The Barnett Shale was once the darling of the U.S. oil and gas industry. From 2002 to 2010, it was the most productive source of shale gas in the country. However, it has fallen from its perch in recent years, losing out to more economic shale plays like the Marcellus, Utica, and Haynesville shales. The Barnett's weaker profitability meant that it couldn't compete against these more productive shale plays when natural gas prices collapsed. Because of that, many drillers cut back on spending for new wells, causing production in the Barnett to decline. Meanwhile, several other oil producers have chosen to abandon the region by selling their position for a fraction of what they paid for it during the boom years.
The Barnett Shale 101
The Barnett Shale is a massive natural gas field that covers 5,000 square miles in Texas, and is located to the west of the Dallas-Fort Worth area. Mitchell Energy initially discovered the field in 1981, though its first wells didn't produce that much gas. However, the company continued to tweak its well designs and techniques over the next two decades and eventually found the key to unlocking the treasure trove of gas trapped in the Barnett's tight rocks. In fact, according to some experts, the Barnett is the largest onshore natural gas field in the country. That said, a significant portion of that gas sits underneath the urban areas of Fort Worth, which limits the industry's ability to access it. Furthermore, despite the amount of gas in the Barnett and the cheaper drilling costs compared to other plays, wells in the region aren't as productive, which results in unappealing drilling returns at current prices.
The land rush
Mitchell Energy's success eventually caught the eye of larger competitors, including Devon Energy (NYSE:DVN), which swooped in with an offer for $3.5 billion to buy the company in the summer of 2001. Other drillers would follow suit in the years that followed, investing billions to lock up a piece of the Barnett. In 2004, for example, XTO Energy spent $200 million for properties in the Barnett shale following two years of studying the play. A couple of years later, it spent $105 million for Peak Energy Resources, picking up nearly 200,000 net acres in the play. It would follow that deal by paying more money for less land, spending $550 million for another 24,000 net acres in 2007, while handing over a whopping $800 million for 12,900 acres near its existing core operations in 2008. Two years later, XTO would get an offer it couldn't refuse when ExxonMobil (NYSE:XOM) offered to buy it for $41 billion, in part because of its prime position in the Barnett.
Before that, XTO seemed to be in a race with Chesapeake Energy (OTC:CHKA.Q) to lock up as much acreage across the Barnett and other shale plays as they could. One of Chesapeake's more notable deals was paying $932 million for 67,000 acres in the Barnett in 2006. By 2008, the company had leased or acquired more than 255,000 net acres in the play, which it estimated held 2,800 future drilling locations. At its peak, the company was running about 40 rigs, which had it on pace to drill one new Barnett well every 15 hours.
Fueling these purchases and subsequent capital investments to deploy drilling rigs was the price of natural gas, which by the middle of 2008 had surged to more than $13 per Mcf:
At that price, the Barnett Shale was a gold mine for drillers.
Popping the bubble
Unfortunately, all that drilling in the Barnett, when combined with surging output from newer shale gas plays like the Marcellus, Utica, and Haynesville, led to a gusher of production. That rising output started weighing on the price of gas, which by 2009 had plunged below $3 per Mcf, thanks in part to slumping demand amid the financial crisis. While gas prices tried to stage recoveries in the years that followed, the price today is currently around $3 per Mcf. That's just not high enough for shale drillers to earn a compelling return in the Barnett, especially when they can get much higher returns elsewhere.
In fact, for some companies, the Barnett shale had shifted from a profit center to a money pit. Nowhere is that more clear than at Chesapeake Energy, which unloaded its Barnett Shale assets last year. Initially, the company agreed to convey its leases to a private equity-backed driller while also agreeing to pay $334 million to terminate its gas gathering and downstream agreements with Williams Partners (NYSE: WPZ). Chesapeake's CEO Doug Lawler summed up the impact of that deal by saying that:
By exiting the Barnett, we expect to increase our operating income for the remainder of 2016 through 2019 between $200 and $300 million annually, eliminate approximately $1.9 billion of total future midstream and downstream commitments, and increase the PV-10 of our proved reserves. Given the significant negative cash flow profile of the Barnett assets, the net cash paid out in these transactions has a payback of less than 18 months.
In other words, Chesapeake Energy was losing so much money on the Barnett Shale that it was willing to fork over hundreds of millions of dollars just to get the assets off its books. That said, Chesapeake's partner in the Barnett, French oil giant Total (NYSE:TOT), preempted that deal by exercising its right to acquire the remaining 75% of their joint venture that it didn't already own. It's a partnership that Total initially paid $800 million in cash and $1.45 billion in development costs to acquire in 2009. Total would end up paying another $420 million to Williams Partners to fully restructure the contracts and $138 million more to be released from three other midstream contracts as part of its deal with Chesapeake, which would improve the profitability of the Barnett.
Chesapeake Energy wasn't the only driller to jettison its Barnett assets in recent years. Oil giant ConocoPhillips (NYSE:COP), which picked up some of its Barnett Shale acreage as the result of spending $36.6 billion to acquire Burlington Resources in 2006, unloaded its remaining position earlier this year. That said, ConocoPhillips only received $305 million for the acreage, which was well below its $900 million net book value for the assets. Meanwhile, Devon Energy is hoping to join them. That's after the company, which has drilled more than 5,000 wells in the Barnett since acquiring Mitchell Energy, unveiled plans earlier this year to sell $1 billion in assets, including about 20% of its 610,000 net acre position in the Barnett. The driving factor for these decisions to jettison the Barnett is that oil companies can make more money by getting rid of these assets than by continuing to operate them.
The Barnett shale's shine has faded over the years as sinking prices have had a significant impact on its profitability. Because of that, oil companies are bailing on the play, and in many cases taking whatever they can get just to get it off their books. It's a reminder to energy investors that the hot play of today could quickly burn out if prices plunge or another region becomes more profitable and popular.