A Natural Gas Bounty Is Turning Against Producers
|November 21, 2012||Posted by Staff under Economic Principles|
After the financial crisis, the rush for natural gas “rents” was one of the few major profit centers for Wall Street deal makers, who found willing takers among energy companies and foreign financial investors — many of whom are now licking their wounds. This 2012 article is from the New York Times, Oct 20.
by Clifford Krauss & Eric Lipton
The nation is awash in so much natural gas that electric utilities, which burn the fuel in many generating plants, have curbed rate increases and switched more capacity to gas from coal, a dirtier fossil fuel.
Companies and municipalities are deploying thousands of new gas-powered trucks and buses, curbing noxious diesel fumes, and reducing the nation’s reliance on imported oil.
And companies like fertilizer, plastic, and chemical makers, which use gas as a raw material, are suddenly finding that the United States is an attractive place to put new factories, compared with, say, Asia, where gas is four times the price.
But while the gas rush has benefited most Americans, it’s been a money loser so far for many of the gas exploration companies and their tens of thousands of investors.
The drillers punched so many holes and extracted so much gas through hydraulic fracturing that they have driven the price of natural gas to near-record lows. Warm weather last winter exacerbated the glut to historic levels, reducing prices even further, since so little gas was needed to heat homes in many parts of the nation.
Because of the intricate financial deals and leasing arrangements that many of drillers struck during the boom, they were unable to pull their foot off the accelerator fast enough to avoid a crash in the price of natural gas, which is down more than 60 percent since the summer of 2008.
Although the bankers made a lot of money from the deal making and a handful of energy companies made fortunes by exiting at the market’s peak, most of the industry has been bloodied — forced to sell assets, take huge write-offs and shift as many drill rigs as possible from gas exploration to oil, whose price has held up much better.
Big companies like Chesapeake and lesser-known outfits like Quicksilver Resources and Exco Resources were able to supercharge their growth with the global financing.
In China, a senior executive at a major Chinese oil company explained that the country wanted to move as much as $750 billion from United States Treasury bonds into the North American energy business.
In all, the top 50 oil and gas companies raised and spent an annual average of $126 billion over the last six years on drilling, land acquisition, and other capital costs within the United States, double their capital spending as of 2005.
Chesapeake spent an average of $7,100 an acre on the drilling sites it had leased in the Haynesville. Lesser-known Plains Exploration and Production paid Chesapeake the equivalent of $30,000 an acre. Wheelers-and-dealers involved in arranging the deal made an estimated $23 million on this transaction.
It wasn’t just the cash-and-carry deals that were forcing them to drill. The land that the natural gas companies had leased, in most cases, came with “use it or lose it” clauses that required them to start drilling within three years and begin paying royalties to the landowners or lose the leases.
Exco, Chesapeake and others initially boasted about how many acres they had managed to lock up. But after paying bonuses of up to $20,000 an acre to the landowners, the companies could not afford to lose the leases, even if the low price of natural gas meant that drilling more wells was a losing proposition.
The industry was also driven to keep drilling because of the perverse way that Wall Street values oil and gas companies. Analysts rate drillers on their so-called proven reserves, an estimate of how much oil and gas they have in the ground. Simply by drilling a single well, they could then count as part of their reserves nearby future well sites. In this case, higher reserves generally led to a higher stock price, even though some of the companies were losing money each quarter and piling up billions of dollars in debt.
Now the gas companies are committed to spending far more to produce gas than they can earn selling it. Their stock prices and debt ratings have been hammered.
Just as in the earlier real estate bubble, the main players publicly predicted success even as, privately, their doubts were growing, court documents show.
Aubrey K. McClendon, chief executive of Chesapeake Energy, suggested in August 2008 to Wall Street analysts that he had fundamentally transformed the once-risky, century-old oil and gas business into something with the reliability of an assembly line. “We consider ourselves to be in the gas manufacturing business, and that requires four inputs in our opinion — those inputs are land, people, science and, of course, capital.” [His inputs cover the major ones in classical economics.]
But in an October 2008 e-mail that has since become public in a lawsuit against Chesapeake, he wrote that the company might have made some big mistakes. “What was a fair price 90 days ago for a lease is now overpriced by a factor of at least 2x given the dramatic worsening of the natural gas and financial markets.”
Ralph Eads III, McClendon’s fraternity buddy from Duke who had become his go-to banker, helped arrange what will go down as one of the great early paydays of the shale revolution: the 2010 sale of East Resources, which his associate Terry Pegula had started with $7,500 borrowed from family and friends, to Royal Dutch Shell for $4.7 billion.
There were a handful of other such profit takers, including the Houston businessman Floyd Wilson, who created a company in 2003 called Petrohawk Energy with the intention from the start of selling it. Petrohawk drilled its first Haynesville well in 2008. Last year, it sold itself to an Australian energy conglomerate, BHP Billiton, in a $15 billion deal that brought Mr. Wilson and other executives a payout worth at least $304 million.
But for many gas drillers, there has been only pain. In hindsight, it should have been clear to everyone that a bust was likely to occur, with so many new wells being drilled and so much money financing them. But everyone was too busy working out new deals to pay much heed.
The bust has hit the Haynesville hard. Some local landowners, having spent their initial lease bonuses, are now deeply in debt. Local restaurants and other businesses are suffering steep losses now that so many drillers have left town.
JJS: Loud mouth, glad-handing salesmen will always be able to reap a fortune whenever there’s a fast flow of unearned cash available for the plucking. But the billions spent for fossil fuels — part of Mother Nature — is not legitimately the property of just a few wheelers and dealers. Instead, it is a revenue stream we should all share in, while forgetting about taxing the incomes that we do earn.
Interestingly, some public jurisdictions do already recover some of the worth of Mother Earth, some land value. See “Projects Approved For Orlando Executive Airport” in Aviation News, Oct 18; “Ground rent to Orlando Executive Airport from Microtel will amount to $330,585 over the first five years of the lease agreement. Ground rent for the GFS store will be $554,085 for the first five years of the lease agreement. The ground rent for the Wawa Food Market and gas station will be $605,920 over the first five years of the agreement.” To read more .