By Bernhard Debatin
It started out quite hopefully for those in Athens County who own land and mineral rights and are not afraid of the potential side-effects of fracking: In November 2011, the West Virginia-based company Cunningham Energy hooked up with local lawyer John Lavelle and set off a fracking frenzy, promising $2500 per leased acre and 12.5% royalties for the oil or gas. On Jan 2, 2012, the Athens News reported that the overall acreage of the initial fracking leases amounted to about 35,000 acres, representing “a total possible initial payout of more than $87 million.”
But the payout did not come. However, now it looks as if fracking is going to come through the back door. What happened?
Elsewhere in the country, the fracking frenzy had led to an overproduction of gas, which resulted in an unprecedented low in gas prices. Then the leasing market went sour — according to many sources the consequence of a Ponzi Scheme initiated by companies like Chesapeake, who figured that they could make more money by flipping leases than actually drilling for gas. But that worked only as long as investors were willing to shell out the money.
Consequently, Cunningham Energy (and probably the other energy groups that made lease contracts in Athens County) could not find joint venture partners or buyers for their leases, which were to expire in mid March. Too small a company to dole out $87 million up front, Cunningham Energy worked out a deal with Lavelle where landowners could extend their leases to mid-June.
Who is Cunningham Energy?
The website of Cunningham Energy LCC lists seven members of the “operating team,” including president Ryan Cunningham, two production foremen, one landman (Joe Blackhurst, who did the negotiations in Athens), a finance and risk assessment director, an office manager, and an executive administrator.
In a May 16, 2012, telephone interview, Cunningham’s landman Joe Blackhurst confirmed that they are too small a company to shoulder the risk and that they “had a difficult time attracting a major partner.” The small company, branding itself as “Aggressive Hydrocarbon Intelligence,” seems mostly involved in exploration and support activities for oil and gas operations and in some vertical drilling projects. According to Blackhurst, those projects are partly outsourced and partly done by Cunningham Energy’s own staff. He said they usually employ 60 to 75 workmen, depending on project needs.
While Blackhurst did not want to divulge the annual revenue of the company, he denied the estimate made by Manta.com, an online listing service for promoting and connecting small businesses, that Cunningham Energy “has an annual revenue of $3,000,000.” He laughed and said their revenue was “significantly higher” but he declined to go into the financials because the company was privately owned.
Bad Geological News
On March 16, 2012, just when the original deadline for the leases had passed, ODNR geologist Larry Wickstrom and others presented an explosive report at a meeting of the Ohio Oil Gas Association. That report showed Athens County outside of the attractive fracking zone, the core productive area of the Utica-Point Pleasant shale. The amount of total organic carbon (TOC) that is, gas, oil, and other organic matter, was deemed to be somewhere between 0.5 and 1% in the Athens County area, with the lower percent toward the western part of the county (see slide 20). According to the presentation, “most geochemists consider a TOC greater than 1.0 percent as good source rock for generating petroleum potential” (slide 11).
The picture is even dimmer if one subtracts the dead organic matter (which is included in TOC) and looks only at the actually available hydrocarbons (S1) and potential hydrocarbons (S2). With regard to S1 — existing hydrocarbons — Athens County lies in the “poor” area (slide 21). Regarding the potential hydrocarbons (S2), which are the most reliable predictor of recoverable oil and gas resources, Athens lies below the 2.5 line (slide 22) , but only “an S2 of greater than 5 is considered to have good source rock generative potential” (slide 11). The overall picture, adding up the different measurements, shows Athens County well outside of the core productive area, with most of Hocking, Perry, and Morgan Counties, as well as parts of Washington County also outside of it.
It is thus no wonder that the leases acquired by Cunningham Energy found no buyers or joint venture partners. In the telephone interview, Joe Blackhurst first blamed the opposition to fracking in Athens County and said he believes “the political climate has turned a lot of people off.” However, he then confirmed that geological aspects are the main reason and remarked, “[investors think] why go south and spend money on a purely speculative project?”
A New Strategy
As soon as the new geological data were released and made the rounds in the local press (see Athens News of March 21, 2012), an unidentified number of landowners who initially wanted to lease their land for fracking did not renew their leases. Whatever the number, it must have been significant enough to force Cunningham Energy and attorney Lavelle to develop a new business strategy.
