Tuesday, November 09, 2010

Daily Marcellus: Tulip Harvest and Timing

I already mentioned the big news that Chevron is buying Atlas energy for the Marcellus play. 

But this has all gone to a new level with no less than Foreign Policy publishing this piece: The Oil and the Glory: Why does big oil suddenly love Pennsylvania.

Forbes has a look at some of the new billionaires being made out of the new Marcellus investment in Pennsylvania...  I don't notice any Pennsylvanians.

There is this.  A new report says there will be a glut in natural gas for the next decade, followed by a 'golden age' later on.

So why are we rushing so fast to develop as much shale gas in Pennsylvania now when prices are so low, leaving that much less for when demand and prices go up.  One thing for sure is that natural gas as a declining pressure curve.  You get the most gas out soon after you drill.  A recent overview of the pressure curve issues is in this: Marcellus Shale Decline Analysis. Looks like a college paper, but not bad and covers the basics pretty well. 

Someone should work up how much Pennsylvanians are losing by developing the gas at such low prices compared to what they would get if the gas was produced at prices as projected.  I also wonder if a slower pace of development would allow more Pennsylvanians to be hired and trained to work on these projects. 

Anyway... you will know when the Marcellus stuff has escalated to a new level when we get new direct flights to the Middle East just as Houston just added.

20 Comments:

Anonymous Joe said...

"So why are we rushing so fast to develop as much shale gas in Pennsylvania now when prices are so low, leaving that much less for when demand and prices go up."

I think it's perfect example of a market failure. These Shale plays were land grabs financed with borrowed money. Now drilling companies need cash to pay off their debts and don't have the luxury of waiting for prices to rise. That's also why these companies are eagerly selling stakes to foreign investors (http://www.star-telegram.com/2010/10/11/2538462/chinas-state-oil-company-buys.html), and why they aren't willing to take on some relatively modest additional up-front costs to install equipment that drastically reduces air pollution and pays for itself relatively quickly because it also increases hydrocarbon recovery. (http://www.post-gazette.com/pg/10305/1099670-109.stm)

Tuesday, November 09, 2010 9:31:00 PM  
Blogger hholt01 said...

No Pennsylvanians on the Forbes list?

A California company striking a second time in a generation stealing away 100 years of built up wealth (Gulf now Atlas).

How is any of this good for Pennsylvania if Corbett won't tax it and all the margins go to San Francisco Houston New York and the middle east. Remember the Benedum, Trees, Mellon, Palumbo names adorn universities, parks, dorms, theaters, arenas etc. and all were from energy money that STAYED PUT here in Pittsburgh. Why should we let Houston build these things with endowments from our Shale?

Tuesday, November 09, 2010 10:17:00 PM  
Anonymous The Wiz said...

Damn, I didn't make the list!

Joe is at least partially right. Companies made huge investments getting land under lease and must get the cash flow up to service the loans. Additionally, they need to drill at least one well per unit so as to tie up the lease under the "Held By Production" clauses. With tens of thousands of acres under lease, it will take a lot of wells just to accomplish that. And after paying tens of millions for the leases, they must tie up the land for long term production. And its my guess that many of these wells will be shut in until prices rise.

But they are also still in the research phase drilling wells in various areas to test the play for production rates and quality. They need to see the play's characteristics and limits to determine profitability...and that will determine which leases they hold and which they will let expire. Most leases are for 5-7 years with an option to extend.

As for the low prices lasting for ten years, I remember being told in the late 70's that gasoline would only continue to climb as we had reached "peak oil." But the high prices sparked an exploration boom and by the 90's oil had tanked, so to speak. If gas is predicted to stay low for ten years, then companies will accelerate their conversion to CNG which will help prices rebound.

@hholt01; Its takes huge investments to develop such a large field. Unfortunately, there are very few companies in Pa with the deep pockets to do so and even fewer with oil and gas experience. I am sure that many wealthy Pennsylvanians are invested as best they can.

Tuesday, November 09, 2010 11:11:00 PM  
Anonymous BrianTH said...

The predicted future demand increases for gas are being driven by low prices for gas, which in turn are being driven by Marcellus. So you can't really put the cork in Marcellus and wait for that future demand to arrive anyway. I think it is also worth noting we are in a relatively favorable time for infrastructure investments, so you may get some net gains from building moree of the necessary roads, pipelines, buildings, and so forth now rather than later.

That said--this is all the more reason to think a robust, volume based severance tax would be a good idea.

Wednesday, November 10, 2010 7:12:00 AM  
Blogger C. Briem said...

I am sure that many wealthy Pennsylvanians are invested as best they can.

