" The Natural Gas 'Ponzi Scheme'"

[dorlomin]

Seeking Alpha

Our analysis of shale gas well decline trends indicates that the estimated ultimate recovery (EUR) per well is approximately one-half of the values commonly presented by operators. The average EUR per well for the most active operators is 1.3 Bcf in the Barnett, 1.1 Bcf in the Fayetteville, and 3.0 Bcf in the Haynesville shale gas plays.

The primary difference between our analysis and the typical well profile proposed by operators is that we observe predominantly exponential (weak to moderate hyperbolic) decline in most of the individual well decline trends, rather than steadily flattening hyperbolic decline. For the Barnett and Fayetteville shale plays, we identify a two-stage exponential decline based on decline curve analysis (DCA) of individual wells; for the Haynesville Shale we observe predominantly exponential decline for individual wells.

In 5 years Congress will shamefully trot out the executives of these companies, putting on a show for the public as they publicly condemn them for what turned out to be a giant investment scam. However, none of them will be willing to admit they were warned when ahead of time by the likes of Arthur Berman, The New York Times, The Rolling Stone, and other sources. It will all play out just like every other scandal we have seen over the past 13 years, from the dot com bubble to the housing boom to the Madoff Ponzi Scheme, etc.

Link

Natural Gas Rig Count: The natural gas rig count decreased for the seventeenth time in 20 weeks to 452 (a drop of 21 rigs from the previous week). As per the most recent report, the number of gas-directed rigs is at their lowest level since July 9, 1999 and is down 52% from its 2011 peak of 936, reached during mid-October.

The current natural gas rig count remains 72% below its all-time high of 1,606 reached in late summer 2008. In the year-ago period, there were 892 active natural gas rigs.

Obviously the move to oil is still a big story. But the NG hype is dying.

[pstarr]

and then the move to tight-shale oil hype will die. Leaving a lot of investors (see OF and SOS) holding worthless penny stocks.

[Plantagenet]

Actually, the drilling is slowly down because the NG supply has ballooned and the price of NG has dropped. The low price is already attracting more NG users (For intance, coal fired power plants are switching to NG as quick as they can). Eventually the drilling slowdown and the increased use of NG will lead to a recovery in NG prices. Then drilling will resume. Somewhere down the road there will be more cycles of boom and bust, which will surprise the investment novices again.

I'm surprised you guys don't know that boom and bust cycles are very common in all commodities--


for example: commodity boom bust cycles in Africa

[rockdoc123]

Plant....a good point that many seem to miss. Thanks for reminding the dull-witted once again!

I can't remember what thread it was on but I've mentioned that many of the "analysts" like Berman do not actually have access to the detail data that the industry players do. They end up making assumptions based on publically available data which results in very misleading conclusions.

The breakeven for some of the shale gas is at a price lower than current spot, but for much of it the breakeven is higher. And the shale gas wells that have some liquid content are still very economic. As a consequence gas production is still pretty strong and hence you haven't seen the slingshot effect in production and prices you used to see due to low price and shutin wells. This is why gas storage still remains high.

[Pops]

You argue with an empty chair.

The argument isn't that the current low level of drilling indicates fracked gas is unprofitable but just the opposite, that it is so profitable and it has such huge potential that the leases that are up for sale are incredibly valuable. In fact the current "glut" plays nicely into the storyline - lookie, lots of gas.

The story is actually that the booked reserves - resources - are inflated if not fraudulent, hence the title: Ponzi Scheme. Actually it gives "pump and dump" a new twist.

Here from Deb Rogers:

The Magic of Shales

[Plantagenet]

Interesting.....The Rogers article says a big part of the problem with the inflated NG reserves is that the Obama administration's regulatory commission (the SEC) recently changed the reporting rules to allow NG companies more "freedom" to book reserves (i.e. they don't have to prove up the resource as they did in the past). I hate it when Obama appoints his cronies to these regulatory boards instead of people who actually work in the industry and know something about it----the liberal lawyers don't understand how industry works. We saw this kind of thing happen when Obama appointed one of his cronies to head up MMS---then the MMS gave BP "waivers" from the environmental laws so they could drill the biggest and deepest ever US oil well spill. THis sounds like the same king of thing but for NG--- now the Obama cronies have screwed up the regulations that formerly required STRICT reporting of NG reserves.

IMHO the rules should be changed back to the way they were four years ago, so they would once again require a more strict accounting for reserves by the NG companies. Then these problems with "inflated" reserves would be mitigated.

[Pops]

The rules were rewritten in '08.

[Plantagenet]

The rules were rewritten in '08.

