DOE Agency Announces Precipitous Downgrade In Marcellus Shale Reserves

Yesterday the U. S. Energy Information Administration issued its 2012 Annual Energy Outlook (AEO2012) Early Release Reference case which provides updated projections for U.S. energy markets through 2035. Of interest to those following the progress of the natural gas development in the Marcellus Shale, the report included a significant downward revision to the Government’s estimate of the unproven technical recoverable resource (TRR) for unconventional shale gas in the U.S. from 827 trillion cubic feet in its AEO2011, to 482 trillion cubic feet.  According to the AEO2012 “[t]he decline largely reflects a decrease in the estimate for the Marcellus shale, from 410 trillion cubic feet to 141 trillion cubic feet. Both EIA and USGS have recently made significant [negative] revisions to their TRR estimates for the Marcellus shale.”

Two of Pennsylvania’s largest daily newspapers, ­the Pittsburgh Post-Gazette and the Pittsburgh Tribune-Review reported on this story today and while each cited optimistic overall projections for the increased production of natural gas in the coming decades resulting in the United States becoming a net exporter of liquid natural gas (LNG) by 2016 and an overall net exporter of natural gas by 2021, there are also some worrisome signs for development in the Marcellus region for the foreseeable future.

While both articles quoted “industry experts” as questioning the validity of and the reasonable inferences to be drawn from the EIA’s downward Marcellus shale projection, a 66% drop in the TRR does not offer short and possibly intermediate term encouragement for many Pennsylvania gas lease holders who are receiving or anticipating royalty income.  This news comes immediately on the heels of major announcements by industry titans EQT and Chesapeake of plans to cut back on shale gas development in 2012.

In particular, Chesapeake’s announcement on Monday that it is reducing its “dry gas” drilling capital expenditures by 70% and refocusing on the more profitable liquid rich plays (to the tune of 85% of its total net operating drilling capital expenditures) is not good news for landowner/lessors in the Commonwealth. Given that most of Chesapeake’s leasehold interest in Pennsylvania is in the dry gas portion of the Marcellus and that as a result it is shifting its focus to the Utica Shale where it also has significant holdings, Ohio is gearing up for significant natural gas development activity.

The Pittsburgh Post-Gazette cites the AEO2012 as projecting natural gas to trade no higher than $5.00 per thousand cubic feet through 2023 and while that is roughly double the current price at $2.30/Mcf (a ten-year low), $5.00/Mcf is presently about the level at which gas would have to trade for many E&P companies to view production as “profitable.”  Natural gas prices are significantly impacted by weather (which is not cooperating from a price standpoint), and the economy (which is not cooperating period), so a change in either (preferably the U.S. financial position) could alter the prospects for production of natural gas in Pennsylvania to return to the lofty heights achieved in the past year.

There’s always a silver lining in this blog and the good word for today – at least for landowners whose leases are held by Chesapeake – is “expiration,” as in leases that were negotiated years ago and are nearing the end of their respective primary terms. If Chesapeake is going to relocate 50% of its drilling rigs from Pennsylvania it stands to reason that those remaining will be working overtime to complete as many vertical wells in order to “hold by production” as much of its undeveloped acreage as possible. However, if land under lease with Chesapeake is outside of its “sweet spots” – all of Bradford and most of Tioga and Susquehanna Counties – the company may not act to perpetuate your lease based on a cost-benefit analysis of where its reduced development dollars can most profitably be spent.

Of course, drilling is not the only way a lessee can extend a lease (a subject which I just addressed at a conference of the Pennsylvania Bar today) so lessors should be examining their leases’ habendum and force majeure clauses, among others. I will be blogging on this topic next week. Some lessors may be able to shed early12.5% leases and look forward to the prospect of a growing economy, increased natural gas prices and a return to the lease bonus amounts paid and royalty rates offered in 2009 and 2010.

So to all my current and future clients, get out your gas leases and bring them in (or email them) so we can evaluate your prospects. And to all Pennsylvania homeowners who don’t have gas leases, but who heat with natural gas, here’s to prices remaining under $3.00/Mcf.