I wonder about that. Sure looks to me that the main investments being made are very concentrated in a few firms without the widest of investor bases to begin with.. and now are being bought out into larger firms even. It would be worthwhile to try and identify the local investors who are making the real money in this.. the ones as pointed out are going to stay and reinvest that money here. Looks like a lot of the profit is going to wind up pretty far away. The Atlas deal is a case in point. Was not the recent news before this that it was Reliance of India that was investing. Those folks must have made a huge amount amazingly fast.

What do we have for locals? See the news story I posted about one of the major shale developers demanding $220 back from a local family. Some disconnect here.

Wednesday, November 10, 2010 8:04:00 AM  
Anonymous BrianTH said...

By the way, I don't really begrudge people who bring in outside capital making a good return on their investment, particularly when the end-users providing that return are mostly elsewhere as well.

But I do think the reported rates of return, even at these prices, support the view that a reasonable severance tax is a good idea. I also think we should be looking at ways of getting more end-users located here, including everything from natural gas vehicles to petrochemical companies and so on.

Wednesday, November 10, 2010 8:05:00 AM  
Anonymous BrianTH said...

Who around here has $4.3 billion in cash sitting idle? And for that matter, why should we want them investing that cash in developing Marcellus instead of something else local, if there are outside investors willing to do the Marcellus investment instead?

Outside people wanting to invest in developing assets in your region is a good thing, not a bad thing. It does raise some important issues, like whether existing stakeholders are getting fair compensation, whether appropriate taxes are being levied, whether local use of the products of those assets is being maximized, and so forth. But again, unless local investors with billions to spare that will otherwise go idle are being crowded out--I don't see a reason to be less than welcoming to outside investors.

Wednesday, November 10, 2010 8:14:00 AM  
Blogger hholt01 said...

Maybe the shale fields need a Chevron or Houston or Middle East Billionaires, but heck at least tax it, at least demand that these organizations re-invest in the state a certain percentage or make their foundations commit to the state for 30 years or something.

I do wonder would we have a Trees Hall?

A Benedum Center?

A Palumbo Center?

A Mellon Park, Mellon Square, C-Mellon University?

If those energy folks had no commitment to Pittsburgh after they extracted it from our earth?

Those were natives without big financing at the time and you had outsiders trying to muscle in. I say let the outsiders in but only if they commit to making this their adopted hometown when it comes to charity, donations, endowments etc. and not some trophy project next year for the next 30 or 50 years, and have Corbett at least fix the bridges from all this new wealth, tax it already!

Wednesday, November 10, 2010 8:55:00 AM  
Anonymous BrianTH said...

The Mellons et al very much did have big financing available. Ironically they were on the other end of the sort of dynamic we are talking about. For example, by the time WL Mellon founded Gulf Oil, the Mellons and their friends and relations had built up their capital supply through banking, railroads, coal fields, real estate, and so forth, much of it concentrated in the Northeast. Gulf Oil was a way of using that capital to fund the development and exploitation of the oil fields in places like Texas and Oklahoma.

Similarly, Benedum and Trees got started in the oil business in the northeast, then moved on to Illinois. They then sold their Illinois holdings to capitalize their Oklahoma and Louisiana operations, and eventually moved on to open new fields in Texas, Mexico, Central and South America, and beyond.

And I suspect some of the Texans and Oklahomans and Louisianans and so forth at the time may have objected to the Mellons, Benedum/Trees, and so forth coming in to supply the capital, then taking back a lot of the profits to Pittsburgh. But at the time these were the people who had the capital to put into developing these resources, and eventually it worked out all right for the producing states as well.

All that said, I completely support instituting a reasonable severance tax, and indeed other measures to help maximize the share of the economic surplus that ends up in Western PA (e.g., job training programs, encouraging gas and NGL use in the area, and so forth). I'm not sure about requiring these companies to do charitable works, but certainly people could put subtle (or not so subtle) pressure on them to recognize the need to maintain good will in Western PA. And so forth.

Ultimately, though, this is going to be something that unfolds over many decades, and it will take time for the local supply of capital, and local supply of labor, and end-users, and so on, to build up. But that is OK, as long as for now we are also making sure to impose reasonable taxes and encouraging the local growth we will eventually need to maximize local participation.

Wednesday, November 10, 2010 10:33:00 AM  
Anonymous The Wiz said...

No one put down $4.6 billion. Chevron is a huge publicly traded company representing millions upon millions of people. Almost anyone with an IRA, pension fund, or mutual funds owns part of Chevron so they will all share in the profits. And since Chevron bought out locally owned Gulf years ago, I am sure that lots of local people still own Chevron stock that was derived from their Gulf holdings.

There are lots of many small oil and gas companies in northern Pa and Ohio that have been drilling shallow wells for decades and many are locally owned. Since they own those leases, they will receive huge amounts of bonus monies and royalties when they sell these leases to the big boys. Say a company has 25,000 acres under lease from 20 years ago. If they get a $4000/acre bonus that comes out to $100 million. They will four to five times that in royalties. They also have the option of drilling their own horizontal wells if they want to go that route. I am searching my family tree for relatives in the business as we speak.

