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Shale gas: ‘The dotcom bubble of our times’

Shale gas: ‘The dotcom bubble of our times’ thumbnail

Comment: output from shale wells declines so quickly that they will never be profitable – when investors realise this, the industry will collapse, writes Tim Morgan

Public opinion has been divided very starkly indeed by the government’s invitation to energy companies to apply for licences to develop shale gas across a broad swathe of the United Kingdom.

On the one hand, many environmental and conservation groups are bitterly opposed to shale development. Ranged against them are those within and beyond the energy industry who believe that the exploitation of shale gas can prove not only vital but hugely positive for the British economy.

Rather oddly, hardly anyone seems to have asked the one question which is surely fundamental: does shale development make economic sense?

My conclusion is that it does not.

That Britain needs new energy sources is surely beyond dispute. Between 2003 and 2013, domestic production of oil and gas slumped by 62pc and 65pc respectively, while coal output decreased by 55pc. Despite sharp increases in the output of renewables, overall energy production has fallen by more than half. A net exporter of energy as recently as 2003, Britain now buys almost half of its energy from abroad, and this gap seems certain to widen.

The policies of successive governments have worsened this situation. The “dash for gas” in the Nineties accelerated depletion of our gas reserves. Labour’s dithering over nuclear power put replacement of our ageing reactors at least a decade behind schedule, and a premature abandonment of coal has taken place alongside an inconsistent, scattergun approach to renewables.

Those who claim that Britain faces an energy squeeze are right, then. But those who claim that the answer is using fracking to extract gas from shale formations are guilty of putting hope ahead of reality.

The example held up by the pro-fracking lobby is, of course, the United States, where fracking has produced so much gas that the market has been oversupplied, forcing gas prices sharply downwards.

The trouble with this parallel is that it is based on a fundamental misunderstanding of the US shale story.

We now have more than enough data to know what has really happened in America. Shale has been hyped (“Saudi America”) and investors have poured hundreds of billions of dollars into the shale sector. If you invest this much, you get a lot of wells, even though shale wells cost about twice as much as ordinary ones.

If a huge number of wells come on stream in a short time, you get a lot of initial production. This is exactly what has happened in the US.

The key word here, though, is “initial”. The big snag with shale wells is that output falls away very quickly indeed after production begins. Compared with “normal” oil and gas wells, where output typically decreases by 7pc-10pc annually, rates of decline for shale wells are dramatically worse. It is by no means unusual for production from each well to fall by 60pc or more in the first 12 months of operations alone.

Faced with such rates of decline, the only way to keep production rates up (and to keep investors on side) is to drill yet more wells. This puts operators on a “drilling treadmill”, which should worry local residents just as much as investors. Net cash flow from US shale has been negative year after year, and some of the industry’s biggest names have already walked away.

The seemingly inevitable outcome for the US shale industry is that, once investors wise up, and once the drilling sweet spots have been used, production will slump, probably peaking in 2017-18 and falling precipitously after that. The US is already littered with wells that have been abandoned, often without the site being cleaned up.

Meanwhile, recoverable reserves estimates for the Monterey shale – supposedly the biggest shale liquids play in the US – have been revised downwards by 96pc. In Poland, drilling 30-40 wells has so far produced virtually no worthwhile production.

In the future, shale will be recognised as this decade’s version of the dotcom bubble. In the shorter term, it’s a counsel of despair as an energy supply squeeze draws ever nearer. While policymakers and investors should favour solar, waste conversion and conservation over the chimera of shale riches, opponents would be well advised to promote the economic case against the shale fad.

