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Page added on May 1, 2015
How Shale Is Becoming The Dot-Com Bubble Of The 21st Century
As I review the financials of one of the largest shale producers in the United States, Whiting Petroleum (WLL), I can’t help but notice the parallels to the .COM era of 1999 which, to some extent, has already returned to the technology and biotech sectors of today. Back then, the faster you burned cash to capture customers regardless of earnings to drive your topline, the higher your valuation. The theory was that after capturing the customers (in energy today, it is the wells) spending would slow and so would customer additions allowing companies to generate cash. By the way, a classic recent case is none other than Netflix (NFLX) which, in the past was exposed for accounting gimmicks that continue even today. It is still following this path of burning cash for the sake of customer additions, while never generating any cash in its entire existence.
Cash was plentiful in 1999 so it could always be raised as the Federal Reserve began its easy money era creating a series of bubbles for the next 15 years. Does this sound familiar to what is occurring now? It will end the same way and that process has already started as currency wars heat up and our economy grinds to a halt proving QE does not, in fact, create wealth (temporary yes for the 1%, short term, until POP) but instead it destroys it by distorting asset prices, misallocating investments, and ultimately creating an equity crash.
We just witnessed this in energy, as all the economic stats that distorted the real underlying economic weakness in the economy led energy producers to overproduce while easy money fueled it and expanded speculation in the futures market. Back in 1999 did the internet companies adapt their business models? Some which still survive today did, but most went bankrupt. The parallels here with energy are simply stunning as most E&P companies need to spend well over their operational cash flow in order to not only grow but to replace the wells that are producing tied to depletion. Money is free right? Well we are witnessing the first stages now and it may not last, as junk bond investors in energy can attest.
Further, US equity markets are beginning to “realize” that the US economy isn’t better off vs. Europe and the US dollar begins to fade as it shows signs of correcting as well. The Fed clearly isn’t as accommodative by instantly launching QE4, for a host of reasons, thus potentially opening the door to a deeper correction vs. prior ones in order to get what the 1% wants again: more QE. Yes the Keynesian feedback loop is real as, in the past, each equity correction was met with more QE.
WLL, in its March quarter, generated over $200M in cash from operations and, with hedges and production expected to be flat sequentially for rest of year in 2015, expects to earn at least $850M in cash from operations, give or take. The problem is though, they need to spend $2B to keep it up because depletion rates are so high. They claim “growth” capital expenditures are discretionary (just like NFLX by the way, in capturing customers), but the realities are that wells in the Bakken deplete 80% in 12 months, so does that really sound discretionary?
What is worse is WLL continues to grow production even though prices have collapsed and cash generation is in decline. In fact, year over year cash generated from operations fell 30% despite production growing some 70% plus percent. Does this sound like a company you want to invest in or like one that is run efficiently? So, let’s review: .com companies did the same and the majority went bankrupt so if WLL and other E&P companies continue to spend cash well above their operation capacity, not because they want to but because they have to, it will lead to the same result as it did in 2000… POP!
Most of these E&P companies who do not adapt will go bankrupt as the money runs dry, unless they spend within their operational CF. As of now, WLL specifically does not seem to be adapting as production rises this year and next. On their EPS call, management did say next year CF would fully cover capital expenditures which is encouraging, assuming current strip. Those companies that do adapt will not only survive but will thrive, as we believe that the ultimate result of all this will be much higher oil prices from here. The shale revolution will see a dramatic period of slow growth/no growth or more likely declining production as marginal players leave and costs to drill overall, outside of most prolific areas (as they run dry), rise. And as a reminder, OPEC does not have the spare capacity in hand to supply the market leading to the next boom in prices longer term. In the short term and as a rule of thumb, do not invest in those companies who spend considerably above the operation cash flow and only consider those that respect their limits.
22 Comments on "How Shale Is Becoming The Dot-Com Bubble Of The 21st Century"
shortonoil on Fri, 1st May 2015 10:20 am
This is one of those whimsical Econ 101 articles that seeks to blame the CBs, and their wanton ways for the oil price crash. It is the typical cart before the horse approach. Surely, the CBs added to the already developing price crisis, but they were not the cause of it. They were responding with an outdated, and insufficient monetary system in the only way they knew. They cut interest rates, and tried to increase the currency base to prop up a declining economy. Well — things went a little haywire, as could be expected, and oil was one of the many commodities that suffered from the result.
Oil prices began their long term decline around 2012. The CBs monetary policies extended the ultimate drop by about 36 months. What they did was instead of letting it decline by about $10/ barrel per year, the price fell by 50% in six months. The present price crisis is the result of the on going depletion occurring to the world’s petroleum reserves, it is not the result of monetary policy. It is in spite of that policy.
