Shale Revolution Did Not Pay Investors Well

By Deborah Lawrence

We have all heard of the “shale revolution”. It has been touted as the energy panacea of our time. Given the extreme hype, one would expect that such enthusiasm would translate into above average share performance for shale operators. This has not been the case. Share performance has actually been quite mediocre and in some cases just downright poor.

The shale revolution started with shale gas. The Marcellus shale which spans Pennsylvania, parts of NY, West Virginia and Ohio has probably received the greatest amount of attention since the State of New York had a drilling moratorium for years which was recently replaced in favor of an outright ban on the controversial technique used to unlock shale reserves called hydrofracture stimulation or more commonly referred to as “fracking”. Looking at the top producers in the Marcellus, one would expect that these companies would have enjoyed returns on their shares which were commensurate with their expectation of future growth potential for their product. Interestingly, this has not occurred.

Five of the top producers in the Marcellus are Exco Resources, Range Resources, Chesapeake Energy, Anadarko and EOG, the former Enron Oil and Gas. Of these five companies, EOG was the only one which had reasonable returns over the past five years. EOG shares rose approximately 85% during that time right in line with the S&P 500 index. So nothing earth shattering here. EOG’s peers, however, had significantly weaker returns for shareholders. The next best performance was from Anadarko with a mere 18% over five years followed by Range with -1%, Chesapeake with -31% and Exco with a dismal -89%. And all during the height of the shale gas revolution.

In 2010, companies announced another shale possibility: extracting tight oil from the rock. Two plays emerged as the industry’s best examples of tight oil in the US: the Bakken in North Dakota and the Eagle Ford in south Texas. Returns for shareholders, however, did not much improve.

The star for share performance in the Bakken was Continental Resources which did indeed enjoy gains of about 120% over the past five years. So Continental outperformed the S&P 500 by a good margin. Its peers, however, significantly underperformed the index. Hess Corp. was next with a return of a mere 22%. Whiting Petroleum and StatOil each turned in negative share returns of -12% and -19% respectively. So only one of the top operators even came close to matching returns from the index which is fine if you were lucky enough to cherry pick that company.

The same was true in the Eagle Ford. There the top operators are EOG, Chesapeake, Anadarko, Marathon and BHP Billiton. EOG matched the index while the next best performer was Marathon at 53% plunging down to BHP at -33%. Further if one considers share performances over the most recent two year period rather than the longer five year time frame, the picture becomes even worse. And this while industry promised energy independence. Financial independence for shareholders, however, would have been another matter.

In short the shale revolution has not produced the types of returns that one would expect. In fact, returns have been marginal for most of the “best” companies. This would seem a curious irony. And yet, perhaps it is not so curious after all. Interesting dynamics are occurring in the energy markets and old paradigms are being challenged. Given the markets role as a leading indicator, the trend that is emerging appears to be that investors see more potential in clean energy companies within the entire energy sector than the tried and true oil and gas vehicles of old. Solar stocks in some cases have outperformed their oil and gas counterparts by multiples. And all during the “shale revolution”. During this same time, investment banks have made extraordinary statements to their most sophisticated clients about hydrocarbons becoming “extinct” within the next decade, a notion which was virtually unthinkable less than five years ago. And in another almost unbelievable example the automobile manufacturer, BMW, has announced that they will no longer make an internal combustion engine by 2022. That is only 7 years away. But all of this is another story.

Energy markets are changing and changing fast. Perhaps this is why the oil and gas industry felt so hard pressed to declare that shales were “revolutionary”. Too bad they did not provide a good return for investors.

Marcellus shale share operators performanc over  5 years vs. index

The Solar Eclipse of Shales

By Deborah Lawrence

Share price matters and solar stocks have significantly outperformed their oil and gas counterparts by multiples.

When looking for market trends it is always useful to examine share price. This can often be your first clue as to emerging paradigm shifts or just health of a particular industry in general. In the case of energy, some interesting shifts are occurring. Moreover, they seem to be flying under the radar. For instance, a quick comparison of the share price of oil and gas companies, particularly those engaged in the self styled “shale revolution” to those engaged in alternative energy activities such as solar, is eye opening to say the least.

If you are an investor, positive returns on portfolio assets are important to your future wealth. If you’re running a company, share price becomes critical because it can affect different metrics. An upward trajectory in your share price, for instance, can beneficially impact your company’s ability to tap into the capital markets. This means you can raise more money for future growth, a crucial step particularly in an industry like shale extraction which has significant capital requirements. Shale wells, whether gas or tight oil, are very expensive to drill and complete.

