Who Should an Investor Believe: The Natural Gas Industry or The New York Times?

by: Devon Shire
If you follow the energy industry or the public equity markets I’m sure that you came across discussion of The New York Times article which basically suggests that the shale gas boom is nothing more than a giant ponzi scheme.
When I read the article I was shocked at how much attention something with so little substance had received. The crux of the piece was that the article was providing shocking e-mails from people inside the industry. The author clearly had an agenda before writing the article and went looking for anything he could find to support that agenda.
That isn’t how it is supposed to work. You should look at the facts first, then formulate an opinion. You don’t formulate your opinion and then try and support it.
I have no dog in this fight. No investments in the shale gas industry. It is of no consequence to me as to whether or not shale gas is the game changer many think it to be. With that in mind I would like to summarize the points made in the New York Times article and compare them with some points that support the bullish shale gas side.
The New York Times Article
The executive summary of the Times article would be as follows from the lead paragraphs:

“But the gas may not be as easy and cheap to extract from shale formations deep underground as the companies are saying, according to hundreds of industry e-mails and internal documents and an analysis of data from thousands of wells.

In the e-mails, energy executives, industry lawyers, state geologists and market analysts voice skepticism about lofty forecasts and question whether companies are intentionally, and even illegally, overstating the productivity of their wells and the size of their reserves. Many of these e-mails also suggest a view that is in stark contrast to more bullish public comments made by the industry, in much the same way that insiders have raised doubts about previous financial bubbles.“

The driver behind this article are “smoking gun” emails from inside the industry. Obviously the author has gone through these e-mails and picked the best out for the article. Here is a summary of the evidence brought forward from inside the industry in the order they appear in the article:
1) Source: A PNC Wealth Analyst Feb 2011 email – “Money is pouring in from investors even though shale gas is inherently unprofitable.”
2) Source: HIS Drilling Data analyst Aug 2009 email - “The word in the world of independents is that the shale plays are just giant Ponzi schemes and the economics just do not work.”
3) Source: Retired geologist Feb 2011 email - “And now these corporate giants are having an Enron moment.”
4) Source: Deborah Rogers Federal Reserve Bank of Dallas - “I think we have a big problem (a former stockbroker with Merrill Lynch, Ms. Rogers said she started studying well data from shale companies in October 2009 after attending a speech by the chief executive of Chesapeake (NYSE:CEO), Aubrey K. McClendon. The math was not adding up, Ms. Rogers said. Her research showed that wells were petering out faster than expected.)
5) Source: Chesapeake Energy Junior Geologist Mar 2011 email - “In these shale gas plays no well is really economic right now. They are all losing a little money or only making a little bit of money.”
6) Source: Senior Ivey Energy Official 2009 email - “Do you think that there may be something suspicious going with the public companies in regard to booking shale reserves?”
7) Source: Former Enron executive 2009 e mail - “I wonder when they will start telling people these wells are just not what they thought they were going to be?” He added that the behavior of shale gas companies reminded him of what he saw when he worked at Enron.
8) Source: Schlumberger official July 2010 email - "All about making money ... looks like crap,” the Schlumberger official wrote about the well’s performance, according to the regulator, “but operator will flip it based on ‘potential’ and make some money on it.” “Always a greater sucker.”
These are the emails that the author uses to support the idea that shale gas reserves in the United States are greatly inflated. Consider that these emails were received either in response to a request by the Times for emails supporting the authors agenda or were volunteered by individuals who you would have to suspect may have an axe to grind. Then consider that this industry has tens of thousands of people and that it would be shocking if you couldn’t find quite a few who like controversy. Considering all of that, the evidence provided from these emails is weak at best.
I think this article received far more attention than its substance merited. This article mentioned Enron several times undoubtedly for the effect that having Enron and the energy industry in the same article. The author had an agenda, which was weakly supported by a few e-mails from mostly anonymous sources and more importantly not a shred of actual data to support assertions of poor performance of shale gas wells.
The Reality of the Current Natural Gas Industry
Now I’d simply like to provide a list of what I considered when trying to determine whether the shale gas revolution is real:
1) We are awash in natural gas. If shale gas production is not living up to expectations why has it killed the price of the commodity for several years and provided us with a glut? The production is real.
2) Independent reservoir engineers provide reserve data, not the companies themselves (key word being independent).
3) The SEC accepts this reserve data.
4) I think it is widely agreed that at $4 shale and most conventional gas reservoirs are not economic. This doesn’t mean the shale gas resources aren’t real, rather that some equilibrium must be found to create the appropriate commodity price.
5) While the Times provided a few emails from skeptics, how can anyone seriously believe that the following companies which are all involved in shale gas are incompetent or trying to pull a fast one? (Anadarko (NYSE:APC), BG, BHP Billiton (NYSE:BHP), BP (NYSE:BP), Chevron (NYSE:CVX), CNOOC (CEO), ConocoPhillips (NYSE:COP), Devon (NYSE:DVN), EnCana (NYSE:ECA), ENI, EOG Resources (NYSE:EOG), Exxon Mobil (NYSE:XOM), KNOC, Marathon (NYSE:MRO), Mitsubishi, Mitsui (OTCPK:MITSY), PetroChina (NYSE:PTR), Reliance, Shell (NYSE:RDS.A), Statoil (NYSE:STO), Talisman (NYSE:TLM), Total (NYSE:TOT)).
6) Every quarter companies like Chesapeake beat their production guidance. Chesapeake is now more than five years into the shale gas revolution. Why isn’t its production falling off the map from the early wells?
The major oil companies like Exxon, BP and CNOOC came to the shale party late. They didn’t need to get in, they did so because of economics. The people making decisions at these companies know more about natural gas reserves and production than anyone in the world and their entry into the shale game is driven solely by economics. I find it impossible to believe the position of The New York Times supported by some anonymous emails over the profit motivated decisions of Exxon and others. If it was only a company like Chesapeake that is built entirely on shale gas that was promoting the resource the argument might be more believable. But that isn’t the case.
So who is the one to believe and knows the truth about shale gas? The New York Times, armed with questioning emails that it asked for? Or virtually every major oil and gas company on the planet armed with reservoir data, the foremost experts on the subject and a desire to make money? Even I can figure that out.
What are the implications for investors if companies like Chesapeake are correct and that they will be producing ample amounts of shale gas for decades to come? Well, I think it becomes very hard to become bullish on natural gas or the producers leveraged toward natural gas.
Chesapeake clearly isn't just talking about the abundance of natural gas from shale, it believes it. The company is trying as hard as it can to move capital spending toward emerging unconventional oil plays in an effort to avoid relying on cash flow from depressed natural gas prices.
Chesapeake and the gassier names are for now victims of their own success. Too much gas equals lower returns. For now I'd avoid them and focus my energy investments on names more heavily weighted to oil.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.