The Great Shale Gas Ponzi Scheme

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–Well today is the big day in Greece. The government meets in Parliament to vote on the austerity budget. Meanwhile, police fired tear gas at protestors outside the Parliament building.

–Judging by the positive action in share markets, most investors expect the Greek vote to be a done deal. And most expect the angry Greeks in the streets will go home after the vote and take their government-prescribed medicine. We’ll know soon enough.

–One safe prediction: this is not the last week you’ll read about sovereign debt problems destabilising markets. If not Greece, then Spain. If not Spain, then Italy. If not Italy, then America.

–Meanwhile, the energy market is giving a clear signal about shale gas: it’s looking for more. Reuters reports, “China issued its first shale gas exploration tender with an offer of four blocks to a group of Chinese energy companies, state media reported, as the country kicks off its search for potentially vast reserves of the unconventional resource.”

–China’s state-owned oil companies are busy trying to diversify the nation’s energy resources. Shale gas is a natural place to look, if only because China is estimated to have large shale gas reserves. And every cubic foot of shale gas China could produce on its own is one it would not have to import from Russia…or Australia.

–The shale gas bandwagon is picking up new riders in Europe as well. A report in yesterday’s Financial Times says,

The development of shale gas has transformed the North American energy landscape and its supporters believe unconventional gas has the ability to evolutionise the European market, which is also home to vast resources… The resources hold the potential to cover European gas demand for at least 60 years, according to a study by the European Centre for Energy and Resource Security.”

–But stop the presses! And hold the bull market!

–The New York Times reports “industry insiders” have doubts about the shale industry. The Times report quotes dozens of geologists, lawyers, analysts, and executives-all of them anonymously, by the way-who cast various levels of doubt on the economics and safety of shale gas production.

–Some pretty sensational language is used too. The name “Enron” is invoked. In one email from 28 August 2009, an analyst at IHS Drilling Data writes, “The word in the world of independents is that the shale plays [jargon for formations] are just giant Ponzi schemes and the economics just do not work.”

–Hmm. How could a shale gas play be a Ponzi scheme? Well, other accusations in the emails are that the exploration companies are over-estimating the amount of recoverable gas. Another accusation is that big oil companies are understating depletion rates for wells, which leads to inflated production projections.

–The Ponzi scheme accusation, and even an allusion to “sub-prime” energy, comes from the assertion that shale gas exploration leases are being bundled and sold to investors the same way mortgage-backed securities were. And another accusation is that large oil companies are exaggerating shale gas reserve figures in order to boost their stock values, insofar as market caps for majors are often related to proven energy reserves. The Times story also suggested shale-related stocks could be in a bubble like Internet stocks.

–All in all, the Times did everything but accuse the natural gas industry of killing John F. Kennedy, Princess Diana, and Elvis. The story quotes anonymous insiders who express doubts about the economics of shale gas. And that’s news to anyone?

–It’s true that anonymity protects whistleblowers from reprisals. We have no problem with that. But the Times story seems to magnify, and make nefarious, things that are perfectly normal in a new industry. Higher costs for marginal producers with marginal assets will put them out of business. A land rush mentality will feed speculation and some people will get burned. How much gas production will increase by and how long it will last are…gasp…unknown.

–But the known knowns are worth remembering. The economics of shale gas production will be driven by natural gas prices. And natural gas prices will be driven by the overall changes in the energy market, including the supply and demand for crude oil and the availability of cheaper substitutes.

–The economics of individual projects will be driven by the geology of the shale deposits and whether they are amenable to the technique that has spurred U.S. production-horizontal drilling and hydraulic fracturing.

–The commercial viability of the industry in any market around the world will depend on the extraction techniques not doing damage to ground water. If it does, and if the industry does not reveal the chemicals it uses when it injects sand and water into the wells, the industry will die a quick death.

–A suspicious reader of the Times would be tempted to conclude the newspaper has something against fossil fuels and energy companies. And it’s probably true at some level that the people at the Times, like so many people in the mainstream media, ideologically support renewable energy and view oil, gas, and coal as evil and unclean fuels. Of course, just because their disdain of fossil fuels is driven by a personal preference for renewables (despite the economics) doesn’t mean they aren’t right about shale.

–But the debate about shale is not going to be settled by the editorial boards of newspapers. It’s going to be settled – unless irrational hysteria takes over – by whether the energy industry can safely deliver a cleaner-burning fuel source for the world’s economy. The Times story smacks of an attempt to shut down the industry just when it’s starting to show what it can do.

–A lot of people have already made up their mind. And it’s certainly a passionate issue, if you let yourself get carried away. But after having studied the issue for the last three months, along with the entire global energy market, we’re ready to publish our own conclusions on the matter tomorrow. Look for them then.

Dan Denning
Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. As for the economic modeling and production estimate/reserve claims of the shale gas industry, 3 factors will in time provide the true math:

    The cost, availablity and management of fresh water. This is not the oft repeated concern of ground water containmenation, although such concerns remain very real, but rather the huge volumes of fresh water needed in the fracking process. To date water remains a vastly underpriced asset but forces within the water industry are in the process of changing this.

    The role of unstable weather as in when drought meets fracking such as is occuring today in Texas. What happens if and when major drought stresses water demand in the high density population of the US northeast in conflict with water demands from Marcellus Shale operations? Today natural gas for heat takes priority over natural gas for electricity in times of significant demand. Might not the same become true regarding the priority use of water for drinking and sanitary needs over energy production in similiar times of high demand?

    Full modeling and understanding of the rapid depletion of a given shale gas well wherein production history from Barnett and other established shale gas plays already show depletion rates up to 85% within the first 24 months of operation. Rapid depletion rates mean more wells, more fracking, more men, machines and fresh water and more costs.

    In time, the economics of fresh water combined with the knowns of rapid depletion rates will provide the ultimate math as to true cost and market price. Severe weather will remain an uncontrolled market force.

    A particular oil and gas company can claim anything they want regarding production reserves or estimates with no laws required to verify such claims.Given no investor can prove what an oil and gas company claims they have in the ground, one might wish to proceed with great caution.

    Energy industry hype has already done significant damage to the reputation and public view of the nuclear industry. Let’s hope history does not repeat itself regarding such hype about shale gas fracking.

    Bob Magyar
    June 29, 2011
    Reply
  2. Very nice correction, Dan. Good work.

    Stuart Davies
    June 30, 2011
    Reply
  3. Hmm. Someone I respect for their scientific credentials, intellect, tireless efforts within the energy and systems theory fields is George Mobus. Here’s what he has to say about all this:

    http://questioneverything.typepad.com/question_everything/2011/06/reality-whats-that.html

    Nathan Chattaway
    July 5, 2011
    Reply

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