Blogthe latest commentary and analysis from EPF

Jan

27

The Cost of Carbon and Climate Change

Cambridge University in the United Kingdom has come out with estimates of the costs of shale extraction on climate.

According to the Guardian:

“Shale frackers operating in Britain should be paying £6bn a year in taxes by the middle of the 2020s to compensate for the damage wreaked on the environment.”

While the Europeans place a cost of carbon emissions at about $100/ton, the U.S., which has no carbon tax, implicitly costs out carbon in the capital markets at only about $28/ton. But the researchers at Cambridge think that methane, a much more potent greenhouse gas, should be costed far higher.

The Guardian states:

“The social impact of methane has been less well studied…but the best estimate for this much more powerful greenhouse gas is a little over $1,200 a tonne.”

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Dec

27

The Myth of Energy Independence

By Deborah Lawrence Rogers

Much rhetoric about energy independence has been bandied about from policy makers in Washington and executives in the oil and gas industry. We are assured that energy independence is possible now thanks to the large shale deposits being exploited throughout the country. The sound bites are frequent and effective. But when one looks more closely at the numbers, it becomes patently apparent that industry claims border on hyperbole.

The story goes that we have been engaged in a “shale revolution” since about 2005 when gas drilling in north central Texas’ Barnett Shale first emerged with significance. By 2009, nearly five years ago, we entered into the tight oil revolution (from shales) with production spiking from the Bakken formation in North Dakota and the Eagle Ford in south Texas. Industry apologists began speaking of the U.S. as having the potential to become “two Saudi Arabia’s”. Of note, however, is what industry executives and apologists were not mentioning: per well production peaked in both the Bakken and the Eagle Ford as far back as June of 2010. We know this from production records filed with state regulatory entities. That’s right. A frenzy of drilling which has more than doubled the number of wells in each formation since 2010 has masked the fact that operators have not been able to increase per well production beyond the levels seen a full three years ago. Another example of the drilling treadmill which can only hide flaws for so long.

But the merits of shale production can and should also be examined by looking at crude and gasoline prices. After all, the shale revolution is propounded to be carrying the U.S. toward energy independence. But is this really the case?

If true, then the added production from tight oil plays should be causing crude prices to decline for U.S. consumers which would then effect a concomitant decline in the price of gasoline. But this hasn’t happened. And for a very good reason. The shale energy “revolution” is simply not large enough to make a significant impact in global supply terms.

While the U.S. domestic production of crude has spiked approximately 34% since 2009, this surge has had minimal impact on global markets because it is almost imperceptible when added to global supplies. Hence the need for hyperbole.

Energy is a global commodity and as such it is traded in global markets where U.S. tight oil flows into the global crude mix. Industry hype would like us to forget this inconvenient truth.

So how much impact has U.S. tight oil had on the global energy mix? Negligible. The “shale revolution” has added about 1.5% to total global crude supplies. Further, this figure is unlikely to change dramatically given that almost all U.S. crude is being produced from only two plays, the Bakken and the Eagle Ford, both of which have already experienced per well declines as discussed above. Without additional significant new finds, the U.S. contribution to global energy supply is limited at best.

An addition of 1.5% to total global supplies does not lower prices of crude and thereby gasoline regardless of political posturing and endless sound bites. In short, the crude markets have been unmoved by the U.S. “shale revolution”. In fact, the average price of both crude and gasoline in the U.S. has fluctuated wildly during the corresponding time period and is, unfortunately, another indication that price stability is not occurring thanks to tight oil. Gasoline prices too have risen during the same time period placing further inflationary pressures on U.S. consumers.

That is neither energy independence nor energy security.

Further, the new crude which is being produced from shales is expensive and difficult to extract thereby driving up the costs considerably as compared to crude produced from more conventional wells. Producers need a crude price of about $100/bbl to make tight oil economic and a bit profitable. If prices decline, production will be priced out and if prices rise, consumers will be priced out.

But perhaps what is most interesting of all is what the industry actually has to offer U.S. consumers: a considerably more expensive version of the same old widget. An effective widget but not a new and improved widget. Industry is not offering an improved version of an old product. In fact, it can reasonably be argued that they are offering an inferior version of an old product in that the environmental costs of tight oil are proving fairly significant together with the costs of damages due to climate change.

