Friday, October 01, 2010

Shale Gas Investment Geography

The bluster about Pennsylvania's Marcellus Shale severance tax has reached the point of hysteria. To suggest that the state government is poised to kill "the goose that lays the golden eggs" is fear-mongering of the worst kind. But that's what the natural gas industry would have you believe.

I've already covered all the jobs nonsense. Today, I'll tackle the threat of investment dollars fleeing the region. Via Burrito Bites, there are already billions of dollars sunk into the shale play:

Companies spent a record $21bn on acquisitions in the first half of 2010 to gain access to the US shale gas boom in a trend that shows no signs of slowing, according to a new report by Wood Mackenzie. ...

... The technology, which combines horizontal drilling with hydraulic fracturing of the rock, is expensive and Wood Mackenzie said the high, upfront costs associated with the initial testing and subsequent full-scale development of shale gas resources were in many cases prohibitive.

This is particularly true for companies with high levels of debt and cash constraints, which fits the description of many of the small, independent producers in the US that have been in on the ground floor of the boom.

It is this need for capital that gave rise to the shale gas partnerships, which Wood Mackenzie said underpinned much of the recent merger and acquisition activity.

In May, for example, Temasek, the Singapore state investment fund, and Hopu Investment Management, a Beijing-based group, agreed to buy $600m of convertible preferred stock in Chesapeake Energy. This followed other deals by Chesapeake with Total of France, the UK’s BP and Norway’s Statoil Hydro to help fund development.

Many of the companies forming partnerships were doing so to divert capital towards opening up new shale plays, Wood Mackenzie said, with the latest trend being a shift toward shale oil projects.

The increased need for financing gives the well-funded majors strong buying opportunities. This year, ExxonMobil completed its $41bn acquisition of XTO Energy and Shell announced a $4.7bn acquisition of East Resources.

Given all the policy unknowns, those are big bets sitting on the table. Drillers aren't the only ones at risk. Steel pipe manufacturers have already committed themselves to the regional shale gas boom:

The Regional Chamber spearheaded overall local economic development efforts that led to Paris-based V&M Star’s decision to invest a whopping $650 million in Youngstown/Girard, Ohio. This project will cause the construction of a more than 1-million-square-foot, state-of-the art seamless steel tube production center. V&M’s massive new facility will create 350 high-paying, advanced manufacturing jobs. The project has been heralded as “transformational” in terms of the impact that it will have on its sprawling 193-acre site, as well as Northeast Ohio’s entire Mahoning Valley. The endeavor is so significant that it even caught the attention of the White House, resulting in a visit by President Obama so that he could see the development first hand.

The goose has laid a lot of golden eggs. Industry across the board is "pot committed". That's why the rhetoric against the tax is so heated. That's why the Marcellus Shale Coalition is hyping job creation numbers that don't add up.

I'm not sure I support the tax as proposed by the Pennsylvania House of Representatives. However, the doom-and-gloom threats read like a weak bluff. How much, exactly, is too much? What's the tipping point? No one knows the answers to those questions because so much will be tied to the price for natural gas:

Gov. Dave Freudenthal doesn’t sound particularly worried about whether coal or natural gas is winning a larger slice of the market share. After all, Wyoming has an embarrassment of energy riches—coal, coal-bed methane, natural gas, oil, uranium and wind. However national energy policies and markets move in the future, Wyoming will benefit.

“I’ve seen these projections (cited by the Wall Street Journal),” said Freudenthal in an interview with New West, adding he’s not sure how solid they really are. “I’m a little softer on these projections.”

The Energy Information Administration (EIA) reports that coal-burning power plants are expected to slip from 18 percent of total new capacity in the U.S. in 2009, to 10 percent in 2013. At the same time, EIA reports that natural gas will grow from 42 percent of total new capacity in 2009 to 82 percent in 2013.

Earlier this summer, Massachusettes Institute of Technology issued a report, predicting that natural gas will play a leading role in reducing greenhouse-gas emissions by replacing older, less-efficient coal plants with highly efficient combined-cycle gas generation.

With natural gas falling to around $4 per 1 million British thermal units (Btu), gas is continually grabbing more market share. Coal is usually the loser, according to EIA stats, as utilities shift to natural gas, renewables like wind, or even nuclear.

Freudenthal notes a couple of flies in the coal-is-dead, long-live-natural gas ointment. “You can’t get a 10-year contact for natural gas,” he said, noting the volatility of natural gas prices in recent years and decades. “Pricing simply isn’t reliable,” he added.

I've added the emphasis. Negotiating a lower tax is one way to manage uncertainty. And if the investment dollars could just pick up and seek a better tax geography, then the pro-energy industry side wouldn't seem so desperate. There would be no need for unsubstantiated hyperbole.

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