Burgh Energy Report: Taxing Marcellus

I'll start off with some news about shale gas drilling in the near term and expectations about the Pennsylvania severance tax debate:

Chesapeake is opening a data room for its Niobrara acreage this month and expects a joint venture deal to be in place by the first quarter of 2011. The firm's expected monetization of a portion of its Marcellus acreage appears to have been delayed, however, with timing on resolution uncertain at this point. Additionally, Chesapeake guided to approximately $2 billion and $1 billion in production sales in 2011 and 2012, respectively. The firm noted that it will continue to push hard on drilling activity in its shale gas plays over the next 12-18 months--especially the Barnett, Haynesville, and Marcellus regions--not only to achieve held-by-production status, but also to meet takeaway minimums and partnership obligations. We continue to view Chesapeake's partnerships as an overall negative fundamental factor for U.S. natural gas prices through 2012. Finally, a quick point on Marcellus: based on Chesapeake's recent meeting with Governor Rendell, the firm doesn't expect a resolution on Pennsylvania severance tax issues until the first part of 2011 at the earliest.

Despite looming political uncertainty and continued low natural gas prices, Chesapeake isn't slowing down. Drilling companies don't appear to be too concerned with the outcome of the tax debate. I'm certain that the drillers (and the investment dollars) are in Pennsylvania for the long haul. One reason (via Chris Briem) is the lack of new opportunities (i.e. alternatives to the PA Marcellus):

"If you decided, I'm going to pass on the Barnett, pass on the Haynesville, pass on the Marcellus, and you were going to wait for the next four or five--there won't be any," McClendon said Wednesday during the company's annual meeting with analysts, referring to tight, hydrocarbons-rich rock formations in Texas, Louisiana and the U.S. Northeast, respectively. "By the end of 2011 it will be over. There won't be any basins that have escaped investigation." ...

... McClendon said Chesapeake will continue to court joint venture partners for its interests, including those in the Niobrara shale in northeast Colorado and the Permian Basin in west Texas. And Chesapeake may sell its expertise to other companies considering shale plays overseas. But Chesapeake isn't planning any foreign investments, McClendon said.

"We aren't going to Poland, we aren't going to Canada," he said. "In terms of spending Chesapeake capital overseas, I don't see it."

The are not the words of a CEO worried about being taxed out of Pennsylvania. Geopolitically speaking, there isn't a rush to exploit new plays in developing markets such as Poland:

The most important shift, however, is not on land but at sea. The big worries over European energy security came when the world gas market was tight. But the price of LNG has plunged, chiefly because America, now well supplied with shale gas, has stopped importing it. Nabucco remains important as an insurance policy, and as a sign that the EU’s common energy policy is more than talk. But it also looks like an answer to a problem that technology and the market may already be solving.

The improved gas line infrastructure for Europe is moving forward and LNG demand in the United States looks to be nil for years (decades?) to come. Canada also has a well-established natural gas supply. Which brings me to the other consideration in divining the state of the PA energy economy after the tax is levied, price:

But in just a few years, a number of shale gas fields around the country are suddenly producing gas, including the Barnett field in Texas, the Fayetteville field in Arkansas, the Haynesville field in Louisiana and the massive Marcellus field that stretches from Western New York through Pennsylvania, Eastern Ohio and West Virginia.

While these developments are almost certain to boost U.S. gas production for years to come, they will have little effect on imports of foreign oil, at least in the short term. There are proposals to use more natural gas as a transportation fuel, but it is now used mainly to generate electricity, heat homes, and as an industrial feedstock.

A recent study by the Massachusetts Institute of Technology on the future of natural gas found that 80 years’ worth of global natural gas consumption could be developed profitably with a gas price of $4 or below.

Plans for nuclear plants and wind farms were made under the assumption that gas prices would average $7 to $9. At that level, electricity prices would be high enough to make wind and nuclear power look affordable. Now many of these projects suddenly look too expensive.

If the market tightens up considerably, then nuclear power and wind come back as a serious alternative to coal-fired electricity. The key is the MIT study and how low prices can be with hydrofracking offering a positive margin. We now know that the Marcellus Play is among the cheapest to exploit and the most productive compared to other US plays.

Investment in Pennsylvania is not going to Poland. That's an absurd claim. There's going to be a lot of drilling in the Marcellus. It seems unlikely to blossom in New York State. I'm not sure if other Marcellus states offer enough of an alternative policy geography (not to mention well productivity) to be a chip that industry can use to push PA politicians. The words from the Chesapeake CEO along with the ridiculous claims emanating from the Marcellus Shale Coalition (the barking dog with no teeth) suggest that there is no such leverage forthcoming.

The tax debate is about how much profit companies such as Chesapeake will reap in Pennsylvania. It isn't a matter of whether or not they will drill in the state. The investment will continue to pour in because an unexpected rise in prices will produce major windfalls and the other options (e.g. Poland) are not attractive. Finally, much of the investment is already in place. Pennsylvania is already playing with the dealer's money.