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"Always With You It Cannot Be Done"

Category: Energy & Environment,Finance

Fracking oil and gas rig on a Mountain Side

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Recent reports about bankers’ demands that shale producers not increase upstream expenditure have caused some to be pessimistic about the outlook for shale production, up to and including last month’s “Shale Boom about to go Bust.”   Other stories have emphasized the poor financial performance of the sector, such as “A Gusher of Red Ink,” suggesting that shale is generally unprofitable and urging caution on investors.

 (Of course, as Robert Rapier points out, some appear to be using an incorrect measure of free cash flow by not treating depreciation and amortization as historical, not current, costs.)

Although there have been projections for shale supply that proved too rosy, the media attention often focuses on challenges facing the industry, implying bearish expectations.  Such pessimism is not new: it began with the initial skepticism about George Mitchell’s pioneering efforts to extract gas from shale and continued with an insistence that only gas from the Barnett shale would prove viable.  When other gas shales proved economical to produce, many insisted that oil molecules, being larger, would not flow through fracked shales.  When Bakken oil production proved successful, that success was attributed to the layer of dolomite which most other shales did not possess; when the Eagle Ford proved successful, it was said in 2013 that “each play is in effect its own ‘resource pyramid,’ characterized by a few small ‘sweet spots’.

Surging production from those and newer shales, notably the Permian, STACK and SCOOP, saw new concerns:  the rapid decline rate of shale wells would severely limit the supply available.   As one recent story put it, “The shale industry faces an uncertain future as drillers try to outrun the treadmill of precipitous well declines.”

This is similar to arguments long made by peak oil advocates: “a whole new Saudi Arabia [will have to be found and developed] every couple of years’’ to satisfy current demand forecasts.”  (Robert Hirsch, quoting Saddad al-Husseini 2005[i])  Unfortunately, he appeared not to notice the near-identical comment from Jimmy Carter in 1977:  “…just to stay even we need the production of a new Texas every year, an Alaskan North Slope every nine months, or a new Saudi Arabia every three years. Obviously, this cannot continue.”

Now, the arguments are focused on the supposed failure of shale producers to turn a profit.  “In the early stages of the fracking boom, investors tolerated negative cash flows from oil and gas producers, believing that the industry would eventually learn to produce cash as well as oil and natural gas. But most frackers never turned the corner. A few companies can now eke out modest positive cash flows, but the sector as a whole consistently fails to produce enough cash to satisfy its voracious appetite for capital.”

Again, this is not new. A 2011 story in the New York Times said “Money is pouring in” from investors even though shale gas is “inherently unprofitable,” an analyst from ... an investment company, wrote to a contractor in a February e-mail. “Reminds you of dot-coms.”  (The Times Public Editor subsequently suggested the article relied too much on the views of a few pessimists and inadequately explained that the story referred not to the industry as a whole, but to particularly aggressive independents.)

On the analytical side, many of these reports suffer from simplistic views, including a failure to recognize the dynamic nature of production methods.  The breakeven price in most if not all shales today is much lower than a decade ago.  Additionally, the massive losses that occurred when oil prices dropped in 2015 explain a lot of the poor performance of the industry when the returns of the past decade are aggregated.

But many of the pessimists appear to simply be biased, for example insisting that, “…no major new field discoveries are expected.”  This before the Permian had been developed.  Or the argument in 2010, when the Marcellus was first being tested, that “The same financial fundamentals that have hurt other shale plays apply to the Marcellus: difficulty identifying core areas, high marginal costs to produce shale gas, poor economics, the play area is so large that a lot more capital will be destroyed than in other shale plays.”

Interestingly, many of the shale pessimists were also active in the peak oil movement, and just as those promoting that idea expressed great certainty about a very uncertain issue, so many shale pessimists have great faith in their pronouncements.  “It takes an enormous leap of faith to see shale oil production rising another 2 mbpd from here, along with several leaps of logic, which the Citigroup report had in abundance.”

The critic bragged about relying on “cold, hard facts” but in fact, shale production has risen by 4 mb/d since then, even after prices dropped below levels said to be necessary to maintain production.  Not bad for a report derided as “amateurish” which made “extremely dubious claims.” (The same pundit trashed myself and others as peak oil denialists a decade ago.)

I once remarked to a peak oil advocate who, describing the many challenges the industry faced, reminded me of Luke Skywalker, who had to be told by Yoda, “Always with you it cannot be done.”  At some point, the pessimists need to explain how the industry has, by their view, defied gravity for well over a decade, continually increasing production as if a dozen pundits had not predicted otherwise (to paraphrase Charles Mackay’s description of the Thames refusal to comply with the London astrologers’ flood warning).

[i]   Hirsch, Robert “The Inevitable Peaking of World Oil Production.”  In:  Bulletin, Atlantic Council of the United States, October 2005.

