven Trauber, vice chairman and global head of energy at Citigroup, in a keynote preceding an economics panel. Then align that with generous oil prices and it would seem as if E&Ps are in an economic sweet spot wherein oil and liquids-rich gas resources reign supreme.

But, while the short-term gas outlook remains dim, new unconventional and liquefied natural gas (LNG) projects are expected to hold greater value in the long run to sustain energy needs, a couple of panelists indicated.

Don Luskin, chief investment officer and founder of TrendMacro, began the panel's presentation by discussing the bigger economic picture and how certain global factors may or may not affect a higher price per barrel of crude oil and, subsequently, how a higher oil price may or may not affect the U.S.' recovering economy.

According to Luskin, "it's impossible to be bearish" on the economy as the oil and gas industry, as technologically innovating and entrepreneurial as it is, continues to transform (and fuel) the world.

Meanwhile, it may be true that crude oil—the most fossil-like of fossil fuels—has "a powerful dead hand" that retains the capacity to bring down the U.S. economy. And with oil's valuation pointing skyward to levels last seen in 2008—right before the U.S. collapsed into a financial quagmire—"(in hindsight) we have to ask the question, 'will higher oil prices sink the economy?'" he posited.

Signaling continuing demand for midstream services, the capital markets for E&Ps are wide open and rates have never looked better.

Rest assured, there will not likely be a double-dip recession tipped off by today's upwardly trending oil prices—or, at least, the historical data does not support this theory, Luskin conceded. Moreover, there is no relationship between oil prices and economic growth that shows in the numbers.

Ultimately, "the only thing you can prove about oil is that when the price goes through the roof, it induces a shock to the economy, and from time to time, that could spark a recession—even though that's easy to say and harder to get a prediction rule out of," Luskin concluded.

But while oil bulls are certainly stampeding to the front lines, what of oil's undervalued counterpart? And given ample gas supplies and no apparent end to North American shale-gas development, will a bearish short-term bias toward natural gas hinder its long-term appeal?

Based on a presentation by Scott Rees, chairman and chief executive, Netherland, Sewell and Associates, in the early days of developing unconventional gas plays, economics appeared to go from bang to bust relatively quickly. The typical lifespan of a shale-gas well would steeply decline following high initial production rates, eventually bottoming out at "very low levels" over time.

Despite still early days in many emerging shale plays, the long-term investment in natural gas can be a boon, given that more and more gas production is coming online faster than ever, with greater efficiencies. And as oil supplies are projected to tighten in the coming decade, the payoff could ultimately be in the cornucopia of gas and its estimated-reserve potential.

Rees pointed to early-reserve estimates for the granddaddy of them all and the inspiration for Hart Energy's DUG series, the Barnett shale play in the Fort Worth Basin. Before the advent of slick-water fracs revived flagging production, the Barnett was experiencing a drastic reduction in rig count and activity. Fast forward to present-day economics: from bang to bust to better bang for the buck, the Barnett's rate of returns have greatly improved thanks to horizontal drilling techniques.

Now, this so-called revolutionary fracing methodology is propping up shale-gas economics. Even as commodity prices remain in a state of flux, unconventional gas is proving to be not only an economic enterprise, but also one that is continuously delivering "pretty good rates" from horizontal wells, according to Rees.

Moving the needle further east, LNG could also prove to be a game-changer, as a plethora of resource-development projects, particularly in the Asia-Pacific region, promise to bring an abundance of new gas supplies onstream to meet burgeoning energy demand (read China's energy needs).

As for North America's role in exporting LNG, according to Biliana Pehlivanova, head of global gas research at Barclays Capital, it isn't a question of whether the U.S. has the resource base to do this (it does), but whether it will.

Citing a bullish expectation for the global LNG trade to grow, Pehlivanova also noted that currently, there are at least nine liquefaction facilities under consideration to propel North America forward in this arena: three in Canada, several in the U.S. Gulf Coast and two on the U.S. West Coast.