Tim Morgan was global head of research at Tullett Prebon 2009-13 and is the author of ‘Life After Growth’


21 Comments on "Shale gas: ‘The dotcom bubble of our times’"

  1. Northwest Resident on Mon, 4th Aug 2014 9:16 am 

    Another really good angle on the dismal future of shale extraction which I posted on an article here yesterday, but just to make sure you didn’t miss it:

    Wolf Richter: How Fracking Is Blowing Up Balance Sheets of Oil and Gas Companies

    “Now even the Energy Department’s EIA has checked into it and after crunching some numbers found:

    Based on data compiled from quarterly reports, for the year ending March 31, 2014, cash from operations for 127 major oil and natural gas companies totaled $568 billion, and major uses of cash totaled $677 billion, a difference of almost $110 billion.

    To fill this $110 billion hole that they’d dug in just one year, these 127 oil and gas companies went out and increased their net debt by $106 billion. But that wasn’t enough. To raise more cash, they also sold $73 billion in assets. It left them with more cash (borrowed cash, that is) on the balance sheet than before, which pleased analysts, and it left them with a pile of additional debt and fewer assets to generate revenues with in order to service this debt.

    It has been going on for years. In 2010, the hole left behind by fracking was only $18 billion. During each of the last three years, the gap was over $100 billion. This is the chart of an industry with apparently steep and permanent negative free cash-flows:”

    nakedcapitalism dot com/2014/07/fracking-blowing-up-balance-sheets-old-companies.html

  2. Plantagenet on Mon, 4th Aug 2014 10:39 am 

    If fracking for gas doesn’t make economic sense, then it will quickly collapse just as the dotcom bubble quickly collapsed. But not everyone thinks gas fracking will quickly collapse—President Obama, for example, boasted that thanks to fracking the US now has a 100-year-long supply of NG

  3. kuidaskassikaeb on Mon, 4th Aug 2014 10:46 am 

    You know the dot com bubble did give us the internet. Profits don’t always follow from good ideas.

  4. shortonoil on Mon, 4th Aug 2014 10:51 am 

    And since day one, we have been calling the shale fiasco the “sub prime mortgage scheme of all times”. Jean Laharerre just shorten it to “a Ponzi” scheme. Short, and simple is probably better. The basic idea of the scheme is simple, and its life span will be short. Our argument is also simple; if an energy production process can not operate energy positive it doesn’t work. The shale fiasco is simply not energy positive. To get around that little problem the scheme to date has simply been to steal from Peter to pay Paul. The shale industry has used a simple little trick developed by the financial industry to do the thievery. It is called debt. That works fine until Peter finds himself tapped out, or smartens up. Simply put, you eventually get to the end of the rope. Hope we made this simple?

  5. Davy on Mon, 4th Aug 2014 11:23 am 

    Short in most Ponzi schemes the turning point leads to tears for individuals but in our case as a country it could lead to something worse with this “Shale Scheme”. Mal-investment in a vital area of our energy economy is extremely risky yet that is what is happening. If the debt was not bad enough but it goes further in creating poor market decisions which are distortions and most likely will shut in vital investment. All this was done for Wall Street psychopathic greed and energy cornucopian fantasy. I am not saying all the shale effort was dubious economically. My point is the effort as we see today with the debt, mal-investment, and the Wall Street Skim is simply wrong. It is wrong because it is personal profit that socializes the resulting energy risk. It may have delayed an energy crisis but in the process it further increased the instability potential of our energy systems. Personally it is my opinion that despite shale being a net energy negative now or soon, it still is a much needed liquid fuel that needs to be subsidized by other energy sources. This does not mean a bubble. What this means to me is a mitigation tool not a Ponzi scheme.

  6. ronpatterson on Mon, 4th Aug 2014 12:00 pm 

    kuidaskassikaeb wrote: “You know the dot com bubble did give us the internet. Profits don’t always follow from good ideas.”

    Surely you realize you have the cart before the horse here. The internet gave us the dot com bubble, not vise versa. Without the internet, which obviously came first, there would have been no dot com at all.

  7. Northwest Resident on Mon, 4th Aug 2014 12:03 pm 

    ronpatterson — You don’t post here much, but when you do, you tend to really drive a stake through the heart of the matter. Your above post is definitely an example of that. Like, duh….