We predicted the decline about a year ago:
http://www.thehillsgroup.org/depletion2_022.htm
The world’s reserves have depleted to the point that the value of the average barrel to the end user is less than the average cost to produce the average barrel. If the CBs had not been pumping unbacked currency into the system, production would have declined along with the value of the oil. Their money pumping approach allowed the production of large quantities of low quality oil that would not have otherwise been marketable. Zero percent interest allowed for the purchase, and storage of a product that had no market in the first place. Once the market realized that it had $billions invested in something that it might not be able to get rid of, all the lemming ran for the cliff at the same time. That is, they followed the usual market approach.
Oil has now entered a long term decline phase. It is not the CBs who are creating this situation; it is called depletion, and it has been going on since the first barrel was extracted 150 years ago. It will go on until the last barrel is taken out of the ground. It is not a difficult concept, but it does seem to eclipse the mind of the average Econ 101 proponent! Like the average barrel, perhaps their value has exceeded their average cost of production.
http://www.thehillsgroup.org
Northwest Resident on Fri, 1st May 2015 12:55 pm
Like shortonoil points out, the central driving force in our world today is declining energy. Combined with rapidly declining resources of all other types (fish stocks, timber stands, coal and mineral deposits — you name it) and an exponentially increasing global population, it isn’t difficult to see the writing on the wall.
To compensate SHORT TERM for this unsolvable dilemma, TPTB enacted ZIRP, QE, stock market manipulation, powerful propaganda campaigns, intense security lockdown, militarized police, concocted international tensions, wealth transfer AWAY from those who would use that wealth to consume the most (and place unbearable demands on decreasing energy) — and all kinds of other initiatives/plans to simply keep the circus on the show for another few years.
We are all living under a regime of extend and pretend. Whether intended or not, whether masterfully planned or simply conjured up out of nothing, the reality is that every effort is being made across the international financial and political spectrum to just keep BAU crawling along a little longer. How much longer it can hold up is THE main question. Whether or not it CAN hold up is an already answered question.
Historical, traumatic and chaotic times are upon us whether we realize it or not. We are caught already in the vortex of a Cat 5 hurricane that has yet to make landfall — swirling around slowly in forces that we cannot control, knowing that imminent random destruction is dead ahead.
BC on Fri, 1st May 2015 1:57 pm
NWRes and Short, brilliantly well said, and I agree, of course. 🙂
Perk Earl on Fri, 1st May 2015 1:59 pm
“Whether intended or not, whether masterfully planned or simply conjured up out of nothing, the reality is that every effort is being made across the international financial and political spectrum to just keep BAU crawling along a little longer.”
On another thread is an article about the decline of the US economy with the past quarter’s GDP coming in at .02 percent growth. So they probably lied to us knowing full well it was in negative territory, but trying to avoid two consecutive quarters with minuses because that’s a recession. They’re doing everything they can now in numerous ways as you state NR, to extend and pretend, but it’s reaching a point where the only way to make this all seem reasonable is to lie their heads off.
I wonder how long a dying patient can be convinced with stats they’re making a miraculous recovery? It would be an interesting experiment. Kind of like using placebo’s, but in this case tell the Leukemia patient their white blood cell count is normalizing while it’s actually racing out of control. “Come on you’re over the worst of it. We expect to see you with rosy red cheeks soon! Statistics don’t lie so it’s up to you now. If you die it’s your fault for not having enough FAITH in yourself. Come on don’t be a loser and fail yourself and your family!”
apneaman on Fri, 1st May 2015 2:11 pm
David Hughes: Has Well Productivity Peaked in the Nation’s Largest Shale Gas Play, the Marcellus?
http://energyskeptic.com/2015/david-hughes-has-well-productivity-peaked-in-the-nations-largest-shale-gas-play-the-marcellus/
joe on Fri, 1st May 2015 2:24 pm
Seem like they are doubling down again. They are developing trade deals in EUROPE and Asia that make NAFTA look tiny, we are talking true global integration that will make world government seem like the next logical step. So long as they can solve climate change and peak oil, it’s all good. For them at least.
apneaman on Fri, 1st May 2015 3:09 pm
solve climate change? There are no solutions for a predicaments. It will be a miracle if there is a human alive in a hundred years. Unless we come up with a way to manipulate physics on global scale in a star trek like time frame – instantaneous.
apneaman on Fri, 1st May 2015 3:15 pm
Survivable IPCC projections are based on science fiction – the reality is much worse
Nick Breeze
27th February 2015
The IPCC’s ‘Representative Concentration Pathways’ are based on fantasy technology that must draw massive volumes of CO2 out of the atmosphere late this century, writes Nick Breeze – an unjustified hope that conceals a very bleak future for Earth, and humanity.
http://www.theecologist.org/blogs_and_comments/commentators/2772427/survivable_ipcc_projections_are_based_on_science_fiction_the_reality_is_much_worse.html
Dr Matt Watson, from the school of earth Sciences at the University of Bristol (UK), made this point strongly at a recent meeting at the Royal Society in London:
“Why are we doing this? Why are we doing this research? This is why, this is the latest projections from the Intergovernmental Panel on Climate Change, and the alarming thing is that these two scenarios [RCP 2.6 and RCP 4.5] both include negative emissions technology. So, there is geoengineering, of the flavour of carbon dioxide removal, in the best case scenarios.
