iOS app Android app More

Featuring fresh takes and real-time analysis from HuffPost's signature lineup of contributors
Andrew Reinbach

Andrew Reinbach

Posted: August 9, 2010 09:40 AM

Gas Drilling, Politics, and Irony

What's Your Reaction:

The citizen environmentalists who lobbied New York's state Senators until they passed a one-year moratorium on hydrofracking for gas on August 4th deserve praise and congratulations. Starting from nothing, they moved the needle among their upstate neighbors from "drill baby drill" to "safe drilling."

What they won't get is what they really want -- no drilling; that's just not realistic .

The Natural Resources Defense Council, for instance, says any drilling in New York's Marcellus Shale has to be done safely --but doesn't oppose it outright. Most national environmental groups see things the same way.

Instead, these hardworking activists have done an enormous favor for their opponents -- especially, for the farmers and other landowners who signed leases to drill on their land as long as three years ago.

That's because right now, the gas business shows every sign of being in a late-stage bubble, and as everybody now knows, when bubbles pop, they take a lot of companies with them. So many of those leases were signed with companies that may disappear.

Meanwhile, a number of those leases, signed during the boom years, may expire during the moratorium; many were two- or four-page documents and ran five years.

If those leases do run out, it'll be the best thing that ever happened to those landowners; said leases typically paid a signing bonus of as little as $50 an acre and, according to an attorney who's seen many such, "1/8th of revenues received by the lessor -- whatever that means."

By comparison, gas companies were signing leases in New York late last year at $4,000 per acre, and 30 percent off the top -- something of an improvement.

During the push for a moratorium many farmers, especially, panicked for fear their leases would run out before they reached the big payday. This in turn provoked a lot of hard feelings against the environmentalists. And the landowners were right; the leases they signed will run out -- and many of the companies they signed with won't exist.

The gas will still be there when the moratorium ends though, regulations will be much stiffer, and you can bet the land men will be back. But the days of ripping off farmers will be over.

That will be great for my neighbors. I live near Cooperstown, New York, and most of my neighbors are dairy farmers. A dairy farmer owns as much as $1 million in equipment, pays upwards of $200,000 a year in property taxes plus debt on the equipment, works 14 to 18 hours a day, 365 days a year -- and based on the hours he puts in, makes less than minimum wage for the privilege.

Other neighbors of mine own big tracts of land that have been in their families for 200 years or more -- some of them are descended from the first Europeans to settle here, before the Revolution.

They may only raise hay on that land now -- but they have to pay taxes on it anyway. To give you an idea of the economics of hay: The six acres behind my house produce about 16 of those big round bales -- worth $25 a bale, or $400. Taxes on a house and farmed land in Otsego County are about $500 an acre.

And while some of you reading this may be tempted to dismiss these people as, well, hicks, let me tell you something: Put a country boy and a city boy together to talk a deal, and the city boy will be lucky to leave with his pants on. Country folk are not idiots; they just don't live in the suburbs. And they're just as concerned about the environment as any city boy -- maybe more, since they live in it.

Of course, you can't say the same about the gas companies. Even if you haven't watched that kitchen sink explode in Gasland, the news from Pennsylvania, where gas drilling has been very heavy, is disturbing to say the least. A recent report from the Pennsylvania Land Trust Association, for instance, reveals that gas companies have racked up 1,435 environmental violations in the past 18 months, including:

· 268 improperly built waste water impoundments;
· 10 improper well casings;
· 154 discharges of industrial waste;
· 16 improper blowout prevention mechanisms.

All those violations posed grave threats to Pennsylvania's fields and woodlands. And in fact anybody listening to the final debate in the Senate chamber in Albany on the moratorium knows that the Pennsylvania example is a major reason -- along with the lobbying from citizen activists -- for passing what several senators called "a time out" on gas drilling, and stricter state regulations than now contemplated by current management at the state's Department of Environmental Conservation.

Among the measures that would be useful to keep New York from enduring such abuse: A thorough seismic mapping of the Marcellus shale deposits in the state. This would locate any fault lines that may be there -- so they can be avoided.

According to James Northrup, a veteran oil and gas driller, fracking a well -- forcing a million gallons of water, sand and chemicals, several of them highly toxic -- is like exploding an air bomb underground. "Once that thing's gone off, it's going to follow the lines of least resistance, and if it finds a fault in the rock, it'll just follow it," he says, taking with it benzene, toluene, diesel oil, and other chemicals.

