Since late June when I saw this article and then this article in the New York Times on consecutive days alerting us to the fact that the shale gas boom in the United States is a giant rouse, I have been determined to spread the word.
The opening paragraphs from the first Times article cut to the chase:
“Money is pouring in” from investors even though shale gas is “inherently unprofitable,” an analyst from PNC Wealth Management, an investment company, wrote to a contractor in a February e-mail. “Reminds you of dot-coms.”
“The word in the world of independents is that the shale plays are just giant Ponzi schemes and the economics just do not work,” an analyst from IHS Drilling Data, an energy research company, wrote in an e-mail on Aug. 28, 2009.
When I saw the phrases referring to the dot-com bubble and Ponzi scheme I was outraged. I thought these independent gas companies must have accumulated a bunch of worthless shale properties, and are talking up those assets so they can inflate their stock prices and sell out before the scam is revealed.
Surely nobody with any oil and gas reservoir knowledge would be fooled like Joe Public who is buying shares of these independent natural gas producers. So I set to doing a little bit of internet investigation and came up with this list of poor old grandmas who have been duped by this scam:
), BG, BHP Billiton (BHP
), BP (BP
), Chevron (CVX
), CNOOC (CEO
), ConocoPhillips (COP
), Devon (DVN
), EnCana (ECA
), ENI, EOG Resources (EOG
), Exxon Mobil (XOM
), KNOC, Marathon (MRO
), Mitsubishi, Mitsui (OTCPK:MITSY
), PetroChina (PTR
), Reliance, Shell (RDS.A
), Statoil (STO
), Talisman (TLM
), Total (TOT
Each one of these companies has purchased shale gas properties from independents over the past couple of years. Each individual purchase was in the billions, so cumulatively the amount is tens and tens of billions. I spent about ten minutes compiling the list, so I’m sure I missed the vast majority of transactions.
I asked myself, what does this group of companies know about oil and gas reservoirs, production and economics? The New York Times has anonymous e-mails, what could this group of companies have? And then I remembered, they have more data, more expertise and more at risk in buying into shale gas than anyone else.
That made me wonder if perhaps I should be a little skeptical about the New York Times article. Then I read about Exxon’s experience with their giant purchase of shale gas producer XTO. It turns out that shale gas production from the acquisition is just fine and that Exxon, now with even more data on shale gas and first-hand production knowledge, actually wants to make additional shale gas acquisitions. Buyer beware! And then I saw BHP acquire shale gas independent Petrohawk for $15 billion which is subsequent to a previous BHP joint venture deal with Chesapeake Energy (CHK). Again, another shale gas acquirer coming back for round two with another multi-billion dollar cheque. Now Noble Energy (NBL) ventures into the game with a $3.4 billion deal with Consol (CNX) to get in on the action in the Marcellus shale.
I’m as up for a conspiracy theory as the next guy, but at some point doesn’t common sense have to kick in? All of the top oil and gas companies have had deep dives into the production profiles of these unconventional shale gas plays, and know the economics cold. These oil and gas companies aren’t just hungry to get into the game, but once in the game they like what they see and are ready to increase their exposure. Combined, these companies have invested what must easily be $100 billion at this point, acquiring shale gas acreage. Wouldn’t this sort of interest, at these dollar amounts, from this many different companies, allow us to conclude that shale gas is likely not some sort of hype/con job?
Recently I read this article that spoke with Chairman Larry Nichols of Devon Energy. Devon has one of the longest histories with shale gas, being an early entrant into the Barnett Shale play - which really was the first major shale breakthrough. In the article Devon actually says that production declines are much lower than expected, and that production is flattening out after much sooner than modeled. Devon has been drilling the Barnett since 2002.
I think what gets some people confused about these unconventional plays, both shale gas and unconventional oil, is that production does decline extremely rapidly in the first year. Usually after one year, production is down as much as 60% from initial production rates. The industry is aware of this, though, and this is factored into the economics. Most unconventional wells, depending on the specific play, pay out all invested capital in 12 to 24 months. The next 20 or 30 years of production are the return on the initial investment.
What excites me about companies in the unconventional game, especially those with unconventional oil properties, is that the technology is relatively new. Most of the companies that I follow are improving their well results every year. The companies are learning how to become more efficient at drilling the wells (reduced costs) and drill wells at higher production rates. These companies are going to get more oil and gas out of the ground than we currently expect.
This recent market sell-off provides an excellent entry point into many of the companies that have locked up huge resource bases in these unconventional properties. If you are interested in a lower risk exposure to this unconventional revolution I’d recommend having a look at Penn West (PWE) which has a huge land base in Western Canada, to which it is just beginning to take horizontal drilling techniques. I don’t think the company is even certain just how much upside they have in reserves and production that are vastly underexploited.
Now don’t get me wrong. I don’t think that at $4 natural gas these shale plays are licenses to print money. The boys need to slow down drilling and let the market balance itself. I think that slow-down is happening as forced drilling due to lease expiries is ending. What I do think is crazy talk is the suggestion that these shale gas wells are radically underperforming production expectations. I believe the production is real, the market just needs to set the proper price for the product.
Disclosure: I am long PWE, CHK.