https://www.youtube.com/watch?v=8akSfOIsU2Y
apneaman on Fri, 1st May 2015 3:29 pm
TPTB and their puppets are not concerned with climate change. They are worried about their money and power – the same things they have worried about all their lives. Fuck you and your kids and grand kids. Your just collateral damage. You see, the part of the brain that says go for the money and power is far and away the driver of most human behavior. The rational part that says “maybe we should slow down” is a whisper that is quickly pushed away by the older reptilian part of the brain. Humans are just a bunch of status seeking apes driven by their emotions. We are not in charge of anything. No different than any other creature following it’s programming. In the end, those who get in the way of MORE will be crushed and many more will be cut out. They will pay lip service to climate agreements – they will never be enforced.
G20: fossil fuel fears could hammer global financial system
Top energy watchdog says two thirds of all assets booked by coal, oil and gas companies may be worthless under the ‘two degree’ climate deal
http://www.telegraph.co.uk/finance/11563768/G20-to-probe-carbon-bubble-risk-to-global-financial-system.html
dissident on Fri, 1st May 2015 4:00 pm
But shale gas an oil will make America the biggest exporter ever in terms of these fossil fuels. I am told this with the zeal of a Baptist preacher almost every day. I need to believe it. It needs to be believe. Otherwise there is no salvation.
🙂
shortonoil on Fri, 1st May 2015 4:26 pm
http://energyskeptic.com/2015/david-hughes-has-well-productivity-peaked-in-the-nations-largest-shale-gas-play-the-marcellus/
Good article, and thanks for the link Ape. The one area that Hughes doesn’t address is the effect of legacy decline. Like he says, the information that comes out of the Marcellus is sketchy at best, but from what we can determine in 2012 the average well in the Marcellus was producing 627 million cubic ft/well/yr. According to his information that has declined to 610 million cubic feet/well/year by 2014. That is undoubtedly the result of legacy decline, and even if the total production can be increased the well decline rate is still too high to allow for increases in the average individual well production rate. This is another example of where technology has failed to compensate for the geology of shale! At best the Marcellus will end up being a huge number of wells that don’t produce very much!
http://www.thehillsgroup.org
Nony on Fri, 1st May 2015 4:37 pm
https://www.youtube.com/watch?v=I-eCX8guIVM
🙂
dave thompson on Fri, 1st May 2015 4:44 pm
http://youtu.be/da5sP3wRuJ8
GregT on Fri, 1st May 2015 6:22 pm
https://www.youtube.com/watch?v=ripQ9jJnw1c
🙁
sunweb on Fri, 1st May 2015 6:43 pm
Didn’t go to the youtube sites yet. The discussion is one of the best I have seen here (of course, because I agree with it) 😉
BC on Fri, 1st May 2015 7:48 pm
https://research.stlouisfed.org/publications/es/15/ES_8_2015-05-01.pdf
“Negative aggregate demand shocks”.
Ya gotta love that eCONospeak.
🙂
They don’t mention (or one must endeavor to infer) the disproportionately large majority share of oil production that was required to be consumed in order to produce unprofitably the 2-3Mbd at $95-$105/bbl that was far in excess of the sustainable demand outside the energy sector at less than $40 required to permit growth of real GDP per capita.
Nony on Fri, 1st May 2015 7:49 pm
ping pong
https://www.youtube.com/watch?v=Vnp4kj5lLOU
GregT on Fri, 1st May 2015 8:22 pm
http://www.carolynbaker.net/2013/11/24/the-sky-is-falling-chicken-little-was-right-all-along-by-don-wilkin/
Nony on Fri, 1st May 2015 9:05 pm
Who am I to disagree?
https://www.youtube.com/watch?v=yA0yi_Fd8aQ
apneaman on Fri, 1st May 2015 9:41 pm
Big oil sands players hope pumping record crude will pay off over time
“Canada’s oil sands industry is pumping record volumes of crude despite sinking profits and warnings of an extended stretch of weak prices.”
http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/big-oil-sands-players-hope-record-crude-volumes-will-pay-off-over-time/article24197316/
apneaman on Fri, 1st May 2015 9:44 pm
We have now entered the post-economic Triangle of Doom period TFC Charts, (click on for big); the triangle has outlived its usefulness, the oil – credit markets have broken down. What remains is relentless decline … as resources along with purchasing power are annihilated.
http://www.economic-undertow.com/2015/04/26/fantasy-islanders/
Nony on Sat, 2nd May 2015 8:38 am
The triangle of doom was always silly. There is no microeconomic reason to constrain prices to be in that sort of triangle from the extension of price-time lines. It’s like technical stock trading–voodoo bullshit.
It was always silly that James Hamilton allowed that stuff to repeatedly be posted on his site and never once pointed out the fallacy. Then again, he is a fluffy macro type who lacks micro analytics (e.g. cost curve construction).