There are additional layers as well. Markets are considered leading indicators. This means that patterns which emerge in share prices can indicate an underlying, but not necessarily obvious, pattern in the broader economy. Though it is often obscure at first, the markets can be pointing to a potential new trend. That is why it is so important to examine share pricing and make comparisons within a particular industry or within competing industries.

The shale revolution has been characterized by a frenzy of drilling for dry gas, liquids and tight oil. While the industry has indeed produced large quantities of gas and oil, its business model is questionable over the long term. Shale operators have relied on massive amounts of cheap debt to finance their activities though the wells themselves are not proving to be the energy panacea industry purports. This has been confirmed by many independent entities but most recently by the University of Texas. According to Tad Patzek, head of University of Texas at Austin’s department of Petroleum and Geosystems Engineering, shale potential has been considerably overstated. When speaking with the science journal Nature, Patzek was quoted as follows:

“‘The results [of our study] are “bad news”… With companies trying to extract shale gas as fast as possible and export significant quantities… “we’re setting ourselves up for a major fiasco'”.

Equally significant is the reaction of the stock market to these shale operations.

Examining share prices of companies engaged in shale extraction over the past two years, it quickly becomes apparent that investors don’t see great potential in shales. Given its self promoted image of being revolutionary, this should have translated into share price returns that are above average. Taking five companies which are considered the darlings of the shale industry, Continental Resources, Chesapeake Energy, EOG, Range Resources and Cabot Oil and Gas, the best performer was EOG racking up 50.32% in gains over the past two years. While this may sound like a reasonable return, it pales in comparison with its solar competition. Further, EOG’s oil and gas peers fared much worse. Continental, for instance gained a mere 15.67%, Chesapeake 10.46%, Cabot -4.2% and Range a dismal -25.97. This is not revolutionary performance.

Interestingly, companies engaged in solar generation have share performance figures that are significantly better. Solar City, Canadian Solar, Jinko Solar, Trina Solar and SunPower have amassed returns ranging from 132.89% to 588.47% over the same time frame. The worst solar performance is double the best oil and gas performance. The best solar performance is ten times better than the best oil and gas performer.

But perhaps more importantly, a trend is emerging with regard to how the markets view the future prospects of oil and gas against that of solar. In other words, the markets appear to be telling us that solar has more future potential than oil and gas. Moreover, this same pattern of underperformance in stock prices is also occurring in the Majors. Companies like Exxon Mobil and Shell have provided mediocre returns compared with the Dow over the past five years. These same companies used to be the leaders of the Dow. Now they are the laggards.

A new energy paradigm appears to be emerging. Investors have unambiguously voted with their dollars and solar was the clear winner. Perhaps this isn’t turning out to be a shale revolution so much as a solar eclipse.

Solar stocks vs. Shale

Economic Impact of Climate Change

Quantifying the costs of climate change in real dollars is an exercise of great importance. Impacts will occur not only to the environment but also to the global economy thereby creating the need for a greater understanding of just how such impacts might play out economically. Combatting climate change cannot be done without a stable investment environment. A report issued in 2014 by The White House addresses these issues from a policy perspective. The following is an excerpt:

“An additional benefit of adopting meaningful mitigation policies now is that doing so sends a strong signal to the market to spur the investments that will reduce mitigation costs in the future. An argument sometimes made is that mitigation policies should be postponed until new low- carbon technologies become available. Indeed, ongoing technological progress has dramatically improved productivity and welfare in the United States because of vast inventions and process improvements in the private sector (see for example CEA 2014, Chapter 6). The private sector invests in research and development, and especially in process improvements, because those technological advances reap private rewards. But low-carbon technologies, and environmental technologies more generally, face a unique barrier: their benefits – the reduction in global impacts of climate change – accrue to everyone and not just to the developer or adopter of such technologies.9 Thus private sector investment in low-carbon technologies requires confidence that those investments, if successful, will pay off, that is, the private sector needs to have confidence that there will be a market for low-carbon technologies now and in the future. Public policies that set out a clear and ongoing mitigation path provide that confidence. Simply waiting for a technological solution, but not providing any reason for the private sector to create that solution, is not an effective policy.”

We could not agree more.

The cost to the U.S. economy of climate change

Shale Reserves Parallel Rise In Costs

Shale operators have claimed that as they have became better and better at drilling for shale gas and tight oil in the US, the costs of producing such shale reserves fell. This is simply not the case. Ernst and Young, a preeminent accounting firm, carries out an annual survey of reserves and cost analysis for oil and gas. Production costs have risen steadily since 2009 right in line with increased shale reserves. So although shale reserves have increased, they have not increased without additional expense. This problem has been obfuscated by the large investment banks which were earning lucrative fees off shale transactions.

