Cheap Oil and Gas Comes at a High Price

oilthing1Good news at the gas pump is mostly bad news for the Northern Michigan oil and gas industry.

Fill up at a Grand Traverse area station today, and you’ll pay from $2.11 to $2.20 per gallon. Adjusted for inflation, that is roughly on a par with 1972 levels.

Then there’s the issue of natural gas, which a majority of Michiganders use to heat and cool their homes. Prices have increased slightly over the past year, but hover currently at about 70 percent of those five years ago.

The Winners

So what’s to complain about from the consumer side? Not much. Cheap fuel means money to spend elsewhere. That helps many retail businesses sell products and services. People drive more when gasoline costs less, so cars wear out sooner. That can boost car sales. Savings at the pump can also mean that people have more money for vacations, which is good for the hospitality industry.

Environmentalists can also find something to like. Non-conventional extraction methods like hydraulic fracking and drilling in tar sands are expensive and therefore become less attractive when oil is plentiful and costs $40-$50 per barrel.

But There Are Losers, Too

For all the advantages to consumers and certain businesses, though, there’s a flip side: Michigan’s gas and oil industry has hit a serious slump. And that’s no small thing in a sector that, according to the Michigan Oil and Gas Association, accounted for $13.6 billion in economic output last year.

From that figure, it is clear that Michigan is still producing oil and gas.

But exploration is another story. Exploration in northern Michigan and the rest of the state is nearly at a standstill. Last year, the state had only 100 permit applications for new wells. That is the fewest number of permits since 1927, and just one-tenth of the permits issued in two decades at the height of the Antrim Shale boom.

“Last year we drilled two wells,” said Patrick Gibson, VP at West Bay Exploration, a Traverse City-based company that has been around since 1981. “In the past we drilled as many as 20 a year.”

Low prices might not be the only problem for the industry.

Sources interviewed for this story said an abundance of federal environmental regulations has also reduced profitability, especially from smaller, less productive sites. These days, they said, a small well producing, say, four to five barrels a day, just isn’t very profitable.

Investors drawn into the market when oil was at $145 a barrel are now shying away. Many lost money when prices plummeted.

In the process, many well-established companies that have weathered past price dips have been forced to reduce staff while some smaller exploration and drilling companies have disappeared altogether.

The most immediate pain is experienced by investors, employees of exploration firms and support industries such as drillers, welding companies, equipment manufacturers and tanker truck operations.

“This year, you’ll see some of the oil and gas companies have the biggest losses in maybe a hundred years,” Gibson said. “We are coming to grips with a new ‘normal.’

“Sustained low prices have led companies to close down countless small wells in Michigan and elsewhere. That has reduced, and in many cases wiped out, payments to landholders who expect income from leasing mineral rights on their property.

A ‘Jittery’ Market

Even in the best of times, drilling is a gamble. Some wells produce oil but no natural gas. Others hit gas but no oil. The vast majority – as many as three quarters – produce nothing at all. And it costs $500,000 or more to drill a well. No wonder then, that many investors lose their enthusiasm when prices are so low.

Current per barrel prices of $40-$50 make for a “jittery” market, Gibson said. “There’s a sweet spot out there, maybe in the $50-$60 range, where oil companies are profitable and more willing to do new exploration.”

Industry veteran Jeff Schwartz, owner of Traverse City-based Energy Quest, is a “land man,” the person who obtains mineral rights for exploration companies like West Bay. Despite the anemic market and the fact that he’s semi-retired, Schwartz has stayed in the game. Volatility is something he and his colleagues have experienced before.

“We don’t get whacked out about $40 oil,” he said. “But this recent downturn has been really, really tough. We’ve had to dial it back. A lot of companies have done the same.”

Like Gibson, Schwartz is hopeful that prices will rise at least to the $50-$60 range.

“Every increment of $10 will open up some new projects. When it gets to $60, that will really make sense.”

Schwartz believes many of the more nimble companies can continue to survive even if the price is $40 per barrel.