This could go far in explaining why industry has engaged the services of public relation firms, indeed, even hiring PR executives and bringing them in house. The hyperbole over shales has reached fever pitch. After all, convincing people to pay considerably more for a product that is neither new nor improved but still extracts considerable damage to the local environment requires considerable Madison Avenue talent.

And yet what’s an industry to do when it has an environmentally unfriendly production model, a finite supply and a product which is known to be the primary culprit behind devastating climate change? Hire a good PR firm, of course!

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Oct

30

Coal Displacing Nat Gas…Already

By Deborah Lawrence Rogers

In January, 2012, the price of nat gas plunged to below $2/mcf due to overproduction by shale operators. Such low prices did, indeed, prompt utilities to switch from coal fired generation to natural gas fired generation if they had the capacity. Industry crowed that this was the shape of things to come with electricity costs plummeting for consumers and heralding the end of “King Coal”.

Unfortunately, as with most aspects of unconventional shale production, this proved short lived and oversold. Glaring numbers show another picture altogether.

Electricity generation from natural gas began to fade only months after it had gained ground in much the same way that shale gas wells fade only months after initial production. As gas prices moved up to trade between $3.50-4/mcf, utilities promptly began switching back to using coal for generation.

According to EIA (Energy Information Administration):

“During the first half of 2013…the price of natural gas delivered to electric generators averaged $4.46 per MMBtu, 44 percent higher than the same period last year.”

EIA continued with:

“Electric generators have been running their existing coal capacity at higher rates so far this year in response to the increasing cost of natural gas relative to coal.”

This is of note for several reasons.

Firstly, industry and its proponents including such entities as the Wall Street Journal, have made fantastical comments about nat gas providing “benefits to the poor” which will be long lived particularly with respect to lower electricity costs for the consumer. Such benefits are already evaporating. We do not live in Camelot regardless of industry and media hype.

Secondly, but most importantly, we can now safely assume that nat gas is priced out of the market for electricity generation somewhere between $3.50-4/mcf. That produces an enormous difficulty for natural gas producers in that the break-even costs of unconventional shale wells is considerably higher with the average probably falling around $6/mcf. Exportation of shale gas will drive these prices higher still creating an unfavorable climate for natural gas as a primary source of electricity generation. That means all those purported “benefits to the poor” are non-existent over the long term. It also means that producers cannot keep this game going forever without incurring significant and further losses which are already quite considerable. Or exporting enough to make up the difference in domestic use. But this of course means that the U.S. will be exporting a natural resource rather than converting those resources into finished product to be exported which historically would provide greater economic benefit. In other words, everything about this picture is essentially based on knee jerk corporate and governmental policy decisions. Always a bad plan.

Utility use of nat gas ramped up in 2012 but as quickly as March, 2013, Reuters reported:

“U.S. utilities will use more coal and less natural gas to generate power as coal becomes cheaper and gas more expensive, electricity traders said on Friday.”

A few months later in June 2013, a further statement by World Resources Institute confirmed this:

“Electricity markets are very dynamic, and while there’s been a lot of press about the success story of the benefits of natural gas, it’s important to realize that that’s temporary and it depends on gas prices staying really low, and we’re starting to see there are these thresholds where utilities will switch back to higher-carbon fuel, like coal.”

Interestingly, however, industry continued to tell a different story. In September 2013, Lynn Lachenmyer, a senior vice president at Exxon Mobil, told attendees in her keynote address at the Petrochemical Maritime Outlook conference:

“[Natural gas] is penetrating into the power sector, which has been predominantly coal in the past. We see it making tremendous inroads there.”

All present tense but in direct contrast with the actual use figures which had swung back toward coal. In other words, increased nat gas use was already past tense. Further, Ms. Lachenmeyer stated:

[By 2040] wind will make up just 7 percent of the world’s stockpile of energy… and solar will make up just 2 percent. Meanwhile, oil and natural gas will make up 60 percent of the world’s energy supply in 30 years, up from 55 percent today.”

Visions of Camelot once again.