I also agree that a reasonable extraction tax is wise. We have been paying the taxes for Texas and Oklahoma for decades. But the tax that passed the house was too high, especially when Pa has the highest combined corporate taxes in the country. Any tax levied should be offset by lowering the Corp Tax, capital and rolling stock tax, and all the other hidden taxes companies must pay to levels that are competitive with most other states.

Wednesday, November 10, 2010 12:00:00 PM  
Blogger hholt01 said...

Very interesting histories on Trees/Benedum there.

Also I am a big history buff of the 1984-85 T. Boone Pickens raid on Gulf Oil, it was my reading of history that Chevron paid CASH to Gulf Shareholders, so no Gulf retirees or shareholders have an inherited steak in Chevron, it was very much a clean break.

I applaud any way that we can make all this wealth last for generations and generations here LOCALLY, great ideas put forth I am not skilled enough in taxcraft to offer THE solution but the general sentiment is that all that sprouts from this wealth shouldnt be used in structures or institutions in New York or Houston over those in Pittsburgh.

My point with charities wasn't to "force" them, they all have several charities or foundations or donation departments already established, no need to force them to do anything other then promise a certain percentage of those funds to only western Pa.

Wednesday, November 10, 2010 12:12:00 PM  
Blogger C. Briem said...

when Pa has the highest combined corporate taxes in the country

If only it were so simple to benchmark.....

How does Pennsylvania personal income tax compare to other states, and our immediate neighbors?

How does the sales tax in income tax compare to other states (both the nominal %, but also how do exemptions compare) with other states?

and when it comes to Marcellus, or leasing in general, how does state property taxation impact us compared to how it works in other states?

and anyway... it sure seems like that corporate income tax is inhibiting shale development as it stands. Here is the key question: Could marcellus be developed any faster than it currently is in Pennsylvania. Are not the inhibiting factors sheer supply constraints across the board in resources. Where corporate income tax issues fit into that equation just has to be way way down the list of factors impacting the trajectory here.

Wednesday, November 10, 2010 12:12:00 PM  
Anonymous The Wiz said...

I didn't mean to suggest that our high corporate tax structure is inhibiting the Marcellus development. My point, poorly made, is that our high taxes inhibit all business development in Pa. It is something that the state Chamber of Commerce, the state NFIB, the Manufacturers Associations and many others have lobbied about for decades. The majority of states have a lower total tax cost of doing business and is a major reason in a business picking a site for development.

However, a combined high business tax plus a high gas tax may be problematic. There are many shale plays developing both in the US and abroad. They will go where profits, after taxes, will be maximized.

Should we get a sizable amount of tax revenue from any other source, including gas development, we should do all we can to reduce the business tax burden. We need to encourage more businesses to locate here and broaden our tax base. Maybe an extraction tax can help in that endeavor.

Wednesday, November 10, 2010 12:56:00 PM  
Blogger C. Briem said...

So you are saying that hypothetically speaking it is potentially possible that Marcellus investment will marginally slow down an undetermined amount if the tax incidence on the firms goes up, even though there is no evidence to that effect right now?

Anyone have a good number for the tax elasticity of marcellus shale investment?

In general, bringing up the corporate tax issue in the context of marcellus stuff is ignoratio elenchi to the degree that anyone has any information to back it up.

Begs a lot of questions. How high would tax have to be to just keep developers from proceeding as fast as they possibly can? Why isn't this uber-high corporate income tax not inhibiting this investment as it is? Is a slower pace of development better or worse for Pennsylvania in the long run. Someone should at least be debating that. Drilling as much as possible, as fast as possible, is not exactly a strategy that always works out in the end. Though I acknowledge Nathan Bedford Forrest may have disagreed.

Wednesday, November 10, 2010 1:09:00 PM  
Blogger hholt01 said...

The only benchmark I need to know about Pa Taxes is the sheer tidal wave of government entities that simply don't exist elsewhere (Allegheny having more police chiefs then the entire state of Montana)

To quote the great Gordon Gekko:

"Teldar Paper [Pennsylvania] has 33 [tens of thousands?] different vice presidents [municipalities] each earning over $200,000 [collecting different taxes every] a year. I spent two months analyzing what these guys [municipalities] did and I still can't figure it out. One thing I do know is this paper company [commonwealth] lost $110 million last year, and I'd bet half of that is in the PAPERWORK going back and forth between all the vice
presidents [municipalities] ..."

Wednesday, November 10, 2010 1:46:00 PM  
Anonymous BrianTH said...