You are right and I was wrong---sorry---...the new rules went into effect on December 31st 2008. So these rules were put in place by the SEC in the very last days of the Bush Administration, and then were in effect through the entire Obama administration. Four years seems like enough time for the SEC and the Obama folks to figure out these rules aren't working. Perhaps as we approach the end of 2012 the SEC will once again revisit the NG reserve regulations and perhaps go back to the rules that were in effect prior to Dec. 31, 2008 .

[rockdoc123]

Sorry Pops but this article is just another classic conspiracy theory

from that article:

how could this happen?

BHP claims they did thorough due diligence on the assets and the impairment is strictly due to the drop in the price of natural gas. But there is another possible scenario. And unfortunately it isn’t peculiar to the deal involving BHP. It is endemic to shales.

Suppose you have a company that is highly leveraged whose wells are underperforming. Cash flow, therefore, is negative. Such a company would have a serious problem because it desperately needs continued access to the capital markets to keep operations going. It can’t do it from cash flow. So how does management get access to funding? They book reserves…aggressively.

this is not possible. Under SEC and OSC regulations all publically traded North American companies must have their reserves first signed by internal qualified reserves auditor and then by an independant third party. Having been in the position of internal qualified reserve sign off I know what is expected and how tight the rules are, there is very little leeway. Once it gets to the third party audit the auditor (eg: Gaffney Cline, Sproule, Degolyer MacNoughton etc) must sign off and when the Sorbanes Oxely regulations were put in place these auditors now put themselves in a position of legal responsibility (they can be pursued by the SEC/OSC for approving reserves improperly). As a consequence the third party auditors are very careful as to what they classify as reserves. PUDs are subject to rules that mainly are a response to price. Because the price can be averaged over the year PUDs get some relief because of the generally higher gas prices that are seen in the winter and spring and more recently in certain parts during the summer. If you were paying attention you would have seen that companies such as Encana and Chesepeake took a hit on PUDs a couple of years ago. The issue here is not that the gas isn't there or that it can't be recovered it is just that it needs a certain price to make it happen. For companies such as Chesepeake with very large PUDs it is nearly impossible to have the capital in any given year to convert much of those PUDs to PDs. The SEC realizes this and does give some leeway. What they do not give leeway on is inventive reserve calculations. I still have in my bookshelf the three volumes of COGEH (Canadian Oil and Gas Evaluation Handbook). They are huge volumes and go into every detail of the technical and economic hurdles required for booking. My point is the system is well prescribed and difficult to maneuver around.

And interestingly, if the SEC had not changed the rules, it would have been much more difficult to engage in this exercise simply because the reserve definition was greatly expanded to include PUD’s. As it turns out, as much as 40% or more of booked reserves at some shale companies, including PetroHawk and Chesapeake, are actually PUD’s which weren’t allowed under the old rules.

There was a reason for the change. The SEC wanted to avoid arguments around what was proven versus probable reserves. As a consequence they built a category in between simply because the reserves that are now classified as proven undeveloped were more certain than probable (by definition proven is 90% likely to be economic whereas probable is only 50% likely to be economic) but required additional capital to drill laterals and frac in order to bring them onto production. This wasn't some whimsical decision that was made. There was a working group comprised of representatives from AAPG, SPE and the SEC that worked on this for a couple of years prior to the changes being made.

Another aspect to this story may have been serendipitous for cash strapped operators. Since the rules for oil and gas were new, there was no precedent as to how they should be applied by operators. A certain amount of time was needed for the SEC to get a handle on just how the new rules would be applied.

Not true. They new exactly how the rules should be applied but what they needed to see was a number of years of reporting as they recognized that even with the comprehensive reserves reporting regulations they put in place there would be oddities that fell outside of their original definitions and the rules would have to be refined. These were not major changes.

The idea that there are a bunch of companies out there lying about their reserves is unreasonable to believe and also there is not good examples that can be given. And finally I need to point out that if those PUDs lost their status they would become Probable reserves. The SEC allows for reporting of Proved plus Probable reserves and every financial analyst I've ever dealt with uses P+P and not just P1 to calculate out valuation. So really this is a tempest in a teapot.

[Pops]

Actually doc, in the Rogers article she says that the SEC found " 84% of the companies were not in compliance with the new SEC rule." So even though it may be as you say and the rules are not easy to get around, it seems to me they are instead simply ignored.

According to company filings, the number of years shale companies would need to develop their PUD’s turns out to be significantly greater than 5 years.

According to the Oil and Gas Financial Journal:

Devon Energy. 9.1 years
Range Resources. 11.8
Chesapeake Energy 13.1
Apache Corp. 15.1

And just for a little comic relief:

W&T Offshore. 104.56

Not one of these companies is in compliance with the 5 year rule.

