Every once in a while I used to pick up a few $2 bills at the bank and leave them as tips... Most waitresses think they are fake. Nobody uses a $2 bill. Of course, the $2 bill is real, just hardly common. For this industry, few thought we would ever see gas below $2 again. That was the price in 1990 at the nadir of low gas prices. On an inflation adjusted scale that's akin to 11¢ per MCF tied to the old 54¢ per MCF controlled prices of the 60s.
This is a disaster for both producers and royalty owners. It especially hits the royalty owner hard with a double or triple whammy. First, some costs are fixed therefore, it means those nasty Post Production expenses we talked about are going to skyrocket. I would not be surprised to see royalty owners lose 40% of their checks to the cost of transportation and marketing. This is ripe for tort action. A royalty owner should have a true royalty and not be subjected to production cost risks.
Secondly, if you get a new well within the next few months, the produciton will exhaust 50% of the reserves within 24 months in a typical decline. This means you are likely to see the best of your reserves sold off during the lowest price period. Even if prices rebound in the next 2 years, you've lost a huge portion of the gas at low prices. I would certainly suggest if you can convince the company to shut in production perhaps it would be better in the long run to delay production for as long as possible.
Third, this will result in many wells curtailing production, entire fields many be shut in. And shutting in a well is fraught with potential problems, not the least of which is the issue of getting them to come back on line. During shut in the wells typically will water up. This has to be pumped off and disposed of, again with the owners sharing some expense usually. Further, water in the lines affect the gas meters and misreadings, and "adjustments" can short your proper accounting. Iniitial periods of re-energizing the lines will result in lots of "adjustments" I predict.
Fourth, low prices will mean new money will be reluctant to pay high bonuses and royalties and will attempt to lease at lower bonus rates and lower royalties. The days of 20% royalties may be rapidly diminishing.
Finally, this may be a chronic situation as associated gas with the "liquids-rich" plays like the Bakken, Eagle-Ford, and "Wolfberry" are very likely to keep a glut of natural gas on hand. In fact, so much gas is being produced there as a by-product of the oil, that the companies are actually flaring (wasting) natural gas to get at the oil. That has some very ominous implications for plays like the Fayetteville. They simply will not be economic to continue to develop if prices do not improve to above $4 per MCF. By almost any metric, natural gas prices at a very minimum must be $4 to break even and nothing on the horizon promises to be a major cost cutting break through, least of all a flat 7% severance tax.
