Southwestern Energy's Shale Problem

In the middle of another strong earnings report highlighted by explosive Marcellus growth, Southwestern Energy (NYSE: SWN  ) detailed a troubling problem for the company and the industry as a whole. The company is a leading driller for natural gas in both the Fayetteville Shale in Arkansas and the prolific Marcellus Shale in Pennsylvania. 

Southwestern Energy has successfully survived the low natural gas prices of the last few years to finally see the stock reclaim the all-time highs first reached back in 2008 before the market collapsed -- a warning sign for the fast-growing exploration stocks.

Southwestern Energy is a top operator, but the first-quarter results highlighted the long-term concerns from the production curve of shale wells. Overall, the company generated production growth of 23% compared to a year ago to reach record levels of 182 Bcfe. On the surface, the numbers appear strong. Yet below the surface the company is struggling to maintain production levels at its original shale area despite still drilling a large amount of wells.

Other companies, including large players like Chesapeake Energy (NYSE: CHK  )  and smaller Comstock Resources (NYSE: CRK  ) have seen huge declines in production from the nearby Haynesville shale after pulling out drilling rigs and dropping capital spending.

Fayetteville struggle
For the first quarter, Southwestern Energy saw net gas production grow slightly in the Fayetteville Shale to 119.4 Bcf compared to 118.9 Bcf in the first quarter of 2013. Those numbers aren't necessarily bad until you factor in that the energy company placed 105 new wells on production during the quarter. According to the details below provided by the company, the new wells placed on production were basically in line with the last couple of years but significantly below the 159 wells from the fourth quarter of 2010.

Table: Fayetteville shale production

In essence, the company spent a ton of effort placing an incredible 105 new wells into production to get nowhere in terms of production growth. Stuck in the details were some more worrisome numbers including 30-day average initial production rates of 2,724 Mcf/d that were originally reached back in the second quarter of 2009, or nearly five years ago. These numbers were despite a nearly 25% increase in the average lateral length during those years to hit 5,680 feet during the last quarter.

The table very much highlights the path of some recent Marcellus shale producers -- including Southwestern Energy -- where the number of wells drilled along with the large increase in lateral lengths plus improved efficiencies led to dramatic production growth. After time has elapsed in Fayetteville shale production, the company is drilling fewer wells and the efficiency gains are smaller, possibly suggesting that the best wells were drilled at the start of the program.

Haynesville examples
Both Chesapeake Energy and Comstock Resources saw production in the Haynesville shale virtually collapse in the last year without the companies drilling on their acreage, due to low natural gas prices and higher costs for the shale compared to other areas. While Chesapeake has started ramping production back up now that prices have rebounded, Comstock Resources continues to ignore the resource, resulting in production declining 26% from the totals of the first quarter of 2013.

Even outside the Haynesville, Chesapeake Energy recently suggested that it requires roughly $300 million in annual capital spending in the Marcellus shale to keep production flat at the existing levels.

Bottom line
With Marcellus shale production growing 147% compared to year-ago levels, Southwestern Energy remains an interesting stock at current valuations first reached roughly six years ago. The flatlining production levels of the Fayetteville shale despite an incredibly large amount of wells hitting production should concern investors regarding the laws of physics in other hot shale areas and producers.

Even worse, Chesapeake Energy's and Comstock Resources' stocks struggled with the companies abandoning areas like the Haynesville shale in the past for better profits in more oily areas. The market is rarely fond of shifting production, especially when it leads to only replacing production declining at a fast clip in another area.

Investors in other energy-exploration companies should follow these examples of what happens when the growth stops, which inevitably will happen to all the hot stocks of the day. Southwestern Energy has overcome the issue by developing another acreage set, but it has taken years to reach the original peak in the stock. Investors of all energy companies should key into the second-quarter results from the Fayetteville shale to track the decline curve of the original wells and forecast that scenario onto the results of their favorite company.

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