Horizontal Fracking – A Bust On The Horizon
Horizontal Frackers With Questionable Profitability Inflate Balance Sheets At All Costs
Technical advances in oil & gas horizontal drilling and completion techniques over the past 10 years have elevated our nation from one of the largest importers of fossil fuel to potentially a net exporter within the next 5 years. It’s been an amazing turnaround, and one that is vital to our country’s economic stability and national security.
Leaders in this industry are mostly public companies that have seized upon the opportunity to lease enormous quantities of mineral acres within the prolific plays of the Anadarko Basin in Oklahoma, Eagle Ford in South Texas, and the Permian/Delaware Basin in West Texas. These public and private equity backed companies are under constant pressure from investors and analysts to increase their oil & gas reserves to bolster their balance sheets and to drill and produce these reserves, ideally on a profitable basis.As reported by the Wall Street Journal on February 25, 2019 in the article, “Frackers Face Harsh Reality as Wall Street Backs Away,” the relationship between the frackers and Wall Street is “fraying as the industry struggles to attract investors after nearly a decade of losing money.”
In Oklahoma, the rush to aggregate reserves and create aggressive drilling programs by some public and private equity-backed companies is leaving some wreckage in its wake, and there appears to be no intention for these companies to admit to or disclose these issues in any way. Simply put, horizontal fracks in the SCOOP and STACK plays are damaging and destroying existing vertical wells without regard to their owners, and in some cases are polluting the surface.
Devon Energy Corporation (NYSE: DVN) has demonstrated their intention to put the blame for pollution from Devon’s frack operations on nearby vertical well operators whose wells get destroyed as high-pressure frack fluids and sand are forced through their well bores, destroying their productive reservoirs, and in some cases forcing harmful fluids onto the surrounding land. Devon is no stranger to environmental controversies: Energy Firms in Secretive Alliance With Attorneys General.
Devon has now proposed a new rule at the Oklahoma Corporation Commission which states, in part, “An operator of a wellbore receiving timely notice of hydraulic fracturing operations pursuant to OAC 165:10-3-10(b) shall be required to take reasonable actions, prior to and during such hydraulic fracturing operations, to prevent an environmental impact.” The irony of this proposed rule is that it would violate long-held trespass laws in the State of Oklahoma, which originated from whip-stock techniques in which a driller would take a lease and then drill diagonally into a productive reservoir that was owned by another company. Also ironic is Devon’s need to guard against their inability to technically avoid these types of disasters (see Devon CEO technical frack interview).
Due to the lack of regulations surrounding fracking, the large public and private equity-backed horizontal drillers have free reign to perform their high-pressure fracks in close proximity to older vertical wells that produce commercial quantities of oil & gas. In fact, these fracks are frequently granted permission from the OCC to occur as little as 200 feet from producing vertical wells, against the protests of the vertical well operators. Hundreds, if not thousands, of vertical wells have been ruined or have sustained some sort of damage from horizontal fracks. In many cases the medium-sized horizontal fracking company are proactive and negotiate agreed settlements in the event damage is caused, or even agree to buy damaged wells. Too often though, the larger public companies simply ignore pleas from the vertical operator, as the OCC provides no relief to those that sustain damage. Rather, the Commission tells them that their remedy is in the district courts. The large frackers know that the small operators cannot afford to pursue litigation against them and therefore they continue to steamroll their way through their drilling programs.
In eastern Blaine County, Rhino Operating owns and operates four active vertical wells that were drilled between 8 and 10 years ago in a geological area that was discovered by his father.
“They are really good wells,” said Rhino’s owner, Louie Willhoit. “Unfortunately, a couple of them were hit by Devon’s horizontal Kraken drilling and fracking program, not once but twice, even after they were warned to stop!” Rhino has photos and video of frack water shooting out of its well and onto the ground during the frack event. Because of Devon’s unwillingness to alter its operations near Rhino’s wells Louie was forced to bring a lawsuit against Devon (NYSE: DVN) to try and recover damages from his lost production.
“I think it is simply their mode of operation right now,” said Louie. “They seem to think that it’s more important to plow through their (drilling and completion) programs than worry about what happens to guys like me. Hopefully this will get their attention.” (see Devon CEO
In Kingfisher County Joe Bryant operates a handful of vertical wells near ever-increasing horizontal drilling operations. Joe’s company, Spring Valley Oil & Gas, has had its share of trouble from the horizontal giants. SK Nemaha (subsidiary of large South Korean conglomerate SK Innovation) is the latest fracker to operate unchecked near his production.
“SK Nemaha hit one of my good wells simply through their drilling operations. I had multiple certified letters sent to their offices – even to their field superintendent – warning them that they had underground communications to my well, and if they went forward with their frack they would hit it again. They fracked anyway and of course hit it again.”
Over the past several months many of the impacted vertical well operators have begun banding together and filing lawsuits against the large frackers who accept little to no responsibility for their actions. According to district court records, close to 50 lawsuits representing approximately 100 wells have been filed within the last 6 months in Kingfisher and Blaine counties alone. Each well claim could represent damages of as little as $150,000 up to $1.5mm to $2mm. (Link to Petitions website)
Court records show that in addition to Devon and SK Nemaha, multiple lawsuit petitions have been filed by vertical operators for trespass against Chesapeake (NYSE: CHK), Sandridge (NYSE: SD), and Newfield (now Encana, NYSE: ECA).
It is interesting to note that heretofore none of the large public companies drilling and fracking horizontal wells in Oklahoma have decided to disclose any of these contingent liabilities in their public filings.
Last September, In response to an Op-ed article, published in the Oklahoman on August 31,2018, titled, Point of View: The rest of the story about fracking, Oklahoma Independent Petroleum Association (OIPA) Chairman, Berry Mullennix, and Devon Senior VP, Wade Hutchings, published an article titled, Point of View: Technology, ingenuity make for a bright oil-gas future.
The article states that “wild claims” have been made about the impact of horizontal drilling on vertical well producers, and that the loss of property of vertical well operators, which are often small business owners, is being exaggerated.
The fact that on February 26, 2019, Oklahoma House Bill 1379 advanced to the House floor for consideration confirms a reality to the contrary. The measure, named the “Art and Yvonne Platt Act,” would require any operator creating a negative impact on a vertical well to take immediate actions to minimize damage. It also would require the operator to conduct timely negotiations with vertical well owners to resolve any claims the latter might have. Art and Yvonne Platt are lifelong Oklahomans whose retirement incomes were lost when their vertical wells were damaged by frack operations.
The article continues, “The oil and natural gas industry has been revolutionized by technology, but not all of those in the industry have embraced it. They want the industry to remain the way it was when vertical wells were the norm and they had significant influence on the industry. In order to do that, they cast today’s industry in a negative light. They are Blockbuster executives in a Netflix world.”
Although there is no record of a Netflix server smashing into a Blockbuster building, the comparison implies that vertical well production is vastly inferior to horizontal production, which does not prove, based on the return for capital invested. Large horizontal companies are already coming under attack for missing earnings targets and guidance. The aggressive accounting treatment used by some publicly reported companies wherein reserves from an entire spacing unit are booked to the balance sheet based upon the drilling and completion of a single well, coupled with the continuous creation and lack of disclosure of contingent liabilities, is troublesome at best.If continued projected deliverabilities continue to miss guidance targets as the full value of claims arising from nearby damaged wellbore are revealed, the only thing that might stop a day of reckoning is a substantial increase in the underlying commodity price.