The Economics of Shale Gas In New York

No Fracking Rush The DEC paid for and published a socioeconomic study that failed to state any shale gas reserve estimates, but that clearly overstates shale gas reserves by a factor of 5 or more. 1 This grossly overstates the potential macroeconomic impact of shale gas development in the state while almost completely ignoring the downside – such as the loss in home values.2 The DEC fails to address the microeconomics of horizontal shale gas drilling, it just assumes that it is economic – when this is demonstrably not the case. The DEC is estimating the number of jobs created and tax revenues from a form of gas production that is not economically viable in New York - and may not be for some time.3 According to the Energy Information Agency’s 2011 projections, dry shale gas, of the type found in the Marcellus and Utica formations in New York, will not be economically viable until late in the decade – around 2018.4 Simply put, there is no rush to permit horizontal shale wells in New York state - despite the industry's push to do so – because the wells are not likely to be economic at current or projected gas prices. 3 4
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As stated in this recent article from an oil and gas investment banking firm: "Supply economics support this financial picture with the majority of shale gas plays failing to break even on a full-cycle basis3 at prevailing gas prices ($4.50 mcf) – the notable exceptions being the liquids-rich plays (see Figure 2). This analysis is backed up by a review of current drilling activity, which shows an increase within the liquids-rich plays, e.g., Eagle Ford, at the expense of the dryer gas plays, e.g., Haynesville. The attraction of an additional, valuable, liquids revenue stream is rapidly driving up liquids-rich asset prices. This harsh economic reality has been postponed through a combination of the continuing flow of new investors, and the ability of operators to hedge gas production at economic prices. Unfortunately, this prop is being removed with companies only being able to hedge their gas production at prices ranging from US$4.00 to US$5.95/mmbtu4.” Meaning, exploration continued as long as share prices were up, and production could be sold on a “greater fool” basis to new investors, foreigners and other companies – in a gas bubble economy. And production could be hedged at prices that would insulate temporary downturns in gas prices – for awhile. But when the music stops, as gas prices stay depressed and the supply of “suckers” runs out, the reality of most of these shale fields sets in – they are uneconomic, even with liberal tax treatment. South central New York state shale gas wells will likely be similar to the dry gas wells in Northeast Pennsylvania. Most New York counties will be no better than and likely considerably less productive than the border counties of Pennsylvania. Meaning they will not be economic for shale gas until late in the decade based on the after tax production costs of similar wells in Pennsylvania and the EIA’s December 2011 projections for gas prices. See Figure 1 below. This, of course, presupposes that shale gas wells in New York will be as productive as the wells in NE Pennsylvania. Well tests of the Utica and Marcellus by Gastem USA in Otsego County indicate that will not be the case. Similarly, Norse Energy’s wells in Chenango County do not look economically promising.5 Which begs the question – what is the rush in New York to issue drilling permits on wells that are demonstrably uneconomic ? Why not take the time to address some of the state’s shortcomings, such as the atrocious standards for gas wells, 6 the DEC’s lack of a full set of rules and regulations for shale gas wells and the DEC’s chronic lack of adequate staffing.7 And bring its gas tax regime into the 20th, if not the 21st Century.8 6 7 8


The horizontal line in the graph is $4.50 mcf. The vertical lines are the full cycle cost of producing gas from different shale gas fields in mcf. The closest analogy to New York would be Marcellus Northeast – such as Bradford County, Pennsylvania, the third vertical bar from the right of the graph. At current prices (around $2.70 mcf), none of these fields are economic. Figure 1 Post Tax Effect Economics of Major Shale Gas Fields

It is the service companies - Halliburton and Schlumberger, etc. that are making money from most of these shale gas fields, as Figure 2 illustrates. Because they make money even on dry holes and uneconomic wells - financed by the overblown stock prices and junk bonds of the exploration and production companies. Until that runs out – and the drilling rigs are stacked away.


Figure 2 Gross Margin of Service Companies vs Gas Production Companies

As the production companies run out of foreign suckers to sell their production to, their bonds revert to junk status, their share price tank and the shale bubble will burst. The lack of economic substance for horizontal shale gas in New York underscores the fact that there is no need for New York to rush the regulations in 2012 – especially given the woeful state of New York’s gas well regulations.9 New York should make its horizontal shale gas regulations based on sound science, hydrology, geology and topography, not political science. 10 And sound economics, not chants of “frack, baby, frack” from gas industry front groups.11 A considerable amount of domestically produced natural gas will be exported overseas where it we be sold by multinationals for a several times the domestic wholesale price – the price used in royalty payments, state severance taxes and local ad valorem property taxes. In Pennsylvania, the gas will leave the state
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virtually un-taxed at either the state or local level. Gas produced in New York will leave the state tax free at the state level, further compounding the exploitation of the state by the gas industry.12 This exploitation is facilitated by gas industry’s PR flaks 13 and sycophants in government, who would enable the gas industry to exploit New York’s resources and environment like a 3rd world country, in exchange for some campaign donations to a few gatekeepers in Albany.14 The Marcellus is dry gas, so it is unlikely to be economic until late in the decade, at around $5 mcf. Most of the Utica Shale in New York is also dry, but deeper, and thin, so say $5.50 mcf. It is not clear that the Utica would be productive anywhere in the state, since it appears to be “over-mature” in most of the state as confirmed by recent test wells. And the Utica may be too thin to frack economically where it might be productive in New York.15 This spotty distribution of possible activity argues for local land and road use ordinances16 – since shale gas development in New York, if it allowed to go forward at all, will probably be a hit or miss affair by counties, if not by towns. James L. “Chip” Northrup Cooperstown 14 15 16
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