Neither Boom nor Bust: Fayetteville Shale Play Falls Short of Expectations

Like so many blockbuster movies, the Fayetteville Shale Play has not lived up to the hype but should be appreciated for what it is.

The price of natural gas, whether from the unconventional formation in north-central Arkansas or elsewhere, fell off a cliff months after the optimistic days of early 2008, when a University of Arkansas study predicted an $18 billion economic impact over five years. And the persistently depressed price has eaten away at anticipated royalties and at the severance tax revenue that was supposed to offset costly damage to rural roadways.

The Fayetteville Shale promise has been further chipped away by a glut of gas from other newly exploited shale plays around the country, by concerns about long-term environmental damage and by the appeal of bigger profits from unconventional oil exploration.

(Click here for a sidebar on the public companies working in the Fayetteville Shale Play.)

But in some ways, the timing could not have been better. Despite slim margins artificially propped up by fortuitous hedging, gas exploration companies had to press forward with drilling in order to lock in the terms of their mineral leases, and construction of two major pipelines has also gone forward.

"You have to say, especially in Arkansas, the Fayetteville Shale Play provided a much-needed shot in the arm for the state when it needed it most," said Kathy Deck, director of the Center for Business & Economic Research at the UA's Sam M. Walton College of Business, which has twice attempted to project the shale play's impact.

"Has the Fayetteville Shale developed as quickly as projected? No. Is that due to the global recession? Yes. Will Fayetteville Shale continue to be an important part of the state's economy? Undoubtedly."

Other observers echoed Deck's conclusion that the development of the shale play has been neither boom nor bust.

"It's somewhere in between those wide boundaries," said John Shelnutt, economist for the Arkansas Department of Finance & Administration.

"We know for a fact that it has been beneficial to have that industry here, but not nearly to the extent that was projected by Professor Deck at Fayetteville," DF&A Deputy Director Tim Leathers said.

"It's been a boon for Arkansas overall," said Sheffield Nelson, the former Arkla Gas CEO and former Republican gubernatorial nominee. "It's certainly had some negative connotations, particularly damage to the road networks."

"From all that I've seen, the economic impact to the state far outweighs the cost to the state in terms of infrastructure and road damage," said Larry Bengal, director of the Arkansas Oil & Gas Commission.

Deck expects to roll out another big-picture assessment of the shale play in 2011, one with much more actual data to work with than the first in 2006, which anticipated $5.5 billion in economic impact during 2005-08, and the March 2008 study with its breathtaking $17.9 billion figure for 2008-12.

No study has been done since the price of gas, which peaked above $11 per thousand cubic feet (MCF) in mid-2008, dropped by half by the end of the year. Since then, the national average wellhead price has topped $5 per MCF only in January 2009 and January 2010 and has even dipped below $3 last September, putting a hurt on the royalties - typically 12.5 percent to 20 percent - paid to mineral rights owners.

Leathers said state revenuers discounted Deck's industry-commissioned 2008 findings even when they were released, believing that some of the benefit included in her total would flow to corporate headquarters in Texas and Oklahoma rather than to Arkansas.

But other projections that the state did buy into - specifically the idea that a severance tax topping out at 5 percent of the value of gas production could generate $60 million a year or more - assumed an MCF price of $8.

"I think everyone got it wrong on that score, both the industry and the pundits," Shelnutt said last week. "At the time, $8 was considered reasonable or even conservative."

He doesn't expect to see gas prices back at those levels for quite a long time since the same technology that made exploration of the Fayetteville Shale profitable has also been deployed to shale formations from Wyoming to south Texas to upstate New York. A glut of new gas coming online during the Great Recession "will make it a very slow recovery, not just from the economy but from the supply story," Shelnutt said. "So [the price is] going to take multiple years to come back."

The jobs created by the drilling and pipeline construction in Arkansas, however, have been real and welcome, he said.

"Those are temporary projects," Shelnutt said. "But they have been nice contributions to the state, both in terms of consumption and wages paid out, and a nice boost to a different type of construction in the state at a time when we needed a boost. It's nice to have it when other things are down."

And there are permanent jobs, he noted.

"The other good news is the sector hasn't totally dropped back. Some of the investments that were made - district offices in Conway and White County and, to some extent, in Little Rock - are still here."

Severance Tax
Rosy estimates in the spring of 2008 helped Gov. Mike Beebe bring the industry and the General Assembly together to accomplish what had been considered a political impossibility for half a century: an increase in the severance tax on natural gas extracted from the state.

