Despite the highly publicized exits of Southwestern Energy Inc. and BHP from the Fayetteville Shale, severance tax revenues from the Arkansas play have remained steady as consumption and demand for natural gas in the power sector continues to set new highs.
However, natural gas production levels in Arkansas have seen a slow decline without any rig activity in the Arkansas shale play. Also, New York Mercantile Exchange futures slid to a three-year low of $2.03 per million British thermal units (mmBtu) on Aug 8, well below the industry’s $3 breakeven level.
At the close of the fiscal year 2019 that ended June 30, Arkansas severance tax revenue rose 4.3% to $38.3 million compared to $36.6 million in fiscal 2018. In the first month of fiscal 2020 that began July 1, severance tax revenue was down 18.3% to $2.23 million compared to $2.73 million in the same month a year ago, according to monthly data from the state Department of Finance and Administration (DFA).
On the production side, conventional and high-cost natural gas wells in Arkansas have produced 136 billion cubic feet (Bcf) of natural gas, according to DFA data that is compiled on a calendar-year basis. About 13.7 Bcf of gross output comes from traditional wells, while the remaining 122.3 Bcf comes from completed high-cost unconventional wells with available reserves for production.
In calendar year 2018, production of marketed natural gas in Arkansas was 601.1 Bcf, down 13.8% from 697 Bcf in the same period of 2017. That is the lowest level of natural gas before Act 145 of 2009 went into effect. Under the current law, natural gas producers are taxed based on the market value of the natural gas produced within the state and at different tax rates depending on the categories of wells.
Until late 2018, Southwestern had been the top natural gas production company in the Fayetteville Shale for nearly two decades, pouring billions of dollars of capital investment into dozens of rural communities and counties across north-central Arkansas. At one point in early 2008, a study by the Sam M. Walton College of Business at the University of Arkansas said the shale play had created more than 11,000 jobs and had an overall economic impact nearing $20 billion.
But with natural gas prices stalling well below the industry’s $3 breakeven level for several years, Southwestern instituted several rounds of layoffs, reduced capital investments in the Arkansas play, and later sold its top leasehold position to Flywheel in late December 2018 at a purchase price of $1.865 billion. The Texas driller has since moved essentially all its field operations to the liquids-rich Appalachian shale play on the East Coast.
QUIET FLYWHEEL TAKEOVER
Flywheel’s acquired assets in the Arkoma basin shale play include 716 million cubic feet of net production per day (mmcf/d) from 4,033 producing wells across 900,000 net acres in the north-central section of the state. The deal also includes an integrated midstream gathering system with over 2,000 miles of gathering pipelines and more than 50 compressor stations.
Although mum on its Arkansas strategy, the Oklahoma City-based oil and gas producer did highlight the Fayetteville Shale earlier this summer after announcing the sale of less than 100 producing wells in the Bakken shale play in Montana.
“The divestiture of our non-operated Williston basin asset will allow us to focus our resources on our core operated asset in the Fayetteville shale and continue to create value for our shareholders,” Flywheel CEO Justin Cope said after the July 2 deal that put $165 million cash in the company’s budget coffers.
Similarly, Australian mining giant BHP Billiton announced in late July that a limited liability partnership owned by Dallas-based Merit Energy Company had acquired the company’s Fayetteville Shale assets for $300 million. BHP had originally purchased its 268,000-leasehold position for $4.75 billion in cash, before halting drilling and laying off workers in 2012 and writing off nearly $2.84 billion in charges after natural gas futures fell well below $3 per million British thermal units (BTUs). To date, Merit Energy officials have remained mum about their Arkansas operations, only allowing that it has produced 110, 500 barrels of oil equivalent per day (boepd) that also includes natural gas.
NO FAYETTEVILLE SHALE RIG WORK
Neither Flywheel or Merit have announced intentions to jumpstart expensive fracking operations, which allow producers to release natural gas from Arkansas’ hard shale rocks using pressurized water, sand and chemicals.
According to Baker Hughes, there has been little to no rig activity in Arkansas since Southwestern mothballed its drilling operations in late 2015. Since then, there has been one or two occasional test rigs in play, but no major production efforts in Arkansas, rig count data shows.
According to DFA officials, severance tax amounts reported by the state’s Revenue Office are based on the “revenue month, not the report month.” For example, a tax payment received in April may not be due until May. The severance tax data is compiled by the DFA’s Revenue Division from monthly tax reports filed by producers with the department. Tax treatment for traditional and high cost wells did not differ between fiscal years 2003 and 2008. However, separate and distinct tax methods have been used over the past decade to tax conventional output and unconventional, high-cost shale production.
Between 2003-2008, before Act 145 went into effect, annual production of marketed natural gas production in Arkansas jumped nearly 188% from 152 billion cubic feet (Bcf) to 438 Bcf. However, In 2009, the first year of the severance tax hike, Arkansas joined the list of the nation’s top marketed natural gas producers when sales of Arkansas natural gas spiked 57.5% to 690 billion cubic feet (Bcf). Arkansas natural gas sales rose another 36.1% to 939 Bcf of annual production in 2010, according to DF&A and EIA figures.
Natural gas production climbed over the one trillion cubic feet of production mark between 2011 and 2014 when Southwestern, BHP, ExxonMobil and other producers pushed Arkansas’ rig count to its highest level in the state’s history. By 2011, the state’s natural gas production jumped from 609 Bcf to 1.01 Tcf with most of the output coming from unconventional, high-cost shale production.
That trend continued in 2012 when production peaked at 1.15 Tcf and remained near that level for another two years. However, production began falling in 2015 in tandem with declining natural gas prices, tailing off to current output just above the pre-severance tax days.
According to industry experts, Fayetteville Shale reserves will likely last for another 30 years, allowing both Flywheel and Merit to sell enough gas on the over-glutted market to keep the doors open until prices rebound. Neither of the privately held out-of-state natural gas producers have responded to several inquiries from Talk Business & Politics concerning their Arkansas operations.