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Fracking oil and gas rig on a Mountain Side

Getty

Recent reports about bankers’ demands that shale producers not increase upstream expenditure have caused some to be pessimistic about the outlook for shale production, up to and including last month’s “Shale Boom about to go Bust.”   Other stories have emphasized the poor financial performance of the sector, such as “A Gusher of Red Ink,” suggesting that shale is generally unprofitable and urging caution on investors.

 (Of course, as Robert Rapier points out, some appear to be using an incorrect measure of free cash flow by not treating depreciation and amortization as historical, not current, costs.)

Although there have been projections for shale supply that proved too rosy, the media attention often focuses on challenges facing the industry, implying bearish expectations.  Such pessimism is not new: it began with the initial skepticism about George Mitchell’s pioneering efforts to extract gas from shale and continued with an insistence that only gas from the Barnett shale would prove viable.  When other gas shales proved economical to produce, many insisted that oil molecules, being larger, would not flow through fracked shales.  When Bakken oil production proved successful, that success was attributed to the layer of dolomite which most other shales did not possess; when the Eagle Ford proved successful, it was said in 2013 that “each play is in effect its own ‘resource pyramid,’ characterized by a few small ‘sweet spots’.

Surging production from those and newer shales, notably the Permian, STACK and SCOOP, saw new concerns:  the rapid decline rate of shale wells would severely limit the supply available.   As one recent story put it, “The shale industry faces an uncertain future as drillers try to outrun the treadmill of precipitous well declines.”

This is similar to arguments long made by peak oil advocates: “a whole new Saudi Arabia [will have to be found and developed] every couple of years’’ to satisfy current demand forecasts.”  (Robert Hirsch, quoting Saddad al-Husseini 2005[i])  Unfortunately, he appeared not to notice the near-identical comment from Jimmy Carter in 1977:  “…just to stay even we need the production of a new Texas every year, an Alaskan North Slope every nine months, or a new Saudi Arabia every three years. Obviously, this cannot continue.”

Now, the arguments are focused on the supposed failure of shale producers to turn a profit.  “In the early stages of the fracking boom, investors tolerated negative cash flows from oil and gas producers, believing that the industry would eventually learn to produce cash as well as oil and natural gas. But most frackers never turned the corner. A few companies can now eke out modest positive cash flows, but the sector as a whole consistently fails to produce enough cash to satisfy its voracious appetite for capital.”

Again, this is not new. A 2011 story in the New York Times said “Money is pouring in” from investors even though shale gas is “inherently unprofitable,” an analyst from ... an investment company, wrote to a contractor in a February e-mail. “Reminds you of dot-coms.”  (The Times Public Editor subsequently suggested the article relied too much on the views of a few pessimists and inadequately explained that the story referred not to the industry as a whole, but to particularly aggressive independents.)

On the analytical side, many of these reports suffer from simplistic views, including a failure to recognize the dynamic nature of production methods.  The breakeven price in most if not all shales today is much lower than a decade ago.  Additionally, the massive losses that occurred when oil prices dropped in 2015 explain a lot of the poor performance of the industry when the returns of the past decade are aggregated.

But many of the pessimists appear to simply be biased, for example insisting that, “…no major new field discoveries are expected.”  This before the Permian had been developed.  Or the argument in 2010, when the Marcellus was first being tested, that “The same financial fundamentals that have hurt other shale plays apply to the Marcellus: difficulty identifying core areas, high marginal costs to produce shale gas, poor economics, the play area is so large that a lot more capital will be destroyed than in other shale plays.”

Interestingly, many of the shale pessimists were also active in the peak oil movement, and just as those promoting that idea expressed great certainty about a very uncertain issue, so many shale pessimists have great faith in their pronouncements.  “It takes an enormous leap of faith to see shale oil production rising another 2 mbpd from here, along with several leaps of logic, which the Citigroup report had in abundance.”

The critic bragged about relying on “cold, hard facts” but in fact, shale production has risen by 4 mb/d since then, even after prices dropped below levels said to be necessary to maintain production.  Not bad for a report derided as “amateurish” which made “extremely dubious claims.” (The same pundit trashed myself and others as peak oil denialists a decade ago.)

I once remarked to a peak oil advocate who, describing the many challenges the industry faced, reminded me of Luke Skywalker, who had to be told by Yoda, “Always with you it cannot be done.”  At some point, the pessimists need to explain how the industry has, by their view, defied gravity for well over a decade, continually increasing production as if a dozen pundits had not predicted otherwise (to paraphrase Charles Mackay’s description of the Thames refusal to comply with the London astrologers’ flood warning).

[i]   Hirsch, Robert “The Inevitable Peaking of World Oil Production.”  In:  Bulletin, Atlantic Council of the United States, October 2005.


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