Hidden Cost Where Are the Profits

[John Mayo]

Hello All,
It's time to get back to the hidden cost of gas production. You know,
the cost we all pay for damage to our land, water sources, and air
quality, not to mention the fact that we are subsidizing this money
making industry ( or is it?). (Some are making big money, but who?)
Here's an excellent article in the New York Times exposing more
industry, how should I say, fraud? Please read on.
John Mayo.

New York Times
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________________________________________
June 25, 2011
Insiders Sound an Alarm Amid a Natural Gas Rush
By IAN URBINA
Natural gas companies have been placing enormous bets on the wells
they are drilling, saying they will deliver big profits and provide a
vast new source of energy for the United States.
But the gas may not be as easy and cheap to extract from shale
formations deep underground as the companies are saying, according to
hundreds of industry e-mails and internal documents and an analysis of
data from thousands of wells.
In the e-mails, energy executives, industry lawyers, state geologists
and market analysts voice skepticism about lofty forecasts and
question whether companies are intentionally, and even illegally,
overstating the productivity of their wells and the size of their
reserves. Many of these e-mails also suggest a view that is in stark
contrast to more bullish public comments made by the industry, in much
the same way that insiders have raised doubts about previous financial
bubbles.
“Money is pouring in” from investors even though shale gas is
“inherently unprofitable,” an analyst from PNC Wealth Management, an
investment company, wrote to a contractor in a February e-mail.
“Reminds you of dot-coms.”
“The word in the world of independents is that the shale plays are
just giant Ponzi schemes and the economics just do not work,” an
analyst from IHS Drilling Data, an energy research company, wrote in
an e-mail on Aug. 28, 2009.
Company data for more than 10,000 wells in three major shale gas
formations raise further questions about the industry’s prospects.
There is undoubtedly a vast amount of gas in the formations. The
question remains how affordably it can be extracted.
The data show that while there are some very active wells, they are
often surrounded by vast zones of less-productive wells that in some
cases cost more to drill and operate than the gas they produce is
worth. Also, the amount of gas produced by many of the successful
wells is falling much faster than initially predicted by energy
companies, making it more difficult for them to turn a profit over the
long run.
If the industry does not live up to expectations, the impact will be
felt widely. Federal and state lawmakers are considering drastically
increasing subsidies for the natural gas business in the hope that it
will provide low-cost energy for decades to come.
But if natural gas ultimately proves more expensive to extract from
the ground than has been predicted, landowners, investors and lenders
could see their investments falter, while consumers will pay a price
in higher electricity and home heating bills.
There are implications for the environment, too. The technology used
to get gas flowing out of the ground — called hydraulic fracturing, or
hydrofracking — can require over a million gallons of water per well,
and some of that water must be disposed of because it becomes
contaminated by the process. If shale gas wells fade faster than
expected, energy companies will have to drill more wells or hydrofrack
them more often, resulting in more toxic waste.
The e-mails were obtained through open-records requests or provided to
The New York Times by industry consultants and analysts who say they
believe that the public perception of shale gas does not match
reality; names and identifying information were redacted to protect
these people, who were not authorized to communicate publicly. In the
e-mails, some people within the industry voice grave concerns.
“And now these corporate giants are having an Enron moment,” a retired
geologist from a major oil and gas company wrote in a February e-mail
about other companies invested in shale gas. “They want to bend light
to hide the truth.”
Others within the industry remain optimistic. They argue that shale
gas economics will improve as the price of gas rises, technology
evolves and demand for gas grows with help from increased federal
subsidies being considered by Congress. “Shale gas supply is only
going to increase,” Steven C. Dixon, executive vice president of
Chesapeake Energy, said at an energy industry conference in April in
response to skepticism about well performance.
Studying the Data
“I think we have a big problem.”
Deborah Rogers, a member of the advisory committee of the Federal
Reserve Bank of Dallas, recalled saying that in a May 2010
conversation with a senior economist at the Reserve, Mine K. Yucel.
“We need to take a close look at this right away,” she added.
A former stockbroker with Merrill Lynch, Ms. Rogers said she started
studying well data from shale companies in October 2009 after
attending a speech by the chief executive of Chesapeake, Aubrey K.
McClendon. The math was not adding up, Ms. Rogers said. Her research
showed that wells were petering out faster than expected.
“These wells are depleting so quickly that the operators are in an
expensive game of ‘catch-up,’ ” Ms. Rogers wrote in an e-mail on Nov.