“A small, independent company with a good science team can move quickly – literally within a day,” he said. “It’s a matter of being resourceful, not having a lot creditors nipping at you, and not overextending.”

For all his optimism, Schwartz warned that a full recovery will be difficult.

“I think everything will shake out,” he said. “But even if it does, there’s going to be a problem. A lot of skilled workers have found other types of jobs. The industry has been decimated nationally. So even if there is a resurgence, it will take a long, long time to get back to the levels it was at before.”

Ripple Effect

Even those who might have a hard time commiserating with an industry sector that is, by its nature, highly speculative can understand that a downturn of any industry as big as gas and oil is bound to take its toll on many Michiganders.

“When we’re down, our suppliers are down,” said West Bay’s Tim Baker. “They provide steel, cement, services and do the drilling. It includes supply companies that provide piping, specialty welding companies. This really is a trickle-down industrial sector.”

Baker said only one or two drilling rig operations are underway in the entire state right now.

“In places like Kalkaska a lot of the industry is related to oil and gas,” Baker said. “And you have towns like Gaylord that might not be so diversified. It’s tough on them.”

What all of this means in the broader sense to Michigan is less tax revenue going into the state coffers (especially into the Natural Resources Trust Fund), more people being laid off and searching for jobs, and whole communities taking a hit.

Not Thriving, But Still Surviving

By diversifying the services they offer, some companies have managed to stay alive and even hire back at least a few of their laid-off employees.

One example is Steve Bigard, owner of Bigard and Huggard Drilling in Mount Pleasant. During the heyday of exploration, he was one of the go-to guys for new wells in the Grand Traverse area. At the time, 80 to 90 percent of Bigard’s business was with oil and gas companies.

When the crash came, he had to cut staff from 130 to 40 employees. “We’ve seen hard times before, but nothing as severe as this,” he said. “But we’re fortunate that we can still drill for brine production (for dust control on roads), gas storage and industrial disposal wells. Now we’re at 60-65 (employees).”

Some Signs of Change

There are a few hints of change in the air. Demand for natural gas is strong, and while federal environmental regulations might make small wells less economically feasible, they are also causing many electric-generating companies across the country to switch from coal to gas. The giant Tennessee Valley Authority is a case in point. And closer to home, DTE Energy will spend some $1.5 billion to replace coal-fired power plants with natural gas facilities. That could significantly expand the natural gas market in northern Michigan since gas reserves here are more plentiful than elsewhere in the state.

The conversion to gas could help the environment, too. DTE chairman and CEO Gerry Anderson said the switch “will significantly reduce greenhouses gases by moving to cleaner technologies.”

On the global level, some OPEC members are pushing for a tightening of production. That is taken as a positive sign by the domestic oil and gas industry. Less OPEC oil and gas on the market would help realign prices and at least gradually restore profitability in the U.S. Higher per-barrel prices might eventually lead to a reopening of some now-closed wells, something which insiders like Baker would like.

“We don’t want to waste reserves by plugging a well,” said Baker, ever mindful of the high costs of drilling.

Higher prices at some point might also lead to renewed exploration of Northern Michigan reserves.

Without a doubt, there is a general upward movement in the market prices of gas and oil during the recent couple of months.

Natural gas prices increased in a jagged but overall upward pattern from under $1.75 (per BTU, British Thermal Units) in March of this year to just under $3.30 in mid-October, then dropped in recent days to $2.94 only to rebound to $3.10. Oil prices, meanwhile, rose from $46 to $53 per barrel over the preceding six weeks then dropped slightly to just under $50 as of the writing of this article (Oct. 25). Still, the big picture is one of upward price trends.

Whatever prices do, it might surprise some to learn that the oil and gas industry would actually suffer if prices go exorbitantly high – say in the $200 or, less drastically, in the $150 per barrel range.

“It would put the world economy in a tailspin. We’d probably see a worldwide recession. Industry would cut back on consumption. Markets would dry up,” said West Bay’s Pat Gibson. “Yes, there would be a short-lived benefit for producers, but very short-lived.”