When horizontal drilling became the norm, it became financially challenging for smaller companies to compete


FARMINGTON — An extended slump in the prices of oil and gas on the commodities market has forced companies to get creative. But some of the solutions involve expensive equipment and procedures that are changing the game for smaller operators.

Diversification is a necessity for San Juan Basin oil and gas businesses that want to stay in the game. One such industry-related option involves mineral rights acquisition, and it has worked well for Merrion Oil & Gas.

“We’ve bought significant properties in various shale plays, some of which have come into production,” said George Sharpe, the company’s oil and gas investment manager. “We’ve had some shining successes that are doing well, and a lot that are just for future value and may not be drilled for 10 years.”

Sharpe said the company is purchasing mineral rights in shale formations that include the Marcellus, Utica, Bakken and Eagle Ford. While the company owns some minerals in the San Juan Basin, Sharpe said they are not actively pursuing mineral rights here.

“Most minerals there are owned by the federal or state government, and they aren’t selling their minerals,” he said.

To date, Merrion has purchased approximately 10,000 acres of mineral rights, typically ranging in price from $50 per acre for BLM land in the San Juan Basin, to $4,000 per acre in the Permian Basin.

Sharpe explained the mechanics of mineral rights acquisition.

“You can think of it like an upside-down building — the original owner keeps ownership of the first floor (surface), and then they lease the minerals on floors underneath,” he said. "Many of the land owners have leased the minerals out and they own royalty interest on whatever wells will be drilled. But they’ve already spent the bonus payment, so they need money now. We’ll come in and buy their royalty plus the mineral interest. When a production company takes over the lease, we begin receiving the royalties instead of landowner."

An advantage to purchasing mineral rights, said Sharpe, is that once Merrion purchases the minerals, there are no additional costs involved as the companies doing the oil/gas production will assume all additional costs.

“Merrion has been an operator since 1960, and has drilled hundreds of wells, almost all of them vertical,” Sharpe said. “Then the shale plays kicked in that required horizontal drilling, sometimes involving dozens of wells on one well pad. This required much more money — what used to cost one million dollars to drill now costs five million.”

When horizontal drilling became the norm beginning in the mid-2000s, Merrion realized that to be truly competitive it would have to drill multiple simultaneous wells. It became financially challenging for the company to compete with this type of drilling.

“Plus, it’s a much bigger financial sting if you drill a mediocre horizontal well compared to drilling a mediocre vertical well,” Sharpe said.

In addition, Sharpe said, at that time the San Juan Basin hadn’t been established as a viable horizontal drilling target.

“First we were in the wrong basin, second we didn’t have enough money to play, so we started looking to buy minerals so we could play with less money,” he said.

Sharpe said the company is also doing a lot of “flipping” of mineral leases — buying them low and selling them for a profit.

“A lot of entities are playing the game of buying royalties these days,” he said.

Sharpe said that even if the climate of oil and gas production improves under the new administration, the nature of the industry has changed so much that it is doubtful Merrion will ever re-enter the drilling game.

“We are still actively making evaluations and we’ve made a number of acquisitions, but in terms of drilling our own wells, we’re not big enough to do that,” he said. “A lot of the big companies have enough horsepower to do development projects, but we’re comfortable staying small. Besides, it’s nice not to have to justify our position to Wall Street investors.”

Leigh Black Irvin is the business editor for The Daily Times. She can be reached at 505-564-4621. 

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