Wednesday, May 02, 2012

Shale Revolution Links

1. Ukraine has fields of shale rocks that the U.S. Geological Survey estimates will hold enough gas to fire the eastern European nation for 100 years or more. Royal Dutch Shell, Exxon Mobil, and Chevron -- three of the world’s four largest oil companies -- bid last week for Ukrainian exploration rights.

2. Royal Dutch Shell is in the preliminary stages of feasibility and design work on a potentially huge, $10 billion, 2 million gallon per day Gas-to-Liquids (GTL) facility in Louisiana, using abundant natural gas feedstock. This development is important for several reasons:  it validates the long-range forecast of persistently high volumes of economical natural gas.  Since the plant would not enter production until 2014 at the earliest, a gigantic, experienced GTL and gas producer must be confident that natural gas prices will remain a relative bargain, and that this will continue for a long time into the life of the plant.

3. Britain may have enough offshore shale gas to catapult it into the top ranks of global producers, energy experts now believe, and while production costs are still very high, new U.S. technology should eventually make reserves commercially viable.

4. Houston-based Cheniere Energy is one of a number of companies that plan to export surplus U.S. gas. For global energy markets, that is a change of potentially huge proportions.  This development could recast a world gas trade long dominated by a handful of energy superpowers – countries including Russia, Qatar and Algeria.

It is difficult to exaggerate the significance of this shift and its consequences for the business model of the big gas suppliers.  Not only will US exports be cheap – they could also be plentiful. Eight projects with a total export capacity of 120m tonnes a year have been proposed, according to Wood Mackenzie, a consultancy. If all are approved and built, the US could become one of the world’s biggest LNG producers.

HT: Jon Murphy

13 Comments:

At 5/02/2012 1:53 PM, Blogger juandos said...

"Britain may have enough offshore shale gas to catapult it into the top ranks of global producers"...

Well that's good! That's real good considering how the green energy revolution was/is an abysmal failure and financially ruinous...

 
At 5/02/2012 8:09 PM, Blogger Benjamin said...

The green revolution failed in Great Britian? They tried pink-o, socialist, mandated ethanol too?

What a bunch of four-flushing, fey, phallic defenestrators.

 
At 5/02/2012 8:37 PM, Blogger C said...

Should we be exporting U.S. surplus gas?

Taking the long view, exporting seems shortsighted.

 
At 5/03/2012 8:18 AM, Blogger Jon Murphy said...

Taking the long view, exporting seems shortsighted

Why?

 
At 5/03/2012 7:15 PM, Blogger Craig Howard said...

Taking the long view, exporting seems shortsighted.

Um, the gas isn't "ours." It belongs to the people who drill for it. I would suggest that it's shortsighted to forbid them to make a profit from it.

 
At 5/03/2012 8:47 PM, Blogger VangelV said...

It is difficult to exaggerate the significance of this shift and its consequences for the business model of the big gas suppliers.

LOL. It is not difficult for you to exaggerate the significance of any bubble Mark. Keep in mind that the shale producers have lost massive amounts of money because their cost of production is much higher than the market prices that are attracting the new investments that you are touting. One side or the other has to be wrong. In all probability both will likely prove to be wrong.

Not only will US exports be cheap – they could also be plentiful.

How the hell can you export product at a price that is lower than the cost of production? Is this some economic model that you are touting?

Eight projects with a total export capacity of 120m tonnes a year have been proposed, according to Wood Mackenzie, a consultancy. If all are approved and built, the US could become one of the world’s biggest LNG producers.

Wells cost $5-$10 million to drill. They are depleted within two years. The EUR is too high and the real recovery rate is insufficient to generate a positive cash flow. That makes this one massive bubble just like tech and hosing were. And once again you tend to ignore the reality.

 
At 5/04/2012 11:17 AM, Blogger ranger275 said...

I have no idea if VangelV is right, but I don't understand if it is so obvious you can't make money at these gas prices why do companies whose very existance depends on understanding the energy market keep investing so much money? It is one thing to keep drilling after the intial cost is sunk, it is another thing to bid on new projects. The housing bubble was driven by non-professionals and professionals looking at a short time frame, neither of which apply to these energy companies. Wasn't the tech bubble driven by start-ups? These natural gas investments are being made by people with a long, successful history in the business.

 
At 5/04/2012 3:54 PM, Blogger VangelV said...

I have no idea if VangelV is right, but I don't understand if it is so obvious you can't make money at these gas prices why do companies whose very existance depends on understanding the energy market keep investing so much money?

Let me make it clear. Many of the producers acquired leases in the expectation of much higher prices and operating profits. These sit on the asset side of the balance sheet. To maintain ownership of the leases you have to keep drilling even if prices are low and you lose money.

So far it is easy to understand. Here comes the trickier part.

Now you are drilling and losing money. But the SEC comes in and helps you out. In the US there is no NI 43-101 equivalent so you do not really have to prove up the shale reserves you are claiming. What you do is overestimate how much gas there is in place and come up with an estimate of ultimate recovery that can generate a profit because your well costs get amortized over a longer time period.

In your filings you report a small profit or a small loss but show a lot of negative cash flow. Given the very easy money policies there is always some way of getting cash even if you have to resort to the type of tricks that Aubrey McClendon is using and is being investigated for.

