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CRAIN’S CLEVELAND BUSINESS
WWW.CRAINSCLEVELAND.COM
Nowacki Asset Management LLC
JANUARY 19 - 25, 2015
Shale is in ‘survival mode’ Drilling is being affected by tumbling oil and gas prices By DAN SHINGLER dshingler@crain.com
Period
Nowacki Asset Management (NET)
Growth of $1 Million
S&P 500 Total Return
Growth of $1 Million
May 2011 - Year End
-7.46%
$925,400
-6.37%
$936,300
2012
29.99%
$1,202,927
16.00%
$1,086,108
2013
51.76%
$1,825,563
32.39%
$1,437,898
10/31/2014
21.59%
$2,219,459
10.99%
$1,595,988
Note: Returns are shown in U.S. dollars after fees. Date of inception for Nowacki Asset Management is May 2nd, 2011. Nowacki Asset Management (NAM) is a registered investment advisory firm specializing in value-oriented investment management. All client assets are included in one composite and invested using a value-oriented strategy. NAM claims compliance with the Global Investment Performance Standards (GIPS®). The S&P 500 Total Return index is subject to volatility and the NAM composite may or may not be more volatile than the index. Past performance is not aguarantee of future performance. Investments carry risks and the potential for loss. Results as of 10/31/2014 are still subject to final verification by an independent third-party. NAM only uses short-term margin or leverage to buy securities after a client commits to deposit funds and the funds are in the process of being transferred, but the money has not yet completed the transfer process. To receive a list of composite descriptions of NAM and/or a presentation that complies with the GIPS standards, contact Michael T. Nowacki at (440) 488-6936 or write Nowacki Asset Management, 29525 Chagrin Blvd. Suite 301, Pepper Pike, Ohio 44122, or michael@nowackiassetmgmt.com.
The price of oil has dropped by more than 50% in about the last six months, to five-year lows of less than $50 per barrel. Natural gas has taken a similar tumble, dropping from nearly $5 per thousand cubic feet (mcf) last May, to less than $3 in recent days. It’s a situation many analysts are equating with the mid-1980s, which was the last time the price of oil, and the U.S. drilling industry, crashed. Except this time, Ohio is an oil and gas producer and has more to worry about than the cost of driving a car or heating a home. The low prices are likely to impact shale drilling, which many see as the state’s biggest economic success story in decades. “We, as an industry, are in survival mode. … It’s having a significant effect in terms of what we’re seeing in drilling programs and operational budgets for 2015,” said Shawn Bennett, who took over as front man and executive vice president of the Ohio Oil and Gas Association late last year. “This isn’t just in the Utica, it’s across the U.S.” So far, the state has not seen a measured slowdown in drilling activity. The number of drilling rigs operating in Ohio has continued to rise, even through December when there were 47 rigs operating at month’s end. There was one fewer rig here as of Jan. 15, according to the Ohio Department of Natural Resources, but the state has seen its count go down by one before on several occasions. There was a slowdown in the fourth quarter of 2014 in the number of drilling permit applications and those granted by the state, as well as in the number of wells completed. But there was a similar slowdown at the end of 2013, so it’s difficult to know if last year’s drop was due to regular seasonal factors, like the weather and holidays, or due to lower prices for oil and gas. But, whether it’s today or later this year, market conditions would seem to dictate that drillers will be less eager to sink their bits into Ohio’s shale this year than they were just a few months ago. “We’re actually looking at that right now,” said Andrew Thomas, a longtime oil and gas attorney who also researches the economics of drilling in Ohio for Cleveland State University. “It’s hard to tell, because it’s so early. But it’s hard to imagine how these low prices would not affect us.”
Not so uplifting Ups and downs, of course, are a natural part of the oil and gas industry — as folks in places like Texas and Oklahoma know from decades of experience. Ohio has even benefited from some of them in recent years. For instance, when natural gas prices tanked and refused to come up a couple of years ago, drilling in Ohio actually got a boost because the state’s gas is “wet” and contains other valuable commodities, such as ethane. Since then, prices for gas, oil and ethane have all dropped. Drillers have simply produced more of all three commodities than the market could process or use, creating rising stockpiles and falling prices.
Now that ethane prices are also down, it has no “uplift” effect for Ohio, even though the gas brought up here continues to be rich in ethane and other so-called “natural gas liquids” or NGLs, Bennett said. That’s, at least in part, because the price of ethane also has taken a hit over the last six months — the price of the stuff, which is a key raw material for plastics and specialty chemicals, has fallen even more than gas or oil. Ethane was trading at about $80 a metric ton at the beginning of 2014, but sells for only about $30 per metric ton today. “There is virtually no uplift at the moment,” said Bennett. “You had (last year) people leaving the dry gas regions to come into the Utica … now, with the price of NGLs being so low, the amount it costs you to process (the wet gas) equals what you would have gained before selling those products.” In some cases, the rich, wet gas of the Utica could even mean it costs more to drill here. That’s because, with ethane now selling for less than the gas itself, many drillers would prefer to leave it in the gas and sell it as fuel. Doing so actually increases the energy contained in the gas — but some pipelines won’t accept wet gas, so drillers attached to them have no choice but to pay to process their gas, increasing their expenses. “Then you have the double whammy — you can’t send it in the gas stream to sell it and you have to pay to have it taken out,” said Steve Downey, vice president of business development for Houston-based EnerVest, an active Utica driller. “Because prices of ethane are so low right now, we’re trying to leave as much of it in the gas stream as we possibly can,” Downey said. Some companies have already announced cuts in their 2015 drilling budgets. Enervest is not one of them, but it’s watching the situation closely. “We’ve not cut that budget yet, but it’s something we’ll be looking at,” Downey said. “We’re constantly having those discussions.” With lower prices, drillers will be more selective about where they
drill, observers say. They will be more cost conscious, so they’ll look for places where they can drill at lower costs, due to factors like geology, access to materials and workforce costs. They’ll also look to drill where they can make the most revenue, either because the wells are more productive, prices are higher or both. In that latter area, Ohio and the rest of Appalachia might be at a distinct disadvantage. There are fewer pipelines here to take natural gas and ethane to end markets, and markets like the Gulf Coast processing centers and the high-population areas of the northeastern U.S. are farther away or tougher to get to. Those factors mean that drillers here don’t get the prices most people see when they read about or look up the price of natural gas — not by a long shot. When natural gas is selling elsewhere for $3 per mcf, drillers in the Utica or even some parts of the Marcellus shale might only get half that. “Unfortunately, that’s not what we’re being paid in Appalachia right now,” Downey said of recent, already-low prices. “We can be anywhere from $1.20 to $1.40 (per mcf) less.” It all adds up to subtraction and just about everyone thinks there will be less drilling in Ohio this year than there was in 2014. “I’d have to believe we’ll see less wells drilled,” said Downey. OOGA’s Bennett agrees, and is more than a little concerned about the impact that drilling might have, not only on drillers but their supply chain and the economy of eastern Ohio generally. For now, drillers are still developing wells with money they budgeted last year, or bringing online wells that they were working on a month ago or even longer. Eventually, assuming oil and gas prices remain low, drilling will slow here though, he said. “I’m not going to say the drilling is going to stop tomorrow, that’s not going to happen. But you’re going to see a slow down. … Not a single company is going to be developing (new wells) in 2015 like they did in 2014,” Bennett predicts.