And yet only one month prior to Ms. Lachenmeyer’s comments, the IEA (International Energy Agency) stated in its second annual Medium-Term Renewable Energy Market Report:

“Power generation from hydro, wind, solar and other renewable sources worldwide will exceed that from gas and be twice that from nuclear by 2016.”

This is an enormous discrepancy with ExxonMobil’s prognostications. In fact, someone’s prognostications are hinting at delusions. Given that IEA’s figures state that renewables will overtake gas in a mere three years and thus are much closer in terms of the future, it stands to reason that the IEA figures are probably more valid than ExxonMobil forecasts for 2040.

Even more damning are the IEA forecasts which extrapolated from the impressive growth rate seen in 2012 within the renewable sector. For instance, global renewable generating capacity grew more than 8% in spite of extreme lobbying by the fossil fuel industry in countries like the U.S. which caused a challenging investment and policy climate for the renewable industry to say the least.

Nevertheless, according to Fuel Fix:

“In absolute terms, global renewable generation in 2012 – at 4 860 TWh – exceeded the total estimated electricity consumption of China.”

That is an astonishing growth pattern.

But perhaps the answer to Exxon’s discrepancy lies in the comments of IEA Executive Director Maria van der Hoeven as she presented at the Renewable Energy Finance Forum in New York. Ms. van der Hoeven stated:

“As [renewable] costs continue to fall, renewable power sources are increasingly standing on their own merits versus new fossil-fuel generation.”

There is no doubt that gets the attention of executive management teams in the fossil fuel industry. Ms. van der Hoeven went on to state:

“Many renewables no longer require high economic incentives. But they do still need long-term policies that provide a predictable and reliable market and regulatory framework compatible with societal goals. And worldwide subsidies for fossil fuels remain six times higher than economic incentives for renewables.”

Renewables are, therefore, standing on their own globally in spite of an extreme bias toward fossil fuel use. Imagine a world where those subsidy monies were transferred to renewable generation and research and development. That, no doubt, would be a policy exercise to be fought tooth and nail by the fossil fuel industry.

In fact, such incredible growth in the renewable sector probably has much to do with the extreme hyperbole, overestimation of reserves, underestimation of costs, etc. surrounding unconventional fuels. The fossil fuel industry does, indeed, need to convince us that business as usual can be a maintained. After all, they are losing market share in spite of their glowing reports.

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Oct

08

“Show Me the Money” in Shales

By Deborah Lawrence Rogers

Dr. Terry Engelder of Penn State, hired by the natural gas industry in 2009, proclaimed that the Marcellus Shale would potentially have reserves of 489 TCF of gas. He caused quite a stir. This number, unfortunately, was slashed in 2012 to 141 TCF by EIA (Energy Information Administration) and 84 TCF by the USGS (US Geological Survey). Dr. Engelder, therefore, has found himself continually trying to defend his former position.

Recently, PennLive interviewed Dr. Engelder. He stated that the economics of wells in the Marcellus made sense. Not only did they make sense but they were making money for the companies involved. Dr. Engelder concluded:

“It shows that the Marcellus is not a financial disaster as some have made it out to be.”

Dr. Engelder went on to state:

“Once the well is paid off, gas production greatly adds to the future cash flow of a company.”

Not to put too fine a point on it but…huh???

Firstly, cash flow can be a tricky thing. There are myriad ways to “creatively” determine “cash flow” for a company. For that reason, most analysts prefer to use the metric of free cash flow instead as it is certainly much more difficult to tinker with free cash flow numbers and “creativity” cannot be utilized as readily. Free cash flow is determined by taking total cash from operating activities less CAPEX less dividends, if appropriate.

In previous posts, EnergyPolicyForum has discussed the significant deterioration of free cash flow at a number of shale companies including Range Resources, Devon Energy, Chesapeake Energy, Continental and Kodiak Oil and Gas. Without exception each of these shale company’s free cash flow has deteriorated consistently in the past few years. Contrary to Dr. Engelder’s assertion that “gas production greatly adds to the future cash flow of a company,” there is absolutely no indication that this is true for any of the above mentioned companies, two of which, Range Resources and Chesapeake happen to be some of the largest players in the Marcellus. A quick look at their cash flow statements confirm this.

