Wall Street’s Shale Bubble

What’s’
Wrong Today:


It appears
that there is reason to be pessimistic about the future production potential of oil
and gas from US shale formations. These are the sources of energy that come
from hydraulic
fracturing,
(“fracking”) a technique used to release petroleum and natural gas. This
technique creates fractures from a wellbore drilled into
reservoir rock formations.


So,
What’s Wrong?


That isn’t
what we have been told.


Analysts
have provided optimistic assessments of the future production potential of US
shale or tight oil. For example, the International
Energy Agency
recently predicted that the US would be producing over 10 million barrels per
day of oil and natural gas liquids by 2020 before resuming a gradual decline.


This has gotten lots of
publicity:


In the 2012
State of the Union, Mr.
Obama said:


We have a supply of
natural gas that can last America nearly 100 years, and my administration will
take every possible action to safely develop this energy…


Ed Morse,
Global Head of Commodities Research at Citigroup:


There’s no doubt that we’re seeing an industrial
revolution…taking place because of the shale revolution.


Fatih
Birol, Chief Economist at the International Energy Agency:


[The surge of U.S. oil and gas production] is the
biggest change in the energy world since World War II.


Two reports
published at ShaleBubble.org challenge
this outlook. The reports are by the Post Carbon Institute (PCI) and by the Energy
Policy Forum
(EPF). The reports conclude that the fracking boom could be lead to another Wall Street bubble.


Media
attention about fracking has been focused on the threats to drinking water and
health in communities throughout North America and the world, but the data in
these two reports indicate that there could also be a different threat.  


The
fracking industry bubble could be similar to the housing bubble.


In other
words, fracking could tank the economy.


Sez
who?


PCI’s
report is titled “Drill
Baby, Drill,”
authored by J.
David Hughes,
while EPF’s report is titled “Shale Gas and Wall Street,” authored by
EPF Director and former Wall Street financial analyst Deborah Rogers.


Hughes
concludes that the “100 years” claim is wrong, and at current production rates,
there are at best, 25 years under the surface.


Really?


Industry
proponents rely on a figure known as “technically
recoverable reserves”
when they promote the potential of shale basins. The figure that actually
matters is production rates,
or what the wells actually pull from reserves after fracking.


In the
case of US shale gas, the booked reserves are operating on what Hughes coins a
“drilling treadmill,” and exhibit diminishing returns. Hughes analyzed the
industry’s production data for 65,000 wells in 31 shale basins nationwide,
utilizing the DI
Desktop/HPDI database,
widely used both by the industry and the US government.


Hughes sums
up what he discovered: (emphasis by the Wrongologist)


Wells experience
severe rates of depletion…This steep rate of depletion requires a frenetic pace
of drilling…to offset declines. Roughly
7,200 new shale gas wells need to be drilled each year at a cost of over $42
billion simply to maintain current levels of production. And as the most
productive well locations are drilled first, it’s likely that drilling rates
and costs will only increase as time goes on.


The reality
is that five shale gas basins
currently produce 80% of the US shale gas and on a steady state “same wells” basis, those five are already in production
rate decline.


What
about shale oil as opposed to shale gas?


Shale oil
is also known as “tight oil”. Over 80% of the oil produced and marketed from
shale comes from two basins: Texas’
Eagle Ford Shale
and North
Dakota’s Bakken Shale.
Hughes writes: (emphasis by the Wrongologist)


Taken together
shale gas and tight oil require about 8,600 [new] wells per year at a
cost of over $48 billion to offset declines…Tight oil production is projected
to…peak in 2017 at 2.3 million barrels per day [and be tapped out by about
2025]…In short, tight oil production from these plays will be a bubble of about
ten years’ duration.”


At current
production rates, Hughes concludes, there are 5 billion barrels of shale oil
located underneath Bakken and Eagle Ford, which equates to just ten months worth of current
US consumption of oil at current consumption
rates.


The most
successful shale US oil-producing field is the Bakken in North Dakota and
Montana, which currently accounts for 42% of the US tight oil total. Hughes
finds that once output from a typical Bakken well begins to decline, within 24
months its production flow is down to 1/5 the level achieved at its peak.


Check out
this graph from Hughes of flow from a typical Bakken well:


Source: David Hughes

Given this
rate of decline on existing wells, it is a straightforward exercise to answer
the question: Suppose that no new wells were drilled after 2010. What would the
path of Bakken oil production then look like? Hughes did this analysis:

Source: David Hughes

Increasing
annual production requires not just new wells but an increasing number of new
wells each year; Hughes estimates that
820 new wells are needed each year just to offset Bakken field decline.
But since only a few wells in the Bakken have proven to be very productive, average
well productivity is much lower. A limited number of lucrative sweet spots account
for much of the success so far, so even more drilling is required just to stay even.

This makes
achieving the IEA projection difficult and means a much more rapid decline in
the production rate after the peak is reached, than forecasted by the industry.


Wall Street’s Plans for Shale


Deborah Rogers
may also open your eyes with her report.
She is a member of the US Extractive Industries Transparency Initiative
(USEITI), an advisory committee within the Department of Interior. She also
served on the Advisory Council for the Federal Reserve Bank of Dallas from
2008-2011.


Her
reporting indicates that there are two types of questionable economics
unfolding: The day-to-day shale oil and gas production economics and Wall
Street’s high finance economics.


On Wall
Street, investors’ needs are driving the economic decisions of those working in
the field, in what Rogers describes as a “financial
co-dependency.”


She
writes: (emphasis by the Wrongologist)


The recent natural gas market glut was largely effected
through overproduction of natural gas in order to meet financial analyst’s production
targets…Further,
leases were bundled and flipped on unproved shale fields in much the same way
as mortgage-backed securities had been bundled and sold on questionable
underlying mortgage assets prior to the economic downturn of 2007.


Yes, she did say: just
like in the real estate bubble. Rogers shows that Wall Street firms
are now married to the shale gas and oil corporations, with Wall Street
analysts acting as promoters of shale gas and oil deals to investors. Here
are the conclusions of her report:


  • Wall Street promotion drove high levels of shale
    gas drilling
  • Overproduction by operators was driven by the
    need to meet financial analysts’ targets of production growth
  • It artificially lowered the price of natural gas
  • The industry is now dragging its feet on further
    shale investment, abandoning pipeline projects, IPOs and joint venture projects

In
Conclusion:


Could we
be witnessing another Inside Job of the sort
Charles Ferguson portrayed in his Academy Award-winning documentary film?


Check out Matt
Taibbi’s work  on Wall Street’s prior bubbles: The
Great American Bubble Machine.


Things are
getting zesty again on Wall Street. If shale oil hits the fan,
we can’t say we weren’t warned.

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