One of the biggest trends within the energy exploration and production space over the past few years has been the diversion of capital away from natural gas plays to oil-rich plays, due largely to the slump in natural gas prices since 2010.
With most energy producers still finding it more profitable to drill in liquids-rich plays, only the most economical shale gas plays have seen strong activity, with Pennsylvania's Marcellus shale being the most notable. By contrast, drilling activity in less economical gas plays has declined sharply over the past few years.
A case in point is the Barnett Shale of North Texas, where drilling activity recently plunged to its lowest point in a decade. Let's take a closer look.
Plunging activity in the Barnett
According to data from the Texas Railroad Commission, the number of drilling permits issued in the Barnett during the first eleven months of 2013 fell to 827, down sharply from 4,065 permits issued in 2008 and the first time since 2003 that Barnett permits have fallen below 1,000.
Through December 2013, companies drilled a total of 784 wells in the play, down from a record high of 3,594 in 2009 and down from 840 in 2012. Not surprisingly, Barnett production declined 6.5% year-over-year to average 5.36 billion cubic feet of natural gas a day in 2013.
Several of the largest drillers in the play have drastically curtailed drilling activity in the play, and the few that remain are mainly focused on the liquids-rich areas of the play. EOG Resources (NYSE:EOG), for instance, only has three rigs running in the play, and drilled 145 Barnett wells in 2013, a sharp reduction from previous years. The main reason the company is still drilling in the play is because of its large acreage position in the Barnett Combo Play, which is rich in crude oil and natural gas liquids.
Similarly, Devon Energy (NYSE:DVN), which has been -- and still is -- one of the largest producers in the Barnett, completely curtailed dry gas drilling in 2013 in favor of ramping up liquids production. In 2013, the company drilled approximately 180 new Barnett wells, down 44% from 322 wells in 2012. With Devon's weighted average production costs for both gas and liquids in the Barnett currently estimated to be $3.91 per thousand feet equivalent, natural gas and NGL prices would have to rise significantly in order for the company to divert capital away from its liquids-rich plays.
Lastly, Chesapeake Energy (NYSE:CHK), once a major driller in the Barnett, has also severely curtailed its operations in the play due to the relatively poor economics of its drilling program there. It is currently operating two rigs in the Barnett, down from 12 in 2011. Going forward, the company will likely continue to focus the largest portion of its capital on liquids-rich opportunities in the Eagle Ford and the Greater Anadarko Basin, which will be the key drivers of its oil production growth.
A tale of two shales
The monumental decline in Barnett drilling activity is due largely to low gas prices and the fact that the play's economics aren't nearly as good as the Marcellus shale's. With natural gas prices at $4 per MMBtu, the Marcellus can generate an internal rate of return (IRR) of about 20%, while other gas plays, including the Barnett, Haynesville, and Fayetteville shales, require a gas price of roughly $5 per MMBtu to generate the same IRR, according to Bentek Energy LLC, an energy market analytics provider.
It shouldn't come as a surprise, then, that Marcellus production surged more than 70%, from 7 billion cubic feet of gas per day in 2012 to 12 billion cubic feet in October 2013, while Barnett production declined 6.5% in 2013. Not surprisingly, Marcellus-focused drillers such as Cabot Oil & Gas (NYSE:COG) and Range Resources (NYSE:RRC) delivered record production numbers last year.
In the third quarter, Cabot reported a 61% year-over-year increase in production and attained a record gross production rate of 1,295 Mmcf per day, while Range delivered a 21% year-over-year increase in production volumes, which reached a record high of 960 Mmcfe per day.
The bottom line
The sharp drop-off in Barnett drilling activity highlights just how quickly a downturn in commodity prices can render a play uneconomical. If the number of drilling permits issued in the Barnett through the end of 2013 is any indication, drilling activity and production are likely to remain subdued in 2014. Only a sustained rebound in natural gas prices above $5 per MMBtu may motivate companies to meaningfully boost activity in the play. Until then, investors can expect the Barnett to remain relatively quiet and uninteresting.