Those numbers are somewhat important in the overall publicity war but are really just a guess of how many wells the companies plan to drill, right?

---


I think I got us off track on PUDs from what to me seems the much more important wrinkle, which is the point in the original line in the original quote in this thread:

Our analysis of shale gas well decline trends indicates that the estimated ultimate recovery (EUR) per well is approximately one-half of the values commonly presented by operators.

New reporting rules written by the oil cos under an oil centric administration, "new" technology and "new" resources enabled by higher nat. gas and oil prices, a rush to get leases secured and proved and of course the old stand by of "low hanging fruit" being reported as average output and decline, don't you see the possibility of a bubble in both lease prices and estimated reserves?

[rockdoc123]

Those numbers are somewhat important in the overall publicity war but are really just a guess of how many wells the companies plan to drill, right?

The only significance is how much can a company afford to drill and hence prove up combined with the sense that fluctuating prices make it a moving target. The PUDs associated with shale gas are very low risk, the only uncertainty is whether the depletion curve will sit above or below the type curve for that particular shale reservoir. If a company had unlimited funds for drilling, prices were robust and there were no issues with access to market or access to rigs and fracing equipment, PUDs would almost certainly be converted to PDs very quickly. But in the real world those things don’t line up and hence drilling gets delayed. Again the important point is those reserves are still there, their classification is just different.

I think I got us off track on PUDs from what to me seems the much more important wrinkle, which is the point in the original line in the original quote in this thread:

I’ve pointed out before where the comment made by the author is basically BS when you look at what is happening in the industry. Berman works from publically available records and does not have access to the wealth of detailed data that companies such as Chesapeake have. There are a lot of papers published in SPE that justify the understanding that shale depletion curves are two phase, an early phase that is quite steep followed by a low period during which the depletion curve is quite flat. These papers also show very good matches to the type curve EURs, which disagrees with the conclusions reached by Berman. Many of the comments I have seen in this regard simply are looking too early in the wells production history. There are bad wells, either poorly completed, have fewer good fracs etc. and hence they will deviate from the type curves. The attraction of shale gas is that it is a statistical play….if you drill enough wells, and pay close attention to fracing and completing your results will statistically match the determined EUR/well based on type curve matching. If the business wasn’t working right companies would not still be spending like they are.

don't you see the possibility of a bubble in both lease prices and estimated reserves?

Definitely a bubble in lease prices simply because there are two many companies competing for land access. You can see these prices starting to fall as of last year. Some companies are even letting leases revert back to the landholders. This is the nature of the oil and gas business however, no different for conventional. Higher commoditly prices result in more small start-ups which results in more competition and hence higher entry prices.
With regards to a bubble on reserves I don’t think so. Those reserves are there in the ground, their category (P1, P2, P3, contingent resource etc) is certainly determined by price but it is not like they are going to disappear off the face of the earth simply because of a short term glut of gas and hence low commodity prices. As Plant said the market fluctuates over time with supply a response to price as much as price is a response to supply. The only scenarios I can see where you might never get to see all of that gas is if there is 1. Developed alternatives that can replace natural gas, or 2. Manpower and equipment costs that continue to rise out of step with the commodity price. The shale gas business is a very marginal one from an economic standpoint and costs need to be managed. In a runaway cost scenario shales could become uneconomic for a very long time.

[Pops]

With regards to a bubble on reserves I don’t think so. Those reserves are there in the ground, their category (P1, P2, P3, contingent resource etc) is certainly determined by price but it is not like they are going to disappear off the face of the earth simply because of a short term glut of gas and hence low commodity prices. As Plant said the market fluctuates over time with supply a response to price as much as price is a response to supply.

Thanks doc. I understand at least somewhat how reserves operate but the argument is in fact, that the reserves will disappear because they were never there in the first place.

You said that the reporting rules are strict yet I'm thinking maybe they aren't as strict now as you remember, as pointed out above regarding the 5-year rule. Take a look at this post by Rogers if you would. It points to several instances of, shall we say, irrational exuberance in the performance reports of wells and EURs by CHK and others. The authority is not just Berman but TRC, USGS and other analysts.

I think I posted that article by Rogers somewhere already, maybe you've already talked about it...

[seenmostofit]

I think I posted that article by Rogers somewhere already, maybe you've already talked about it...

deborah-rogers-nothing-hyped-more-than-fracked-gas-t66597.html

A point of order on the basis of her claim (versus her expertise on the topic which might make any of her opinions problematic), isn't the prevailing opinion on the USGS generally a bad one, if only because they disagree with...well....whatever we need them to disagree with on a given topic?

the-us-geological-survey-usgs-thread-merged-t531.html