  8. rockman on Mon, 4th Aug 2014 12:30 pm 

    “…does shale development make economic sense? My conclusion is that it does not.” With all due respect to Tim’s vast experience developing fractured reservoirs his conclusion is not relevant. OTOH no one’s opinion (optimistic/pessimistic) is relevant IMHO: there hasn’t been enough testing yet.

    As far as shale gas being a potential bubble…well Da!. In fact, double Da!!. Every oil/NG play ever developed has been a “bubble”. Either the play becomes fully developed and drilling stops or the economics becomes unsustainable usually due to falling prices and drilling stops. The bubbles burst for all the conventional oil trends in the mid 80’s when prices fell as low as $10/bbl. The east Texas shale gas bubble of 2008 burst when prices fell from $12/mcf to less than half that amount. The much acclaimed Deep Water Brazil oil play could easily turn into a “bubble”: just drop oil prices low enough.

    All resource plays are “bubbles”: they boom in good economic times and bust in bad times. Always have…always will. For one reason or the other there has never been a sustainable play in the history of the oil patch.

    Calling any of the current trends bubbles doesn’t require much analysis: they’ll all bust if prices collapse or until most of the locations in each trend are drilled. Very few situations on the planet last forever. As far as some companies currently digging themselves into financial graves…well double Da!! again. That has happened to some companies throughout the entire history of the oil patch: during good times/high prices and bad/times. In fact, during my four decades in the oil patch I’ve yet to see as much financial damage done to the industry as the drilling boom that started in the late 70’s. Folks think we’re booming with 1,800 rigs drilling today. Ha! In that earlier boom we had more then 4,500 rigs drilling. I worked for one company back then that spent $550 million to find $60 million worth of oil/NG. The “boom” today pales in comparison.

  9. JuanP on Mon, 4th Aug 2014 1:01 pm 

    Plant, are you agreeing with Obama or being sarcastic?

  10. Nony on Mon, 4th Aug 2014 1:44 pm 

    1. The fast decline is really not that much an issue. For one thing, the people making bets get a very quick return. Either they were right or wrong. It’s not like drilling some project in the Caspian or deepwater or the like where you don’t know for 5-10 years the outcome.

    2. Production can/will turn on and off with price. But that’s more of a bug than a feature. From a financial perspective, it’s actually desirable. (Not a financial bubble. Maybe from a counting the barrels point of view, its a bubble, but not from investments.)

    3. Shale gas looks very, very strong for the long term. It’s already half of US production. The Marcellus has just a HUGE amount of gas reserve and wells that have extremely high IPs. It’s outperformed every forecast. And it’s waiting on infrastructure to do even more. And the local field prices are as low as one and half dollars less than current, low price of ~4 in some areas. It’s not going away for a long, long time. Rogers and Berman look really silly for their 2009 remarks about the Marcellus based on they Haynesville data!

  11. Arthur on Mon, 4th Aug 2014 2:05 pm 

    The dot-com metaphore is not really convincing. IT is still a lucrative business.

  12. Plantagenet on Mon, 4th Aug 2014 2:18 pm 

    JuanP: I’m just pointing out the facts—President Obama has the considerable technological and regulatory apparatus of the federal government at his disposal, and based on this dataset and his industry contacts and his personal knowledge of fracking for NG, Obama predicted the US would have enough NG to last for another century thanks to fracking.

  13. JuanP on Mon, 4th Aug 2014 2:34 pm 

    Plant, I know that, but do you agree with Obama on this? I’m just saying cause you tend to be against Obama all the time and agreeing with him on this would do you credit.
    I, personally, don’t think we’ll have that much gas for 100 years, but it could happen, for all I know, I am no expert on the subject.

  14. rockman on Mon, 4th Aug 2014 4:40 pm 

    Juan – I get the point you’re making. But let’s not stray from the simple fact that the statement “the US would have enough NG to last for another century” is meaningless. IOW at what price, at what production rate and at what demand level? Without those metrics and a few more that statement can mean anything a person attributes to it. Which logically says it has no meaning.

