Study Examines Why Small Firms Enter Natural Gas Market

A 2019 study published in Energy Economics investigated the increase of small firm entry into the natural gas market between 2005 and 2008, a contrast for a market previously saturated by large firms. Researchers identified two plausible causes of the increase of small firm involvement--increased future resale value of mineral rights, and perceived new higher natural gas prices. Study results revealed that many small firms were participating in lease speculating, anticipating an increase in land lease resale value and resulting profit, a trend researchers found more common in the Marcellus play than in others. Additionally, wellhead prices after 2000 were substantially higher but also more unstable. Researchers suggested that smaller firms may have viewed the price increase as a larger shift in natural gas prices.

The study tested three possible causes for increased small firm involvement--increased resale value of mineral rights, perception of a new higher and more stable natural gas wellhead price, and increased technological advances to make drilling more advantageous. While research supported the first two of these hypotheses, the study concluded that the increase of technology, including horizontal drilling, fracking, and 3d seismic imaging did not likely account for increase in small firm involvement, as most small firms entering the market continued traditional vertical well drilling.

Researchers created a model that allowed for the modification of certain variables, including: wellhead prices, proved reserves, exit fees, appreciation/depreciation rates, and sunk entry costs, to determine the minimum number of wells necessary to incentivize market entry. Model output from pre-boom (pre-2000) values created baseline data, and adjustments to these variables allowed researchers to test each of the three hypotheses. Variable modifications that decreased the number of wells needed were identified as causes for increased small firm involvement. One limitation of this research is the lack of a clear definition of what denotes a small, medium, or large firm--a more clear denotation of the characteristics of small firms may show further causes for small firm entry. Additionally, pre-boom data used for baseline analysis represents averages taken from a market dominated by large firms. These large firms may be impacted differently by variable shifts than smaller firms, therefore potentially skewing the relevancy of baseline data.

The escalation of small firm involvement as caused by the two hypotheses supported in this research has two potential impacts on the natural gas market. Small firms that entered the market to take advantage of higher natural gas prices could diversify the overall market and therefore create a more competitive market. Conversely, small firms that entered hoping to resell for profit after lease appreciation may sell to larger firms and create a more homogenous market more similar to pre-boom conditions.

Written by: Samantha Green, Contributor