Is Shale Gas Similar to the Internet Bubble?

Includes: APC, BHP, CHK, XOM
by: Carlos X. Alexandre

These are not my words, but the statement made by Alexander Medvedev, the deputy chief executive of Gazprom, the Russian state-controlled gas company. As I frequently look for interesting news, the following came via the Financial Times:

The surge in U.S. “unconventional” gas production is a “bubble," and the country’s gas prices will rise sharply in the next few years, the export chief of Gazprom has said.

Mr. Medvedev “likened the shale gas boom to the Internet bubble, ‘which first blew up enormously and then flattened itself out to some rational and logical size.’” I can understand his frustration, especially as gas prices continue to plummet, with the March futures contract currently trading at $3.82. The article sheds a little more light on Mr. Medvedev’s position, further defining his reasoning:

Weak U.S. prices have put Gazprom’s hopes of exporting to the U.S. on hold and forced it to sell about 7% of its gas at prices linked to the European spot market, which for most of last year were lower than the oil-linked formula that it uses for most of its sales.

Mr Medvedev predicted that, as with the Internet bubble, many shale gas companies would be forced out of the industry. “The massive production of shale gas is impossible against a price which is below $6-$8 per million BTU,” he said. “Therefore we do not see in the development of shale gas any threat to us.”

Certainly the shale play has grabbed plenty of headlines and like every other investment, new ideas eventually attract crowds and inevitably some will become casualties. That’s capitalism at its best - or the risk/reward formula that we have embraced. But I must now look back to the end of last year, and recall the talk about mergers/takeovers in the energy sector mostly driven by oil prices and the like. The one I recall best came out on December 30, 2010, and refers to the rumor, or not, that BHP Billiton (NYSE:BHP) “may make a $90 offer for Anadarko (NYSE:APC).” The story was published by Bloomberg and the source was the Daily Mail, a U.K. newspaper, and the Daily didn’t say where the information came from. Anadarko is not a small fish, and is a well established company with a market cap of $40 billion, but thus far BHP hasn't said much about acquiring anybody.

More recently, BHP’s CEO Marius Kloppers stated that “in six months’ time or a year’s time, something else may come up. The oil and gas market is a very large one where there may be opportunities going forward,” according to Bloomberg. Reading between the lines, he doesn’t see current opportunities and is likely to hang on to his cash as far as conventional oil companies are concerned, while citing inflated prices. As a mater of fact, BHP announced that it will “make a 5 billion Australian dollar off-market buyback of its Australian-listed shares as part of its $10 billion capital management program,” according to MarketWatch. And as the company’s first entry into the shale game, not traditional oil, BHP “will pay nearly $5 billion for natural gas assets from Chesapeake Energy Corp. (NYSE:CHK),” also reported by MarketWatch.

Another article by Bloomberg on December 23, 2010, pointed to Maersk as a potential buyer, but a quick scan didn’t turn up anything. So what is the strategy in the energy sector? Some of it may address Mr. Medvedev’s assertions. The Oil & Gas Financial Journal brought some facts to light with an article on January 26, 2011:

Luke Parker, lead analyst for Wood Mackenzie’s M&A Service explains: “The M&A market returned to peak levels in 2010 and the healthy deal activity at the end of the year bodes well for 2011. We have identified some key themes which contributed to the US$183 billion of deals of last year, many of which will continue to drive activity in 2011.” Parker expands: “The biggest driver of M&A activity in 2010 was unconventional resources and they are likely to remain so for the coming year. The market was underpinned by a steady stream of mid-sized deals; 20 in the US$1 billion to US$5 billion range whereas 2009 was dominated by two ‘mega-deals’ – Suncor/PetroCanada (US$19 billion) and ExxonMobil/XTO (NYSE:XOM) (US$41 billion).”

That’s not to say that oil driven acquisitions will not take place, but the focus has shifted to unconventional sources. To Gazprom’s position that shale, or anything that is disruptive to the company’s product line, is a bubble, I can assure Mr. Medvedev that the going will only get worse, for this is how markets work - and he knows it. As for the low price of natural gas, it will be detrimental to some players, but by the same token it will present extremely good opportunities to those companies that have deep pockets and can acquire high-cost, inefficient companies for pennies on the dollar.

And finally on February 18, 2011, further explains why Alexander Medvedev is making those statements:

Ukrainian national energy company Naftogaz said it has signed a memorandum of understanding and a confidentiality agreement with Exxon Mobil to jointly develop unconventional natural gas in Ukraine. Naftogaz said the companies will jointly study Ukraine's potential in shale gas, methane production from coal and other unconventional energy sources. Ukraine's government aims to make the country, which imports gas from Russia, energy self-sufficient both by cutting consumption and by producing its own gas. Naftogaz signed a similar agreement with Russia's Gazprom in December.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.