The urgency that drove the lease market in the early years of the “Marcellus Boom” is long gone. The rush for producers to acquire and develop acreage in the most geologically attractive areas (e.g., Washington County, PA) appears to have ended. Now, producers that have settled into areas where they are the primary, if not the only, leaseholder are finding themselves without much competition. As undeveloped leases with traditional five-year primary terms near expiration, drillers now comfortably situated in the Marcellus Formation may be in a position to begin offering leases with 10-year primary terms in areas that have not yet experienced vigorous shale development.
Dan Brockett of Penn State Extension cannot imagine any producer that would not prefer a longer primary term. When considering the main reason why oil and gas companies may desire longer primary terms, Brockett suggested envisioning a table with thousands of alarm clocks set to go off at different times. These alarm clocks represent undeveloped leases with primary terms set to expire. Each time an “alarm goes off,” regardless of whether or not the lessee is prepared for the expiration, a decision involving costs needs to be made. For example, the lease could be allowed to expire, in which case the cost of the lease will be lost, or the lease could be extended for a price. Brockett posed the question, “Wouldn’t it be nice to have these clocks set longer so that there is more time to develop capital, infrastructure, and markets in order to have the ability to drill when you want to?”
Brockett said that if many landowners are willing to accept longer terms, 10-year primary terms could become a “new normal” in Marcellus Shale development. “There is still a lot of acreage in Pennsylvania that is potentially economical but not as (geologically) attractive,” he said. “This land that was leased but not drilled is on a five-year clock and the clock may be running out, therefore companies may have some unattractive options. They could let the leases expire, drill a well to hold the land by production, which is inefficient, or invoke the lease’s renewal option, which might be expensive.” The alternative may be to offer a new, longer lease for a lower price.
Location is an important factor that may motivate lengthier leases for a number of reasons. According to Brockett, these less attractive areas tend to be less-developed and still require infrastructure such as pipelines and compressors. These areas likewise may not have a history of strong proven production or high lease prices, which cuts against a landowner’s ability to secure prime lease terms. Furthermore, companies may not feel a sense of urgency or competition in less attractive areas. “In some cases landowners may be presented with a 10-year lease or no lease,” said Brockett.
According to Brockett, whether or not 10-year primary terms will become more prevalent depends on two factors. The first is landowners’ willingness to accept longer leases, and the second is whether producers will decide to hold land outside of “core areas” or wait until conditions are more favorable to develop these lands. “There are risks on both sides of this equation.” Brockett posited that producers might seek longer terms either to keep competition out of the areas they choose to lease or merely to acquire greater and more secure land assets. “This gives landowners some potentially difficult choices,” he said. “Do they take the money with less advantageous terms now or do they hold out and wait for the better offer?” The better offer, of course, may or may notarrive.
Posted March 21, 2014