— Nancy Miller, online editor, OilandGasInvestor.com

National CFO survey finds serious inflation concerns

Within the manufacturing sector, two-thirds of chief financial officers (CFOs) plan to raise prices, nearly doubling the number from six months ago, according to a recent national survey of U.S. CFOs and senior comptrollers conducted by Grant Thornton LLP, the U.S. member firm of Grant Thornton International Ltd. The study found growing optimism about the U.S. economy, as 48% say it will improve over the next six months (this number is up from 30% six months earlier).

However, despite this optimism, concern continues to grow over inflationary drivers in the economy. Nearly 50% of polled executives say their company intends to raise prices for its goods, a figure that is up from 31% six months earlier and 24% from one year ago.

In fact, the financial system poses an even greater risk to taxpayers than before the great recession crisis, according to analysts at Standard & Poor's (S&P). The next rescue could be about a trillion dollars costlier, the credit rating agency warned in a recent report.

S&P put policymakers on notice, saying there's "at least a one-in-three" chance that the U.S. government may lose its coveted AAA credit rating. Various risks could lead the agency to downgrade the Treasury's credit worthiness, including policymakers' penchant for rescuing bankers and traders from their failures.

— Meredith Freeman, news editor,

Midstream Business

Centerpoint's Harper: Marcellus ROW costs doubled in five years

When most people think of taking lessons learned in one shale play and utilizing those experiences in other plays, it is generally taken from a producer's viewpoint. However, these experiences can also be used in the midstream, according to C. Gregory Harper, group president, pipelines and field services at CenterPoint Energy.

"Right-of-way costs escalate when developing 'hot' fields," he said while speaking at Hart Energy's recent Marcellus Midstream Conference in Pittsburgh, Pennsylvania. CenterPoint Energy was able to achieve first-mover advantage in the Haynesville through its Carthage to Perryville pipeline.

He noted that since 2005, CenterPoint Energy Pipeline and Field Services has deployed over $3.8 billion in capital to transport natural gas, much of this from shale plays to new markets.

Although this figure is high, it would have been larger were it not for the company entering plays early. Harper said that CenterPoint Energy's right-of-way costs doubled in a five-year time span since it first entered the Woodford shale. Over that same five-year period, the right-of-way costs in the Haynesville grew more than three-and-a-half times.

In addition, Harper said some of the challenges that midstream companies face are the same as producers when it comes to right-of-way issues.

"In the Haynesville, there are wealthy landowners controlling large parcels of land that obtain legal counsel, which adds more time and expenses to the process," he said.

Other issues that help to drive up costs for midstream operators in the shale plays include adding expenses for multi-line rights for potential expansion or transporting other products such as natural gas liquids (NGL) or producer water; long-lead times for materials; and weather that could extend the project timeline and add expenses.

Terrain is another big issue in the shale plays, because not all of the plays have similar formations. It is important to try to identify the sort of terrain within the play and determine what shale it is similar to and use that information to drive down costs.

The same goes for the quality of the gas, which, depending on the contents of the stream, may require gas treating. "The Fayetteville requires little treating for its gas since it was near pipeline quality. The Woodford requires amine treating due to its higher CO2 content, while the Haynesville may require both amine treating as well as thicker-walled pipe due to its H2S content," he said.

— Frank Nieto, editor,

MidstreamBusiness.com

Magellan may reverse pipeline for crude service

Downstream logistics operator Magellan Midstream Partners LP will proceed with permitting and final engineering for the potential reversal and conversion of a portion of the partnership's Houston-to-El Paso pipeline to crude oil service.

The reversed pipeline system would have a capacity of up to 200,000 barrels per day but will take 18 to 24 months once approved to go into service. Management expects shipper negotiations and decision making to last another two months.

"We believe our pipeline system coupled with the crude oil distribution system purchased last year would provide the most direct and cost-efficient route to deliver West Texas crude oil to the refineries on the Houston Ship Channel and Texas City," said Mike Mears, chief executive officer. "Recent market dynamics continue to favor the reversal," he added.

Magellan was one of two pipelines cited by the industry as a potential solution to the crude bottleneck at the U.S. Cushing, Oklahoma, oil hub.

Storage levels at this hub have been setting new highs due to the revival of onshore crude production and since new pipelines from Canada began delivering heavy oil into the hub.