What happens if you stop drilling? Well, in that case you have to write down the leases. That will mean immediate bankruptcy as your equity is wiped out. As a manager of the company you are out and do not get all of the money you were hoping to earn over the next few years.

The incentives are very simple. Keep drilling even if you are losing money and you get rewarded. Stop chewing through capital and you are ruined sooner. So what exactly is the rational choice?

It is one thing to keep drilling after the intial cost is sunk, it is another thing to bid on new projects.

As I pointed out above, you lose the leases if you stop. That means writing off the costs, negative equity, and bankruptcy.

 
At 5/04/2012 3:56 PM, Blogger VangelV said...

The housing bubble was driven by non-professionals and professionals looking at a short time frame, neither of which apply to these energy companies.

Of course the short term applies. Once you have all kinds of legal obligations you need to keep meeting those obligations or wind up being ruined.

Wasn't the tech bubble driven by start-ups? These natural gas investments are being made by people with a long, successful history in the business.

Human nature is what it is. The history of the oil business is full of booms and busts. That is not about to stop.

 
At 5/07/2012 8:35 AM, Blogger ranger275 said...

VangelV,
I understand why you would have to keep drilling after you paid for the lease, but these companies are bidding on rights to explore in Ukraine where I assume they haven't spent any money on leases yet. Is your point they expect gas prices to go up enough to make a profit? Also why would Royal Dutch Shell invest in a GTL if they expect prices to rebound, wouldn't that make the GTL a money loser? Or will the price be high enough to make money getting it out of the ground but low enough for GTL to be profitable?

I also understand why companies employ accounting games to look better in the short term, but if it is public knowledge what they are doing how can they get new money to invest in them? Thanks for your reponses.

 
At 5/07/2012 10:12 AM, Blogger VangelV said...

VangelV,
I understand why you would have to keep drilling after you paid for the lease, but these companies are bidding on rights to explore in Ukraine where I assume they haven't spent any money on leases yet.


You have to look at which companies are bidding. If you are a small player who needs cash flow to survive you will not bid for any of those leases. But if you are a large conventional producer losing money is not a problem because shale gives you a way to hide your decline in reserves.

The SEC allows producers to use the 6:1 boe conversion even though the price ratio is much higer. A bigger issue is the fact that reserves do not have to be strictly proven to be claimed. A company can pick the EURs that it wants to use and use a simple trick to hide the decline. That means that the company can protect its market share by blowing a billion or two on unprofitable operations even as it seeks to increase its conventional reserves by using its overvalued paper as acquisition currency.

Is your point they expect gas prices to go up enough to make a profit? Also why would Royal Dutch Shell invest in a GTL if they expect prices to rebound, wouldn't that make the GTL a money loser? Or will the price be high enough to make money getting it out of the ground but low enough for GTL to be profitable?

As I pointed out, the EURs and conversion ratios allow the large players to hide very serious reserve declines. You can make money from the core areas of the best shale formations but those are a tiny fraction of the total formations. For shale in general you need to invest more energy to drill, produce, and transport the gas than there is in the gas that comes to market.

I also understand why companies employ accounting games to look better in the short term, but if it is public knowledge what they are doing how can they get new money to invest in them? Thanks for your reponses.

Look at the SEC investigation into the dealings of Aubrey McClendon. Companies can use off balance sheet vehicles to hide debt problems as Enron did. They can also use hedge funds to attract investments into activities that will make them rich but will wipe out shareholders eventually. And do not underestimate the effect of the promoters. When they spin a nice story many people will step up and risk their pension savings for a chance to get very rich on the newest next big thing. This is not new. We have already seen money flow into uranium, moly, zinc, potash, and now graphite because the promoters told a good story. Some of the companies will do well but most of the money invested will disappear into the pocket of promoters.

If you live anywhere near Toronto I suggest that you take a day or two to visit the PDAC. You will see thousands of companies looking for investment all with a great story to tell. Out every thousand companies there ten will turn an investment of $10K into $1 million within five to ten years. The problem is that half (500) will go to zero and most of the rest will have a small gain or loss that will be outperform the S&P 500 but not by so much that it justifies the much greater risk.

Whenever you get a lot of promotional activity it is better to stay away.

 
At 5/07/2012 1:52 PM, Blogger ranger275 said...

VangelV,
The following link seems to share your view on the situation. Tell me what you think.

http://www.declineoftheempire.com/2011/07/how-does-the-shale-gas-scam-work.html

 
At 5/07/2012 2:09 PM, Blogger VangelV said...

The following link seems to share your view on the situation. Tell me what you think.

http://www.declineoftheempire.com/2011/07/how-does-the-shale-gas-scam-work.html


The article fits nicely with what I have been arguing here. But there is one more issue that we need to deal with.

Even if much of what the companies said were true, and it isn't, the falling prices will force them to write off their reserves. The trouble is that few of the companies have the equity that will allow them to survive such write-downs. The regulatory and accounting tailwinds will turn into headwinds very soon. When they do you can expect many of the players to move to Chapter 11. The problem is that all those players will stop paying their bills. Money owed to the oil services companies will not be paid. That will set off a spiral that will destroy many of the boom ares much faster than they were built up.

 

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