Interestingly, Dr. Engelder does not mention Range or Chesapeake which are pure shale operators. He chooses instead to single out Anadarko Petroleum and Cabot Oil and Gas as his examples so it is of note to look into the free cash flow of these particular companies both of which have struggled over the past few years with regard to free cash flow.

In the case of Anadarko, from 2010-2012 the company spent $17.9B on capital expenditure only to amass an impressive loss of $1.8B in free cash flow. Cabot spent $1.6B in capital expenditures for a loss of $1.0B in free cash flow over the same time frame. One cannot help but be reminded of the famous line from Jerry Maguire, “show me the money”…not lack thereof!

Moreover, we could expand the universe of shale operators above and include EOG and Encana and we would still see significantly negative free cash flow for the longer term.

Dr. Engelder concludes his interview with the statement:

“Keeping the price of natural gas low will benefit Americans in the long run…”

Uh…only if the price stays low for the long run!

The sad irony is that if the price of natural gas remains low this will drive some operators into potential bankruptcy, fire sales of assets (we are already witnessing such sales) and others to abandon shale production altogether by abandoning leases ( which is also occurring) or shutting in production until they can get better prices. Indeed, Cabot, Dr. Engelder’s example, announced in a press release dated 26 September, 2013 that they were holding back production in the Marcellus until spot prices recovered. This is simple market driven economics. You can’t produce gas at a loss forever no matter how much public relations spin you put on it. But perhaps more importantly, Dr. Engelder did indeed acknowledge that higher, not lower, prices are really the name of the game. He concluded his statements with:

“…this is a business and companies know they can get a higher price overseas.”

Yes, they can. And that will go far to salvage ailing balance sheets that are far too heavily laden with toxic shale assets. It is of note, however, that one of industry’s primary apologists has now inadvertently admitted that producing shales is not an exercise designed to make America energy independent or keep nat gas cheap for the long term. It is an exercise to make money.

What a relief to finally lay to rest that ridiculous and intellectually insulting notion that shales were designed all along to wrap us up cozily in a red, white and blue flag proclaiming energy independence while America dismissed forty years of promoting globalization and thumbed her nose at global markets as she produced ALL her energy needs from…shale oil and gas??? You betcha’!

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Oct

01

Shale M&A Plummets

By Deborah Lawrence Rogers

In February 2013, EnergyPolicyForum issued a report which exposed the role large Wall Street investment banks have played in keeping shales afloat. The report received a tremendous amount of interest from the investment community worldwide. During the promotion of this report, I gave a number of presentations in which I stated that it would be of paramount importance going forward to see if the banks could continue to generate large fees off shale transactions. It was my contention that we would see a significant downturn for deals given the inherent problems with shale production and the growing body of evidence that shales had never been what they were promised to be. Interestingly enough, shale mergers and acquisitions have indeed taken a slide. Or perhaps I should be more precise: a nosedive.

In August 2013, Bloomberg reported:

“North American oil and gas deals, including shale assets, plunged 52 percent…in the first six months [of 2013].”

This is not at all surprising given the massive write downs which have occurred in shales. BHP Billiton, a large Australian multinational, bought all of Chesapeake’s shale assets in the Fayetteville and 18 months later was forced to write off more than 50% of the purchase price. Shell and ExxonMobil recently took large hits to their bottom lines with Shell announcing the sale of 50% of their North American shale assets. Although industry likes to maintain that such write downs are only attributable to the decline in natural gas prices, the numbers belie this. A decline in price does not wholly explain away such declines in asset values, revenues generated or the fact that a doubling in the number of producing wells still can’t push per well production higher. In other words, the hype is catching up to the operators no matter how fast they try to run.

And there’s more.

A recent article in Rigzone stated:

“We are seeing dealmakers go deeper and broader in their diligence to assess whether current deal valuations can deliver long-term value.”

Going “deeper and broader” in due diligence means only one thing: past buyers got burned…badly. Anyone looking to buy shales now is wising up to the fact that many of these properties simply are not living up to expectations or industry hype. Chesapeake’s Mississippi Lime transaction is a classic example. Chesapeake valued their Miss Lime assets in the summer of 2012 at $8000/acre. When they were sold earlier this year the purchasers were only willing to pay about 1/4 of that value. In all fairness, this is probably where shales should have been all the time but emotion and significant over promotion got in the way.

