Shale, A ‘full tank of freedom’ or a ‘Faustian bargain?'

Neil McNaughton admits a few shaly prejudices. Seismic shows sweet spots but are these reported in reserves numbers? One engineer speaks of ‘Faustian bargain’ to fiddle the numbers. How long will the frackers continue with $70 oil? Who'll pay for the billions of ‘distressed' energy junk bonds?

Writing this editorial has been like trying to catch a falling knife. Since I started it a month ago, actualité has caught up with its sentiments and by the time you read it will likely have overtaken them. Apologies in advance for any stating what, by the time you read this, has become either blindingly obvious or obviously wrong!.

Pundits and forecasters in the shale game tend to polarize. They are either pro industry—think American Petroleum Insitute or watch Marathon Oil’s fabulous ‘Full tank of freedom’ ad promoting US domestic production. On the other side of the argument there are folks of a greenish hue who are anti fracking and often anti oil and gas in general. It would be nice to pretend to be objective in such matters, but we all have some prejudice or other so I though I should try to introspect my own.

A straw poll at ECIM asked attendees to hold up their hands if they had ten years of industry experience. Then twenty.. I was getting quite excited as I realized that I could, as of this year, claim forty years. But the pollster quit at thirty! Seems like old farts like myself are beyond the pale.

When I was hired the oil price was riding high at around $50. It has been up and down quite a bit since then. Folks like to talk of a ‘cyclical’ industry but that hides the fact that price movements usually come out of the blue and careers get buffeted. Sometimes it’s not just the oil price but the exchange rate too. French exploration in the early 1980s got a boost when the oil price hit $40 and the exchange rate was 10 Francs to the dollar. A couple of years later, oil was $10 and the Franc was at $4, a ten fold fall that had companies (except mine!) fleeing the country quicker than you could say Beaujolais nouveau.

To get back to my prejudices. Having spent years on conventional oil and gas, I have a problem with the sophistication and expense of multi-stage fracs and horizontal wells. I can’t see how these will produce more than small fraction of in-place hydrocarbons. My next prejudice is more of a psychological nature. Our industry, like others, is in general better at telling a good tale when speaking of the upside than it is when saying how much a project is going to cost. Oil and gas, like banking, also does quite a good job of divesting itself of risk—by farming out or issuing paper of (possibly) dubious value.

Given my skeptical starting point, how is shale looking in the face of a plunging oil price? Well even before the price fall, as we reported last month, Schlumberger’s Patrick Schorn was warning that ‘40% of the shale wells drilled in the Eagle Ford of Texas are uneconomic.’ The fraught nature of shale was also highlighted in the October 9th edition of Business Week (BW) in a piece by Asjylyn Loder and Isaac Arnsdorf titled ‘Fracking’s funny numbers.’ BW compared shale reserves as reported in company presentations with what the frackers are telling the SEC. Many shale drillers report one figure in filings while advertising a higher number to the public. On average, the number for resource ‘potential’ was 6.6 times higher than that reported to the SEC.

Industry insiders will understand the differences between reserves and ‘resources’ as cited in presentations to investors. Also, the industry has a quite a few tools and techniques that ought to provide some reliable estimates of what is truly. But are these tools really being used?

At the SEG in Denver I sat in on a presentation from the CGG-Baker Hughes shale alliance that showed how seismics can pinpoint sweet spots in a shale play. The results were pretty impressive, showing a high potential trend weaving its way across the tract. Not so long ago, the SPE managed to convince the SEC to allow geophysical techniques like seismics to supplement the traditional, more restrictive approach to reserves reporting. But the idea then was that seismics would be used to increase reportable reserves to the full extent of a (conventional) reservoir. Not, as they implied in the CGG presentation, that only 20% of the acreage was actually sweet!

Another shale caveat comes from a recent post on petroleum engineering software specialist Kappa Engineering’s website where CEO Olivier Houzé wrote, ‘In the dash to exploit unconventional resources it has been tempting [..] to bend traditional methods to fit the observed response rather than trying to understand the physics […] We have resisted this trend and, probably at the cost of some business, have not entered into such a Faustian pact, [preferring to] keep our engineering soul intact.’

And what of the geoscientists working in the shale arena? I have ‘anecdotal evidence’ i.e. whispers from a couple of buddies, that geoscientists are being ‘let go’ by some shale explorers. To save on costs? Maybe. Or perhaps to stifle the Cassandras!

Shale exploration in the US has proceeded at such a rate that it is hard to find out what is really going on. The US Energy Agency reports on the number of rigs and on ‘production growth’ but does not provide answers to obvious questions like how many wells are producing and at what rate. The current drilling frenzy makes it hard to see, at the macro scale, how fast shale production really declines.

This is likely to change if the oil price stays low for a while and drilling slows. Maybe in a year or two we will know. Maybe we’ll know sooner than that. The FT recently reported that ‘energy debt’ accounts for 16% of the $1.3 trillion US junk bond market. That’s $200 billion of which one third is currently classified as ‘distressed.’ Hedging by the producers and ‘slicing and dicing’ by the lenders will save some. But others may end up holding yet more paper of doubtful value!

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