Barnett Shale: An economic discussion
I read an article recently about Barnett leasing in Tarrant Co. The question many landowners have is: What constitutes a good deal? Specifically, should I accept a larger bonus (money up front) or a larger royalty payment (a share of future production)?
To answer this question you need to consider both sides of the deal. First, what can the operator pay and still get a reasonable Rate of Return (ROR)? Second, how does the future cash flow adjusted for inflation vary relative to the royalty interest? To illustrate the ying and yang of a Barnett leasing we ran economics for an average Barnett Shale well in and around the core area. We then created graphs to illustrate the economics from both the operator's perspective and the landowner's perspective. The economic variables are royalty interest and bonus money.
The constants are:
- 2.65 BCFG of reserves
- 1.5 MMCFD first 30 days of production
- 3.5 MM$ to drill and complete
- $5.75 (1st yr), $6.00 (2nd yr), $6.50 flat for remainder of life gas prices
- 80 acre production unit
One of the important economic hurdles for the operator is ROR. The graph illustrates ROR vs. Royalty %. Although ROR requirements vary from company to company, anything below an unrisked 20% ROR is difficult for a company to swallow. That being said, notice how bonus money and royalty affects the companies ROR. At a 25% royalty and a $5,000 dollar per acre bonus, the company is right at the 20% ROR. At a 20% royalty a company can afford a higher bonus of $8,000 per acre. It's important to note that a bonus greater than $8,000 throws the ROR below the 20% ROR line. A $30,000 per acre bonus with a 25% royalty results in a ROR around 8%.
Now let's look at the deal from the landowner (royalty) owner point of view. As a royalty owner you are concerned with bonus money (money up front) and future cash flow from production. This future cash flow must be adjusted for inflation because money is worth more today than at some future time. We assumed a 4% constant rate of inflation throughout the life of the well. The value of this cash flow today is represented by Present Value at 4% (PV4%) of one acre. The purpose of the graph below is to illustrate how value is affected by royalty and bonus money. For example, a royalty of 20% combined with a $5,000 bonus is close to the same value as a 25% royalty combined with no bonus. Again, the Y-axis on the graph represents the value of one acre in the 80-acre production unit.
The point I want to make is that at present gas prices the days of $30,000 per acre bonus money that we saw in early 2008 is not realistic when considering the economics of a Barnett Shale gas well. As gas prices increase the economics can bear a larger bonus, until then, expectations need to be lower. Also, the economics parameters I used are for an average well over several counties. Geographically specific areas may possess better or worse economics. Gene Powell of the Powell Barnett Shale Newsletter does an excellent job of looking at revenue estimates for neighborhood in Tarrant County.