  15. JuanP on Mon, 4th Aug 2014 5:00 pm 

    Rock, of course the statement is meaningless, just another pacifier for the masses, “We have 100 years of gas” from the mouth of the US president sounds very reassuring to people who don’t know about the details and never will.
    My understanding is that some shale gas has been sold below production costs in the USA for years, and prices will have to rise some at some point to meet costs. Am I right in that? I understand and agree that everything is about costs and prices.
    I was mostly picking on Plant in a friendly way.

  16. Nony on Mon, 4th Aug 2014 5:27 pm 


    The Vegas odds say that prices will rise very little and slowly (less than inflation even). See here:

  17. dissident on Mon, 4th Aug 2014 5:47 pm 

    So let’s get this straight: the USA is planning to use fracked natural gas to shift away from coal for electricity generation, use natural gas for transport, and supply the EU with LNG to free it from the paws of the evil Russian bear. That’s some nasty crack the US is smoking. It has LSD side effects.

  18. kuidaskassikaeb on Mon, 4th Aug 2014 9:31 pm 

    Ron Patterson wrote
    ” Surely you know the internet gave us the dot com bubble and not visa versa”

    No I don’t know that. Where I was there was a parallel optical fiber bubble, which did give us the physical internet. In the 19th century the railroad bubbles gave us railroads, while the tulip bubbles did nobody any good. The shale oil dot com analogy just doesn’t work. How investors make out is a bad indicator of how good an idea is.

    Basically people did figure out the internet was going to be big, and well things got a little out of hand. But shale oil is a business that should not have cash flow problems. Big oil should have the cash flow issues. Fracking has fast decline rates, and one should get their money out fast. It seems that most operators are hoping for al 30 year well life to pay back loans. This suggests they’re not getting one.

  19. rockman on Tue, 5th Aug 2014 6:34 am 

    Juan – Understood. I think most here realize the silliness of such statements. And yes…you’re correct. But another picky point: not being sold below “production costs” (what a company spends to keep and existing well producing). But being sold below “development (or drilling/completion) costs”. Folks often miss the distinction and it can lead to arguments where there really isn’t much of reason.

    A well might have cost $6 million to drill and complete but only costs $3,000/month in LOE (Lease Operating Expense). The well nets $30,000/ month so it’s produced. But with a low URR it will never recover the $6 million. But as long as cash flow is positive it will be produced.

    But that doesn’t just work on the production cost side of the ledger. A real life example: I drill a conventional NG well that costs $6 million to get to the evaluation stage. The reserves indicate it will only recover $4 million in net production. But it will only cost $2 million to complete. So the well is completed with a total cost of $8 million and thus loses $4 million. But the go forward decision costs $2 million to make $4 million…2:1 on my money so I complete it. The $6 million is “sunk costs” and doesn’t enter the decision making process about completing it.

    So yes: a lot of producing shale wells will never recover their total investment. And I’ve completed more than a few wells I was pretty sure would never recover their total investments. Public companies are especially pushed hard to complete marginal wells even if they doubt they’ll make a profit even on the completion costs: better to report completing a “successful well” then plugging a dry hole.

  20. Nony on Tue, 5th Aug 2014 8:09 am 

    There’s a metric butt ton (an actual official energy unit) of natural gas in the Marcellus at under $5.

    The problem for Rock in the GOM is that Marcellus gas is outcompeting him. Someone else makes it cheaper. ‘s truth.

    We already had the glut and the correction from it. Those sub5 NG prices are long term.

    If you need $8 (Berman, Rock), you are going to be waiting a generation for that. The Marcellus is HUGE.

  21. JuanP on Tue, 5th Aug 2014 8:42 am 

    Thanks Rock, I meant to say all exploration, development, leases, and production total costs and used the wrong word, betraying my ignorance of the subject. Glad you understood my meaning.

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