In Spring 2014, Ed Morse, Global Head of Commodity Research at Citi and one of the chief cheerleaders for shales, stated in Foreign Affairs:

“…the cost of finding and producing oil and gas in shale and tight rock formations are steadily going down and will drop even more in the years to come”.

Production costs and shale reserves

Bakken Shale: Too Many Wells, Too Much Expense

The number of Bakken shale wells needed to produce a million barrels a day is staggering when you compare it to a typical OPEC well. If you’ve ever wondered why shales are struggling to compete with OPEC, this may give you a clue.

According to the IEA, International Energy Administration, it takes approximately 2500 Bakken shale wells per year to produce 1 million barrels of crude per day whereas only 60 Iraqi wells are needed to produce an equal amount.

Bakken shale wells are land consumptive and expensive. They also decline rapidly. In short, drilling for tight oil faces a number of headwinds not least of which is low crude prices.

Number of shale wells needed to produce 1M BPD

The Solar Economic Engine

Solar prices have plunged over the past five years. Average PV systems prices dropped more than 50% between 2010-2014. As these costs came down, more and more solar was installed. This meant more and more investment and subsequently economic benefit. The value of solar installations has risen steadily since 2010 and has trebled in a mere 5 years in spite of the precipitous drop in prices.

Economists often refer to virtuous circles. The Oxford dictionary defines a virtuous circle as follows:

“A recurring cycle of events, the result of each one being to increase the beneficial effect of the next”.

This is truly what is happening in solar today. As prices decrease, installations are increasing which in turn increases valuations of installations and thereby economic benefit and increases the number of people employed. It also creates a deflationary effect on the economy in general since energy prices impact virtually every other activity. When energy prices come down then it is a win, win.

But here is the irony.

When hydrocarbon energy prices come down, it can indeed be beneficial for end use consumers. Gasoline becomes cheaper, feed stock prices plunge and consumers have more money in their pockets for other products. This is not the case, however, for the coal, oil and gas industries. For them, it is devastating. Capital expenditure must be slashed and jobs are lost by the thousands. That is precisely what is happening now in the industry. The self-styled “shale revolution” was built on the back of very expensive oil and gas prices. For shales to take off, oil prices were near $100/bbl and when shale gas hit its heyday, natural gas was trading around $8/mcf and even went as high as $13/mcf. Shales need very high prices to work. While high prices are great for oil and gas balance sheets, they cannot help but translate into more expensive products and services overall in the economy. It does not benefit all. It benefits only a few.

Solar, on the other hand, is producing more jobs, more economic benefit and less inflationary pressure as prices fall. A economic virtuous circle.

What’s not to like about that?

Solar valuation growth

YOY job growth: solar vs. O&G

Shocking Deterioration In Tight Oil

Tight oil in the US is experiencing shocking deterioration in production vs. declines percentages just since November. Rig counts have plunged and though production overall is still rising, the amount used to offset the steep declines in older tight oil wells is skyrocketing. For instance, in the Bakken as recently as November 2014, 71% of all new production coming online was being used to do nothing but offset the declines in older wells. This was a very high figure. But over the ensuing three months as crude prices crumbled and capital expenditure has been slashed this figure has soared to 86%.

The same thing is happening in the Eagle Ford where 72% of all new production was needed in November 2014 but has now risen to 89%. This is problematic because these figures are rapidly approaching 100% which means that the plays are quickly falling into decline. The amount of new production simply cannot keep up with the steep declines in older wells. Unfortunately “older” in shale gas and tight oil means a mere 4-5 years. These are not long lived wells.

This is a classic illustration of the challenge of shale production. Without a frenzy of relentless drilling, operators just can’t maintain a stable production profile. Almost literally, the minute they stop drilling, the whole exercise begins to unravel. And yet, this is what the industry proposes we bet our energy future on.

New production needed to offset declines

Oil and Gas Now Destroying Jobs Rather Than Creating

The oil and gas industry created thousands of jobs during the “shale revolution”. Now it is destroying thousands of jobs. 38% of all jobs lost since the beginning of the year have been in the “energy” business according to Bloomberg. But actually, this is not true. 38% of all jobs lost have not been in the energy business but in the fossil fuel business. Solar jobs are thriving…and growing.

Read all about it!

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