This could be pretty dangerous if a well was fracked near Cooperstown's water supply -- Lake Otsego. Current regulations allow a gas well to be drilled within 150 feet of the lake, he points out, and if a frack found a fault, it could poison the lake. Lake Otsego is also the headwaters of the Susquehanna River, which flows to Chesapeake Bay.

You'd imagine a state would take steps to avoid an outcome like that. And yet there's been precious little seismic exploration in Pennsylvania; if anything, it appears the pressure's been on in the past few years to drill as much as possible -- as if it wanted to catch up with Colorado, Wyoming, Texas and West Virginia.

Which is where that late-stage bubble and the favor to the gas industry I mentioned comes in; because while it may strain the imagination, there's no money in the gas drilling business right now.

Here's the arithmetic. Rule-of-thumb costs for producing a well are about $4.35 per MBTU (One thousand BTUs ,or British thermal units), and natural gas futures closed on July 6th at $4.47 per MBTU.

That doesn't even include the cost of things like pipeline transmission, storage fees, or commissions. And according to the Energy Information Administration, average wellhead prices -- in 2008 dollars -- are expected to rise only modestly over the next ten years.

Given that arithmetic -- no secret to the gas industry -- what's with all the drilling?

Arthur Berman, a Houston-based energy consultant who produces the Petroleum Truth Report, explains that most natural gas companies are relatively small operations -- unlike Chesapeake Energy Corp., which told analysts on an August 4th conference call that it was switching its operations from natural gas to oil and liquid gas, and wouldn't be drilling its remaining gas fields until the market improved.

Many of these companies are publicly held, have little real shareholder equity, and are judged by analysts and investors on their production -- not their profits. If they stop producing, he says, the share price will tank, their loan and bond covenants will be violated, the companies won't be able to meet their obligations, and the fortunes of senior management will vanish.

But said senior management keeps going because, to say the least, they're not lacking in self-confidence. In fact, they're the sort of people who can sleep at night with their signatures on $500 million in personal loan guarantees. They know things are bad, and they know bad things are coming; but they believe they can pull it off, even if their competitors can't. If they didn't believe that, they wouldn't be in the business.

One of their hopes: Getting bailed out by selling some, or all, of the company to offshore investors -- from India, for instance, which is about to begin developing major gas fields. But this is a slender reed. Most of what those offshore investors really need is expertise, and the company's expertise goes home every night. So looked at this way, it's obvious that said senior management is as human as the guy on the loading dock.

It all sounds very familiar to someone like myself, who was covering commercial real estate in the late 1980s, when it was crashing. In fact, the rationales for pressing on then were exactly the same.

The difference: Commercial real estate is a huge sector. When it began collapsing in 1988, it ran up actuarial losses of something like $1 trillion -- 20 years ago, when that was real money.

A burst bubble in the natural gas business could never have the same impact on the economy, says Richard Bove of Rochdale Securities. "It might have some impact on some banks in the southwest, but the sector just isn't big enough to hurt the big banks," he says. "The nation's three biggest banks are taking loan loss reserves of $7 billion a month; the gas sector just isn't that big in comparison."

Which is something, I suppose. Instead of taking down the economy when this bubble bursts, expect the big fish to eat the little fish -- what Kenneth Austin, a VP and Senior Credit Officer at Moody's, calls "Some consolidation in the industry" -- followed by some firming of gas markets. Then, at some point, drilling will be feasible again.

An EPA review of fracking and its dangers is only just getting underway, and given the realities of government studies, may not be delivered until after its 2013 deadline. Meanwhile, New York State Assembly Speaker Sheldon Silver has indicated that it might be wise for New York to wait for that report before issuing any new regulations itself.

That pushes gas drilling in New York's Marcellus shale past what the Mayans say is the end of the world in December 2012; so perhaps New York's citizen activists will have stopped gas drilling in New York, after all.

At the very least, what regulations do emerge in Albany will likely come as close as practicable, in an imperfect world, to a guarantee that gas drilling won't poison our ground water.

That may not satisfy said citizen activists, who haven't been publicly encouraged by the big national environmental groups to keep fighting to stop gas drilling altogether, but haven't been publicly criticized, either.

It may be that the big outfits in Washington find it convenient to have the citizen activists play bad cop, so said Washingtonians can seem like reasonable negotiating partners. Politics, after all, is a practical business.