Rather than a flat rate of three-tenths of a cent per MCF, no matter the value of the gas, a formula passed in a special legislative session capped the tax at 5 percent of its value at the time of extraction, with discounts to help companies quickly recoup the costs of new and high-cost wells like those drilled into the solid rock of the shale play.

Suddenly an obscure tax that had traditionally generated only a few hundred thousand dollars a year was projected to bring in $57 million in its first year. But between the law's passage in April 2008 and its effective date on Jan. 1, 2009, the price of gas dropped by half.

Collection trails production by two months, so the state actually received 10 months worth of the higher severance tax in 2009: just under $27.5 million, according to DF&A's Office of Excise Tax Administration.

Severance tax collections are on track for $56 million this calendar year, based on January-May totals of $23.3 million, of which 95 percent is earmarked for road improvements - mainly state highways, but also county and municipal roads that take a pounding from the heavy equipment moved to drilling sites.

Because the drilling has continued apace but severance tax receipts have not, dollars available for road repair have been in short supply. County judges in the Fayetteville Shale region have reportedly been trying to at least restrict the drilling equipment to designated roads, and some gas companies have made direct payments to cover the cost of repairs.

Two months ago, Arkansas Highway & Transportation Department Director Dan Flowers told the Legislature's Joint Performance Review Committee that the industry had caused $200 million worth of damage to state highways, a figure that will takes years for the severance tax to cover and which doesn't include damage to county roads. Sheffield Nelson took steps in 2008 to put an even higher severance tax to a public vote. Last week, he said the issue needed to be revisited.

"We need to get realistic about the severance tax and get the people who are damaging these roads to pay for it. This is one of the areas we have to take a close look at," Nelson told Arkansas Business. "... My 7 percent proposal would generate the needed money. That's something we have to look at again."

Bengal, director of the Oil & Gas Commission, said it would be a mistake to assume that the industry's impact on roads would always be as severe as it has been during the past three years, the height of the Fayetteville Shale Play's exploration and development phase.

The play is currently being serviced by 86 companies operating 1,058 tank trucks, according to the O&GC. This compares with a census of 94 companies and 1,374 tank trucks last summer. Bengal attributed the drop to more disposal wells along with producers recycling and reusing drilling fluids more.

Despite low gas prices, production has continued to increase, although not as sharply as earlier days. Drilling activity has stayed flat, with an up-and-down pattern for new well permits.

"We've not seen a real large impact from the reduced prices," Bengal said. "They continue to produce. The wells are responding the way everyone expected. The price of gas is the issue that is driving whether it's a success or not."

Environmental Damage
Questions about the environmental impact of shale gas drilling have increased as the technique of using a high-pressure mix of water and industrial fluids to fracture the rock and release the trapped gas has spread nationwide. While scientific opinion is mixed on whether "fracking" could actually be causing mild earthquakes, concerns about groundwater contamination seem well-founded - if not as dire as portrayed in "Gasland," an award-winning documentary screened earlier this month at the Clinton Presidential Library in Little Rock.

The Arkansas Department of Environmental Quality continues to refine its oversight of the Fayetteville Shale Play, Director Teresa Marks said last week.

"We're trying to institute more regulations to ensure there's no long-term environmental harm," Marks said. "Arkansas was not ready for this onslaught of drilling activity, especially as far as waste disposal goes."

Complaints bloomed during the fiscal year that ended on June 30, 2009, Marks told the Joint Performance Review Committee in late June. That year, ADEQ's Water Division received 108 complaints related to oil and gas activities and performed 216 inspections. As the 2010 fiscal year drew to a close in June, the number of complaints was about 80.

The agency had to use trial and error to get a handle on pollution issues related to the fracturing fluids, Marks told Arkansas Business. Recycling the tainted water was a rarity in the early days of the Fayetteville Shale Play, and some storage pits were overrun with trucks unloading drilling fluids into storage pits. Land application of the fluids sometimes got out of hand, too.

About a year ago, ADEQ recalled its land farm permits and issued new permit requirements in what amounted to a regulatory mulligan.

"There were problems we didn't expect, and some permit holders were not adhering to existing regulations," Marks said. "There were some instances of over-application that should never have happened.

"We also needed to lower the level of chlorides in the wastewater. Soil specialists from the University of Arkansas helped us develop a better idea of how soil can take different concentrations of chlorides. This also helped with run-off issues." 

Air emissions associated with compressor stations and the drilling process are drawing more attention as well. The federal Environmental Protection Agency started a comprehensive two-year study this summer that will generate more information for state regulators.

"We're anxious to see the results," Marks said. "Companies, for the most part, have been co-operative. But then, there's a lot we don't know, and hopefully, these EPA studies will shed a lot of light on areas we just don't have enough information."