In the new deal, landowners will get only $100 per acre ($125 minus $25 Lavelle-fee) as an up-front bonus by July 20, 2012. Then, Cunningham Energy, together with a yet unknown “risk partner,” is planning to drill five deep-shale vertical test wells in Athens County in order to determine whether this area has potential for deep shale oil and gas production. In the telephone interview, Joe Blackhurst said, “we have no data, no well logs, and no wells that have been stimulated [in Athens County]… we want to prove to the world that Athens County is viable.”
The money for the $125 up-front bonus goes into an escrow account and will then be dispersed. However, if Cunningham should fail to escrow all of the up-front bonus payment, the lease contracts are void. During a landowner meeting, held on May 17, 2012, at the Market on State Street Mall in Athens, John Lavelle emphasized, “If Cunningham doesn’t deliver by July 20, then I am done; I will not renew the lease.”
On the other hand, if Cunningham delivers and if the test wells show potential for oil or gas production, then landowners would receive $325 bonus per acre by 7/20/2014, $600 per acre by 7/20/2015, $850 per acre by 7/20 2016, and another $850 by 7/20 2017. This adds up to a total 5-year bonus of $2750. Throughout the “optional renewal period” (which is at the discretion of Cunningham but not of the landowner), a landowner may receive another $3000, spread over the next five years. This makes a total per acre bonus of $5750 minus a $50 attorney fee.
Three things are noteworthy about this: First, the total amount of this bonus is relatively small. For instance, if a total of 10,000 acres were to be leased under these conditions, then Cunningham would have to pay $1,250,000. If the total 35,000 acres from the initial lease were leased, it would amount to $4,375,000. Yet this amount and the capital needed for drilling the test wells are high enough that Cunningham Energy is still looking for a “risk partner,” as John Lavelle phrased it during the landowner meeting. While the initial total bonus of $87 million was obviously completely beyond Cunningham’s financial capacity, the risk of simply losing one to four million dollars is serious enough that a small company like Cunningham needs a partner with deep pockets.
Second, while Cunningham cut the up-front bonus from $2500 to $125 — just 5% of the original bonus — Lavelle reduced his up-front attorney fee only by half from $50 to $25. For instance, if a total of 10,000 acres were to be leased and the bonus escrowed by July 20, Lavelle would receive $250,000 regardless of whether the Athens area turns out to be an attractive production site or not. If nothing happened after July 20 or if the Cunningham decided after the first dry test well to stop the process, Lavelle would rake in 20% (one fifth) of the overall bonus money.
Third, the new deal includes an important condition that is not easy to figure out from the language of Cunningham ads and the material distributed by Lavelle and Cunningham at the landowner’s meeting. The ad (run in the Athens News on May 14, 2012, p. 16) touts, “5 wells to be drilled within 18 months.” Similarly, the flier distributed by the Lavelle law firm at the landowner meeting states “Cunningham must drill five Utica formation wells within 18 months.” But it also says, somewhat obscurely, “As a condition of retaining leases, five wells must be drilled and logged withing 18 months.” While one might assume that this forces Cunningham Energy to drill five wells in 18 months, it actually means in plain language that Cunningham Energy can get out of the contract if it has not drilled and logged five wells within 18 months after 7/20/2012.
So, even if Cunningham were to drill five wells, but failed to log them by 7/20/2012, they could still get out of the contract. The more likely scenario, however, if they ever find a “risk partner,” would be that they drill one or two deep wells without finding sufficiently productive shale and quickly cut their their losses without any further obligation. “If they do not complete the five wells within the time frame, the leases are null,” affirmed Lavelle during the landowner meeting on Thursday.
It has to be kept in mind, too, that drilling is a costly enterprise. According to Joe Blackhurst, drilling a single well costs about $900,000 plus $40,000 per day overhead. In other words, if the drilling takes two weeks, the overall costs amount to ca. $1.5 million. Drilling five wells could easily cost $7.5 million. Together with the bonus money, the overall expenses could quickly reach a total amount between $9 million and $14 million. That’s why a well capitalized risk partner is necessary. And it is indeed unlikely that any drilling will happen without an investor. “We have to backload the money to make it attractive enough [for investors],” Lavelle explained in the meeting.
Of course, this raises the question why anybody would allow Cunningham to drill on their land if they are only trying to prove the existence of hydrocarbons or the lack thereof. An article in the Athens News of May 7, 2012, quotes a landowner who brilliantly sums up the overall situation:
“I think it would be silly to put a well on my property for $150 an acre more or less, and if nothing comes up, then I got a mess to deal with. If they drill somewhere and they hit good, then I can sit back and wait for the offers.”