17, 2009, to a petroleum geologist in Houston, who wrote back that he
agreed.
“This could have profound consequences for our local economy,” she
explained in the e-mail.
Fort Worth residents were already reeling from the sudden reversal of
fortune for the natural gas industry.
In early 2008, energy companies were scrambling in Fort Worth to get
residents to lease their land for drilling as they searched for so-
called monster wells. Billboards along the highways stoked the boom-
time excitement: “If you don’t have a gas lease, get one!” Oil and gas
companies were in a fierce bidding war for drilling rights, offering
people bonuses as high as $27,500 per acre for signing leases.
The actor Tommy Lee Jones signed on as a pitchman for Chesapeake, one
of the largest shale gas companies. “The extremely long-term benefits
include new jobs and capital investment and royalties and revenues
that pay for public roads, schools and parks,” he said in one
television advertisement about drilling in the Barnett shale in and
around Fort Worth.
To investors, shale companies had a more sophisticated pitch. With
better technology, they had refined a “manufacturing model,” they
said, that would allow them to drop a well virtually anywhere in
certain parts of a shale formation and expect long-lasting returns.
For Wall Street, this was the holy grail: a low-risk and high-profit
proposition. But by late 2008, the recession took hold and the price
of natural gas plunged by nearly two-thirds, throwing the drilling
companies’ business model into a tailspin.
In Texas, the advertisements featuring Mr. Jones disappeared. Energy
companies rescinded high-priced lease offers to thousands of
residents, which prompted class-action lawsuits. Royalty checks
dwindled. Tax receipts fell.
The impact of the downturn was immediate for many.
“Ruinous, that’s how I’d describe it,” said the Rev. Kyev Tatum,
president of the Fort Worth chapter of the Southern Christian
Leadership Conference.
Mr. Tatum explained that dozens of black churches in Fort Worth signed
leases on the promise of big money. Instead, some churches were told
that their land may no longer be tax exempt even though they had yet
to make any royalties on the wells, he said.
That boom-and-bust volatility had raised eyebrows among people like
Ms. Rogers, as well as energy analysts and geologists, who started
looking closely at the data on wells’ performance.
In May 2010, the Federal Reserve Bank of Dallas called a meeting to
discuss the matter after prodding from Ms. Rogers. One speaker was
Kenneth B. Medlock III, an energy expert at Rice University, who
described a promising future for the shale gas industry in the United
States. When he was done, Ms. Rogers peppered him with questions.
Might growing environmental concerns raise the cost of doing business?
If wells were dying off faster than predicted, how many new wells
would need to be drilled to meet projections?
Mr. Medlock conceded that production in the Barnett shale formation —
or “play,” in industry jargon — was indeed flat and would probably
soon decline.
“Activity will shift toward other plays because the returns there are
higher,” he predicted. Ms. Rogers turned to the other commissioners to
see if they shared her skepticism, but she said she saw only blank
stares.
Bubbling Doubts
Some doubts about the industry are being raised by people who work
inside energy companies, too.
“Our engineers here project these wells out to 20-30 years of
production and in my mind that has yet to be proven as viable,” wrote
a geologist at Chesapeake in a March 17 e-mail to a federal energy
analyst. “In fact I’m quite skeptical of it myself when you see the %
decline in the first year of production.”
“In these shale gas plays no well is really economic right now,” the
geologist said in a previous e-mail to the same official on March 16.
“They are all losing a little money or only making a little bit of
money.”
Around the same time the geologist sent the e-mail, Mr. McClendon,
Chesapeake’s chief executive, told investors, “It’s time to get
bullish on natural gas.”
In September 2009, a geologist from ConocoPhillips, one of the largest
producers of natural gas in the Barnett shale, warned in an e-mail to
a colleague that shale gas might end up as “the world’s largest
uneconomic field.” About six months later, the company’s chief
executive, James J. Mulva, described natural gas as “nature’s gift,”
adding that “rather than being expensive, shale gas is often the low-
cost source.” Asked about the e-mail, John C. Roper, a spokesman for
ConocoPhillips, said he absolutely believed that shale gas is
economically viable.
A big attraction for investors is the increasing size of the gas
reserves that some companies are reporting. Reserves — in effect, the
amount of gas that a company says it can feasibly access from its
wells — are important because they are a central measure of an oil and
gas company’s value.
Forecasting these reserves is a tricky science. Early predictions are
sometimes lowered because of drops in gas prices, as happened in 2008.
