The frenzy of over drilling in the Haynesville Shale may peter out by the end of 2011, as the exploration and production industry is rapidly converting its leases here from term to held by production. This excessive drilling in the Haynesville Shale and other areas is partly responsible for some of the oversupply and weak fundamentals in natural gas.

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Term Leases
When operators lease mineral rights from owners, there is a deadline specified in the contract by which time the operator must start drilling or the lease will expire. Once the well starts producing, the lease is converted to held by production. Exploration and production companies typically pool large amounts of acreage into production or drilling units and can hold these larger units through the drilling of one well.

Several exploration and production companies have indicated that a majority of its acreage will be in the held-by-production category by the end of 2011.

EXCO Resources (NYSE:XCO) is a large operator in the Haynesville Shale and established a second core area in the Shelby Trough area of East Texas in 2010. The company has 24,000 net acres here and expects to have its acreage in San Augustine and Nacogdoches Counties held by production by the end of 2011.

Petrohawk Energy (NYSE:HK) is also a significant player in the Haynesville Shale and at an analyst meeting held in May 2010 detailed its extensive effort to hold its acreage here before expiration. At that time, the company had 294,000 net acres under lease across 1,568 sections in the Haynesville Shale.

Petrohawk Energy participated in 351 wells in 2010 and can potentially have 870 sections held by production at the end of 2011. After accounting for acreage that it has decided not to develop, the company needs to drill only 25 operated and 120 non-operated wells to hold the balance of its acreage here in 2012. The end of this effort is reflected in the 2011 Haynesville Shale rig count for Petrohawk Energy, which will drop from 16 currently to seven by the middle of the year.

Other exploration and production companies don't have to deal with the lease capture issue. CONSOL Energy (NYSE:CNX) is active in the Marcellus Shale and reported during its recent conference call that 98% of its acreage was held by production. This allows the company to exercise more capital discipline than some of its peers as it can defer natural gas drilling until fundamentals improve.

EnCana (NYSE:ECA) reported average daily production of 410 million cubic feet of natural gas equivalents per day from the Haynesville Shale during the fourth quarter of 2010. The company recently transitioned its strategy in the play away from lease retention, and will focus on drilling multiple wells from a single pad.

The Bottom Line
Natural gas prices remain weak due to the large amount of natural gas drilling by the exploration and production industry. This drilling was motivated by a need to convert leases from term to held-by-production, and there are signs that this frenzy may draw to a close in 2011. (Long-term energy outlooks which suggest a fundamental energy shift to natural gas. To learn more, read Natural Gas Forecast.)

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Tickers in this Article: XCO, HK, ECA, CNX

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