With those high storage levels have come record crude oil price discounts for this oversupplied land-locked inland crude hub versus crudes that can travel easily to the highest valued global market via waterborne deliveries.

Some of the rising supplies of North American crude production are coming from trends and basins in Texas such as the Permian Basin, the Austin Chalk, the Eagle Ford, and Wolfcamp.

Some of these crude oil production plays are spurred on by unconventional horizontal drilling and hydraulic fracturing technologies that have been adapted to oil production from highly prolific and pioneering success in unconventional gas regions such as the Marcellus and Haynesville and others.

The unconventional crude producing trend is also alive and well outside of Texas, as in the Niobrara and D-J Basin in Colorado and Wyoming, and in the Bakken region of North Dakota, Montana and Canada.

While some of these rising flows of unconventional crude are reaching refiners in the producing region, much more is heading to or through the Cushing oil hub to contribute to higher storage levels and lower pricing for Midcontinent crudes.

The Seaway Pipeline owned by ConocoPhillips Co. was seen as a likely candidate for reversal to alleviate the bottleneck. This pipeline carries petroleum directly from the Gulf Coast to Cushing.

But on February 15, 2011, ConocoPhillips chief executive Archie Dunham told listeners on a conference call that, "We don't really think that's in our interest because we need more crude in the area."

Yet the fact that Magellan is considering the reversal of its pipeline is good news for both conventional and unconventional producers of West Texas that can access the pipeline to ship crude through it one day to the Gulf Coast region rather than to the glutted Cushing hub.

Hart Energy's Refinery Tracker (RT) contacted Magellan Pipeline spokesperson Bruce Heine on March 17, 2011, and he said, "The origin of the crude pipeline would be in Crane, Texas, which is in the Permian Basin.

"We also have the option of expanding this system to provide transportation options to Houston for producers in the Eagle Ford shale," he said.

Refining unconventional oil of the light, sweet sort that is coming from the Eagle Ford unconventional oil plays can be done in any refinery with the capability to refine light, sweet crude.

Should the pipeline reverse, the Gulf Coast refining fleet, which is at least twice the size of the Midcontinent fleet, will likely find new profits in refining discounted unconventional and conventional West Texas crude rather than expensive waterborne crudes from either offshore in the Gulf of Mexico or imported from points far and wide.

— Greg Haas, editor, World Fuels

Advice from George Mitchell to explorationists: 'Be bold'

George Mitchell's advice to oil and gas explorationists? "Be bold." The founder of America's—and now the world's—unconventional oil and gas plays says the late, legendary explorer Michel Halbouty would rib him decades ago, telling him, "Come on. Explore. Do something."

Upon discovering how to extract natural gas resources from the Barnett shale after a first well, C.W. Slay No. 1 in Newark East Field, 30 years ago, and hundreds more thereafter, he told Halbouty, "Mike, I found this field because of you."

He quips in an exclusive interview with Hart Energy for a video tribute celebrating the 30th anniversary of C.W. Slay, the Barnett play opener, "I've been busy now for 60 years, drilling wells all over the country, and now I've done something important."

The application Mitchell pioneered of horizontal drilling and multistage fracturing into the low-permeability, low-porosity shale has reinvented the U.S. natural gas profile. The U.S. led in 2009 for a third consecutive year in percentage increase in gas production, posting 3.5% more than in 2008, according to the annual BP Statistical Review of World Energy published in June 2010. It has surpassed Russia as the world's most prolific gas producer.

And, the application of the technology into U.S. oil plays is now contributing to the U.S. also posting the largest increase in oil production in 2009. "(Daily) U.S. production increased by 460,000 barrels (bbl.), or 7%, the largest increase in the world last year and the largest U.S. percentage increase in our data set," according to the BP Plc analysts' report. That data set is of 59 years of world production history.

Mitchell says America could readily use the additional oil that is being produced from horizontal and multi-frac plays. "We have to get more oily and you'll see a lot of the industry trying to make more oil out of plays…If we have the same information on oil plays right now that we have on the gas plays, we would solve a lot of our oil problems…There's a lot of work that's still to be done."