Intentionally overbooking reserves, however, is illegal because it
misleads investors. Industry e-mails, mostly from 2009 and later,
include language from oil and gas executives questioning whether other
energy companies are doing just that.
The e-mails do not explicitly accuse any companies of breaking the
law. But the number of e-mails, the seniority of the people writing
them, the variety of positions they hold and the language they use —
including comparisons to Ponzi schemes and attempts to “con” Wall
Street — suggest that questions about the shale gas industry exist in
many corners.
“Do you think that there may be something suspicious going with the
public companies in regard to booking shale reserves?” a senior
official from Ivy Energy, an investment firm specializing in the
energy sector, wrote in a 2009 e-mail.
A former Enron executive wrote in 2009 while working at an energy
company: “I wonder when they will start telling people these wells are
just not what they thought they were going to be?” He added that the
behavior of shale gas companies reminded him of what he saw when he
worked at Enron.
Production data, provided by companies to state regulators and
reviewed by The Times, show that many wells are not performing as the
industry expected. In three major shale formations — the Barnett in
Texas, the Haynesville in East Texas and Louisiana and the
Fayetteville, across Arkansas — less than 20 percent of the area
heralded by companies as productive is emerging as likely to be
profitable under current market conditions, according to the data and
industry analysts.
Richard K. Stoneburner, president and chief operating officer of
Petrohawk Energy, said that looking at entire shale formations was
misleading because some companies drilled only in the best areas or
had lower costs. “Outside those areas, you can drill a lot of wells
that will never live up to expectations,” he added.
Although energy companies routinely project that shale gas wells will
produce gas at a reasonable rate for anywhere from 20 to 65 years,
these companies have been making such predictions based on limited
data and a certain amount of guesswork, since shale drilling is a
relatively new practice.
Most gas companies claim that production will drop sharply after the
first few years but then level off, allowing most wells to produce gas
for decades.
Gas production data reviewed by The Times suggest that many wells in
shale gas fields do not level off the way many companies predict but
instead decline steadily.
“This kind of data is making it harder and harder to deny that the
shale gas revolution is being oversold,” said Art Berman, a Houston-
based geologist who worked for two decades at Amoco and has been one
of the most vocal skeptics of shale gas economics.
The Barnett shale, which has the longest production history, provides
the most reliable case study for predicting future shale gas
potential. The data suggest that if the wells’ production continues to
decline in the current manner, many will become financially unviable
within 10 to 15 years.
A review of more than 9,000 wells, using data from 2003 to 2009, shows
that — based on widely used industry assumptions about the market
price of gas and the cost of drilling and operating a well — less than
10 percent of the wells had recouped their estimated costs by the time
they were seven years old.
Terry Engelder, a professor of geosciences at Pennsylvania State
University, said the debate over long-term well performance was far
from resolved. The Haynesville shale has not lived up to early
expectations, he said, but industry projections have become more
accurate and some wells in the Marcellus shale, which stretches from
Virginia to New York, are outperforming expectations.
A Sense of Confidence
Many people within the industry remain confident.
“I wouldn’t worry about these shale companies,” said T. Boone Pickens,
the oil and gas industry executive, adding that he believes that if
prices rise, shale gas companies will make good money.
Mr. Pickens said that technological improvements — including
hydrofracking wells more than once — are already making production
more cost-effective, which is why some major companies like ExxonMobil
have recently bought into shale gas.
Shale companies are also adjusting their strategies to make money by
focusing on shale wells that produce lucrative liquids, like propane
and butane, in addition to natural gas.
Asked about the e-mails from the Chesapeake geologist casting doubt on
company projections, a Chesapeake spokesman, Jim Gipson, said the
company was fully confident that a majority of wells would be
productive for 30 years or more.
David Pendery, a spokesman for IHS, added that though shale gas
prospects had previously been debated by many analysts, in more recent
years costs had fallen and technology had improved.
Still, in private exchanges, many industry insiders are skeptical,
even cynical, about the industry’s pronouncements. “All about making
money,” an official from Schlumberger, an oil and gas services
company, wrote in a July 2010 e-mail to a former federal regulator
about drilling a well in Europe, where some United States shale
companies are hunting for better market opportunities.
“Looks like crap,” the Schlumberger official wrote about the well’s
performance, according to the regulator, “but operator will flip it
based on ‘potential’ and make some money on it.”
“Always a greater sucker,” the e-mail concluded.
Robbie Brown contributed reporting from Atlanta.