Wednesday, June 3, 2009
Changing Environment of Business: The Marcellus Shale
Breaking news in Pennsylvania
Anyone who has picked up a local newspaper, turned on a local television news broadcast, or listened to a local radio station has probably heard about the 3.6 trillion cubic feet of natural gas reserves locked some 8900 feet below Pennsylvania’s surface, in a geological formation known as the Marcellus Shale. According to some experts, this reserve is the one of the largest in North America. This untapped reserve has enormous economic potential for the natural gas industry in Pennsylvania.
A brief background of the history of Pennsylvania's natural gas industry
From a period spanning from the early 1900's into 2007, the industry standards for natural gas production in Pennsylvania were based on drilling large numbers of low volume production wells. These wells were drilled vertically to an average depth of around 3000 feet. Of course, this led to the rise of entire service and supplier based industries built around these standards. As the years passed, these support industries grew more and more complex and became heavily intertwined with the industry as a whole, employing tens of thousands of people ranging from high powered CEO's to rough necks working on the drilling rigs. Many of the natural gas production companies were small, locally owned and operated businesses, allowing for close and personal relationships between the service and support company owners and the producers. Business was done on "a man's good word and a handshake." Although there was much competition among the service based companies, it was not uncommon for these contractors to have exclusivity with the work. In other words, many producers developed what one might call a sense of "brand loyalty" and were willing to pay little extra to retain the services of companies that they trusted.
Major changes and shifts in the industry
The discovery of the Marcellus Shale reserves has dramatically changed the face of the local natural gas industry in Pennsylvania. Many of the cost of completing standard wells (from now on I will reference these wells as "shallow" wells) such as leasing tracts of land, permitting, environmental studies, drilling, and construction were long established by the laws of supply and demand. These expenditures had been very stable and predictable for many years. The news of the Marcellus Shale discovery, along with its astronomical profit potential, attracted the attention of several very large, NYSE and NASDAQ traded companies that could raise huge amounts of needed capital. The cost of completing Marcellus Shale wells (from now on I will reference as "deep-horizontal" wells) was significantly higher than those of drilling the shallow wells. This posed a problem for almost all of the small, locally owned companies that had the leases and reserves to drill the deep horizontal wells, but couldn't get the capital. Many of the large, publicly traded companies were coming to the area and making severely overpriced offers to local producers to acquire their reserves, along with lofty offers to Pennsylvania land owners to obtain new reserves. The industry wide dollar amounts in Pennsylvania literally totaled in the low billions. Also, the philosophy was shifting form a large number-low per capita production rate, to a small number-high per capita one. In other words, this meant a significant reduction in new construction projects. This posed a huge problem for the support and service based business in the region, including my own. The overpriced offerings have completely turned the local natural gas economy upside down in Pennsylvania. Hundreds of local jobs have been lost, due to the reduction of new construction volume. To compound the problem, the Pennsylvania Department of Environmental Protection (DEP) has taken notice to the increased demand for water in order to complete these deep-horizontal wells. Many new agency laws and restrictions have been recently enacted by the DEP such as requiring more intense environmental impact studies, water restrictions, and more strict requirements for drilling permits, driving the cost of Marcellus based drilling even higher. This means that natural gas prices have to continue to rise to make production profitable. Finally, the recent economic prices have sent natural gas prices plummeting. The industry is currently in "sleep" mode. Many of the remaining small, locally owned producers are unable to acquire new leases for shallow drilling because the overpayment for leasing has literally driven the per acre cost of leasing new tracts of land hundreds of times higher than in 2005.
This revolutionary change has driven many small local service based companies out of business. The new, NYSE traded producers do not care about the principle of "brand loyalty" I discussed earlier, or about building trusting relationships with experienced service contractors. It now goes to the lowest bidder. Every aspect of the projects is solicited for bid, even minuscule amounts by industry standards. Many of the local companies need a "steady and consistent diet" of work to survive. They are not accustomed to the sporadic work generated by the new "bid everything" policies. However, it would appear that the change is here to stay, at least for a while. If a company is to survive, its management has to recognize this changing environment and must adapt. I have made several fundamental changes to my consulting and construction business in order to survive. I have sat down with my partner and went through our budget line by line and cut out any and all unecessary expenditures. We also restructured our employee personnel by consolidating two of our construction crews into one, saving on vehicle and heavy equipment overhead costs. We also had to make minor adjustments to our employee health care plan to ensure the survival of our firm. I have sharpened my skills immensely at scrutinizing every project we bid to determine the best profit margin I can work with, but still be competitive. I still work on the same basic principles, just changed my style. To quote Thomas Jefferson, "in matters of style, swim with the current; in matters of principle, stand like a rock."