I've seen good arguments made for simplifying business taxes in PA and eliminating some perverse incentives. The idea that businesses are overall taxed at too high a rate--I actually haven't seen much evidence to that effect, just some bare assertions. And the overall evidence in other jurisdictions doesn't show much tax rate effect on business location decisions, probably because businesses actually benefit as much or more than most entities from government spending.

So reforming the business tax situation to make it simpler and less perverse? OK, but that has little to do with a severance tax.

Demanding we offset a severance tax with business tax cuts? Not so much, particularly not when we are still trying to figure out how to prevent disasterous cuts in state transportation funding (no, not just public transit--roads too), and so forth.

Wednesday, November 10, 2010 3:09:00 PM  
Anonymous MH said...

probably because businesses actually benefit as much or more than most entities from government spending.

That depends on whose cousins they hire and where they send campaign funds.

Wednesday, November 10, 2010 4:44:00 PM  
Anonymous The Wiz said...

@Briem So you are saying that hypothetically speaking it is potentially possible that Marcellus investment will marginally slow down an undetermined amount if the tax incidence on the firms goes up, even though there is no evidence to that effect right now?

Kinda hard to show an effect from a tax that hasn't been passed yet.

In general, bringing up the corporate tax issue in the context of marcellus stuff is ignoratio elenchi to the degree that anyone has any information to back it up.

It is relevant when the companies have to figure in all the taxes in total as part of the cost of doing business here. Some gas companies even referenced that issue in response to the gas tax that passed the House last month.
Chesapeake said their break even point was $2.45 I have to assume that was EBITDA as most business cost discussions are so. Add in the $0.39 proposed tax plus EBITDA and their break even point may be above $3.00, very near the recent gas prices and perhaps high enough to make them reconsider the worthiness of investing here.

@Brian TH And the overall evidence in other jurisdictions doesn't show much tax rate effect on business location decisions, probably because businesses actually benefit as much or more than most entities from government spending.


If that is true why do cities and states across the country offer huge tax incentives to businesses looking to relocate? Sometimes the feeding frenzy for businesses is quite extreme with states constantly trying to outbid each other.

In reading through the many articles rating various cities in the WSJ, CNBC, Forbes, and more, Pittsburgh is rated high in things like education, cultural, environmental, aesthetics but is always docked points for taxes. IIRC, the tax issue portion often ranks Pittsburgh between 40 and 45.

Wednesday, November 10, 2010 10:48:00 PM  
Blogger C. Briem said...

Kinda hard to show an effect from a tax that hasn't been passed yet.

ha, the whole tax exasticity thing has never been addressed in economics ever before.

are you suggesting the market price will drop below the point where it is economical to drill in Pennsylvania? Given all these firms shifting out of texas to focus on what is going on here, they must either be pretty irrational or expect there to not be much of a severance tax?

and I do hate to point out some real basic economics here. You can't say taxes like this are borne by firms in these circumstances. Would you not expect the tax to be capitalized into land valuation in whole or part? This premise some have that the tax will just have to be paid by firms ignores what is gone over in anyone's econ 101. Again, what is the elasticity of demand. The debates over all of this in the public are in many ways gibberish.

and you do realize you have switched topics again. Shale investment is mostly a Pennsylvania issue.. but you dropped Pittsburgh in there, the place that is among the least impacted by new marcellus drilling as yet.

Wednesday, November 10, 2010 11:03:00 PM  
Anonymous BrianTH said...

Note that because it is largely Marcellus that is driving low prices, if firms actually started to slow down Marcellus development, prices would likely rise. Generally, as Briem points out, the incidence of the tax is unlikely to be exclusively on the producer.

So the real calculation would have to be whether after the tax was allocated, and assuming a competitive rate of return for the producer, the delivered price of Marcellus was pushed past the next-cheapest gas that could be developed and delivered at high enough rates to substitute for a decline in Marcellus production. And as I understand the numbers, that sort of analysis leaves a lot of room for a sizable severance tax.

But you may also run into a tax rate range where the wetter portion of Marcellus (which I believe is in the SW) starts taking development share from the dryer part of Marcellus (in, I believe, the NE). That could actually help explain the current political dynamics regarding the exact level of the severance tax in PA.

If that is true why do cities and states across the country offer huge tax incentives to businesses looking to relocate?

Often because the relevant politicians are desperate to make it look like they are doing something about economic forces which in truth are beyond their control, and in so doing are willing to ignore the wonks and their research. And sometimes the politicians do get credit for something which appears in the headlines, and then they find a way to avoid taking responsibility for the bad things to come. And sometimes they are paid off, either in political contributions or flat-out bribery or future employment in the industry. And so on.

The idea that business executives in competitive industries are always doing what makes the most sense for their business is suspect enough. As applied to politicians, there really is no grounds for such an assumption.

Thursday, November 11, 2010 12:10:00 PM  

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