So, one could assume that landowners do exactly this. However, at the landowner meeting on May 17, about 120 to 140 interested people appeared, and some of them came to the tables to sign contracts. Most of them did not look particularly wealthy. The big landowners in Athens County have long ago made their deal, and they don’t depend on it. For them it’s yet another piece in the endless game of buying and selling.
Consequently, the rhetoric of the last chance seems targeted at people who are already struggling. The Cunningham ad claimed that the May 17 landowner meeting was their “final push to acquire acreage.” During his presentation at this meeting, John Lavelle very carefully emphasized that not the bonus but the anticipated royalties are the important part. “The real money is in in the royalties, not the bonus,” he said. And, conjuring a sense of urgency, “we’ve got to get the data out of the ground (…), we’ve got to start drilling, folks!”
The new percentage for the deep-shale royalties is indeed promising. It was raised from 12.5% in the original lease to now 16.5%. To pay out, of course this assumes significant amounts of recoverable oil. While Lavelle presented enticing examples of how much oil could come out of a well and how this would translate into five-digit monthly dollar figures, one has to remember the many cases of people who leased their land for minimal returns while dealing with contaminated water and serious health problems (see, for instance, the New York Times Magazine article The Fracturing of Pennsylvania, the Rolling Stone article The Big Fracking Bubble, and the SD-FRAC article New Study: The Health Impact of Fracking).
Good Intentions not Good enough
These articles, like many others, show that the foremost danger of fracking is water contamination. Although the industry has long claimed that water contamination due to fracking is close to impossible, there are many cases where exactly this happened. Most notably, the renown Duke study, published on May 17, 2011, in the journal Proceedings of the National Academy of Sciences, a prestigious academic publication with rigorous peer-reviewing standards, showed the occurrence of methane contamination in drinking water at 60 sites in New York and Pennsylvania, all of which were close to drilling and fracking operations.
The ongoing EPA ground water study in Pavillion, Wyoming, found high concentrations of volatile organic compounds of the BTEX group in both shallow and deeper ground water. The study found that for the deeper water, “the data indicates likely impact to ground water that can be explained by hydraulic fracturing” (p xiii). Another study, recently published in the journal Ground Water, demonstrated that — contrary to industry claims — fracking chemicals from the deep shale could reach the surface through natural faults and fractures in just a few years. Though opponents immediately pointed out that the study was largely based on simulation models and thus questionable, one has to consider that most industry studies are based on simulation and extrapolation, too.
Water has thus become the number one concern in the fracking debate. Consequently, baseline water testing for organic compounds, though not mandated by state regulators, has become the gold standard in the attempt to avoid, identify, and fight water contamination. Asked about Cunningham’s policy regarding water testing and contamination, Joe Blackhurst said in the phone interview, “We all have children, we all have to drink the water, we all have to breathe the air (…). I am not here to poison my kids’ future water supply.”
Yet, while he agreed that water testing was a good idea, he would not commit to providing comprehensive Tier 1-3 water testing, the only method that can identify volatile organic compounds (particularly BTEX) that may occur due to drilling, fracking, and oil or gas production. Similarly, the Lavelle flier distributed during the landowner meeting mentions that Cunningham is “liable for any damage to landowner’s property and water” and that the company “must test water.” However, a commitment to comprehensive water testing was not to be found there, either, nor did it show up in the Agreement to Enter into an Oil and Gas Lease that was distributed at the beginning of the meeting. Since Lavelle did not comment on this during the meeting, one can assume that the lease still only includes mandatory Tier 1 water testing, which does not address any of the contamination caused by the drilling, fracking, and production process.
The Backdoor Approach
Assuming that Cunningham Energy drills the test wells and finds the area a promising production field, the fracking frenzy and all the related problems would come back to Athens County. Even if the company is doing a responsible and clean job, as Blackhurst promised, they are only preparing the ground for a bigger player in the fracking business who may not have this kind of commitment. Since Cunningham Energy has neither the knowledge, nor the equipment and workforce to conduct horizontal drilling and high-volume hydraulic fracturing, they would either need to flip the leases or find a joint venture partner to do the horizontal drilling and fracking.
Though Joe Blackhurst emphasized in the interview “Not once have I seen a single soul who would purposefully destroy the environment,” he conceded that accidents happen but asserted that small and mid-size companies tend to act more responsibly. “We are not Chesapeake Energy,” he said, referring to that company’s rather doubtful reputation.
But the problem is, Cunningham Energy is opening the backdoor for exactly this type of big player.