According to data from Whiting Petroleum Corp., a leading operator in the Bakken oil play in North Dakota, production there has gone from virtually zero several years ago to some 400,000 bbl. per day. Pipeline operators are gearing up to increase take-away capacity from the Williston Basin to nearly 1 million bbl. a day by year-end 2013, according to Jim Volker, Whiting chairman and CEO.

Mitchell says the Bakken is a play he missed, and chuckles. "The Bakken's been an old play. I remember looking at it. I drilled a well there back in '83, a wildcat well. We had the (oil) show, but we never could make a well out of it. I couldn't figure out how I missed it, but I did.

"It's a big play now and it's oil, so that's good for the country."

T. Boone Pickens has been lobbying the U.S. government to incentivize use of natural gas as a transportation fuel, beginning with heavy-duty trucks. One thousand cubic feet of gas is the energy equivalent of five gallons of diesel, according to Pickens.

Mitchell says, "If you have trucks getting three miles to the gallon, get fuel for them. Let's figure out how to do that. I think there are a lot of gas uses that this nation needs and that can be devised from the excess gas that's coming out of the shales…The gas production can help take care of some of our oil needs.

"Oil production is still deficient, but we have excess gas." He urges producers to take care of water use when drilling, though. While one of the most recognized American oil and gas explorationists, Mitchell is also active in environmental and ecological endeavors, such as creating The Woodlands, Texas, community north of Houston.

"You have to clean up the water (used in drilling). It is extremely important that the industry is not criticized for not cleaning up the water. Devon Energy Corp. is doing a good job. The industry needs to work with the government and help them understand. I think we can do much better."

Where would Mitchell look for oil today? "I'd still say the shales right now, and I'm looking at that too," he says.

— Nissa Darbonne, editor-at-large,

Oil and Gas Investor

Nuevo Midstream launched with $65-MM commitment

Nuevo Midstream LLC recently announced that it has secured a $65-million equity commitment to support formation of the company. Nuevo Midstream is a midstream start-up based in Houston, Texas.

The company plans to focus on developing and operating midstream infrastructure for natural gas producers in the Permian Basin with emphasis on the Bone Spring and Wolfcamp formations, including the Avalon shale trend in southeast New Mexico and West Texas.

The new company is backed by $65 million in equity commitments from the EnCap Energy Infrastructure Fund (EEIF), Torch Energy Advisors Inc. (Torch Energy) and Petroleum Fuels Co. Inc. (Petroleum Fuels). EEIF is managed by EnCap Flatrock Midstream, a private-equity firm based in San Antonio, Texas.

Nuevo Midstream will be owned by EEIF, Houston-based Torch Energy and Petroleum Fuels. Torch Energy will contribute management services to Nuevo Midstream along with assets it co-owns with Petroleum Fuels, including the Ramsey gas-gathering system.

The Ramsey system consists of about 130 miles of natural gas-gathering pipeline; compressor and measurement stations; and processing, fractionation, storage and loading facilities in Reeves County, Texas. The gathering system crosses through Eddy County in southeast New Mexico and Culberson, Loving, and Reeves counties in West Texas.

"The Bone Spring and Wolfcamp formations and the Avalon shale are unconventional plays that are generating big news and strong results. We are excited about working with this team to develop Nuevo's acreage dedications and midstream capacities as production accelerates in the area," said Dennis Jaggi, one of EnCap Flatrock's managing partners.

Nuevo Midstream's management team will be led by Jay Lendrum, Torch Energy's current president and chief operating officer. The senior leadership group at Nuevo Midstream also includes Randy Ziebarth, vice president of operations; Chris Work, vice president and chief financial officer; and Dwight Serrett, vice president of engineering and construction.

"Nuevo Midstream will focus its early operations on upgrading our gas-gathering lines and the processing plant near Orla, Texas. We expect our system to have initial processing capacity of 10 million cubic feet (MMcf) per day online by mid-summer. We will expand our system as demand from the producers increases, bringing on additional gathering, processing and treating capacity," notes Jay Lendrum, chief executive of Nuevo.

"Our preliminary plans call for a second processing plant at the same location with capacity of 50 million cubic feet per day," Lendrum said.

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