Rigzone admits as much:

“…successful sellers are providing a clearer and more transparent picture of their assets in order to minimize transaction timing.”

It is unfortunate that a “more transparent picture” was not there all along. It might have saved billions in shareholder destruction.

And there’s more.

Foreign and private equity investors are now shying away from shales. PriceWaterhouseCoopers (PwC) confirms that these investors are now concentrating more on potential returns than hype. This makes for a nice change. They state yet again:

“We also believe that foreign acquirers are increasing the scope and breadth of their cross-functional diligence which can have the effect of lengthening the deal process”.

Further, according to Rigzone, private equity investment has dropped “90 percent from the second quarter of 2012″. That is a significant pullback, particularly when one considers the barrage of hyperbole about “game changing”, “revolutionary” performance “for decades and decades to come”.

Moreover, two of the purportedly most promising new shale plays in the U.S., the Utica and the Monterey, are being downplayed…before they even really got started!

PwC stated:

“For the first time in seven quarters, no deal activity occurred in the Utica shale”.

But the Utica was touted to be “the greatest thing to hit Ohio since the plow”. Just as the Monterey shale in California was supposed to be the greatest thing to hit California since the talkies. Ok, I made that up. I have been subjected to shale executives on company analyst call transcripts for so long that I’m getting the hang of this! Nevertheless, the Monterey has produced nothing but dud wells and companies like Chevron are proclaiming that the gas has likely migrated out of the shale altogether.

I wonder…would that be in a similar fashion to the migration of the billions of investment dollars that have disappeared into the black hole of shales?

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Sep

25

Fracking Benefits the Poor?

By Deborah Lawrence Rogers

A recent opinion piece in the Wall Street Journal touted the financial benefits “to the poor” from fracking for natural gas. The piece based its entire premise on the ridiculous assumption that natural gas prices will stay low indefinitely. Such logic is seriously flawed. But for one of the world’s most prominent business papers to propound such an assumption is tragic.

Natural gas prices have indeed declined 61% from their highs which has translated into near term cost savings for manufacturing and electricity generation. No one would dispute that fact. But to infer that such a decline was intentionally designed by industry to continue long into the future requires a leap far beyond credibility. These same purportedly “altruistic” companies are struggling with massive impairment charges, negative free cash flow, fire sales of assets and ever weakening balance sheets, some even tottering on the brink of bankruptcy, because of the decline in natural gas prices. It is far beyond the realm of credibility to infer that such a decline was intended and even wished for by industry in order to “help the poor”. This borders on delusional.

The opinion states:

“…fracking is a much more effective antipoverty program than is Liheap.”

That statement can only be argued true from one angle: prices declined precipitously which in turn benefited consumer costs in the short run. This price decline, however, was the direct result of oil and gas operators over-producing natural gas on such a massive scale that they significantly disrupted the market and tanked prices. Further, and equally, one could reasonably argue that such disruption was irresponsible and poor management of natural resources. Leaving that aside, however, there have been not one but two rounds of massive impairment charges that have occurred in shale companies since 2009. The latest round began about a year ago with billions in write downs and culminated in the last quarter with corporations the size of Exxon Mobil and Royal Dutch Shell announcing intended shale asset sales as they reeled from a considerable drop in earnings.

Moreover, free cash flow in shale companies has been consistently deteriorating since 2008 with greater and greater losses incurred each passing quarter. Taking a universe of only five shale companies with onshore operations – Continental, Range, Devon, Kodiak and Chesapeake – one finds that free cash flow is alarmingly negative in every case. Further, CAPEX exploded during the same time in spite of the fact that no free cash was generated.

According to the WSJ opinion:

“Thanks to the lower price for natural gas, families saved roughly $32.5 billion in 2012.”

No one would argue that a cost savings of $32.5 billion to consumers is a bad thing but it must be juxtaposed against the fact that these 5 companies alone spent approximately $56 billion in capital expenditure since 2010, well in excess of the $32.5 billion in consumer savings. Nevertheless the free cash generated from their $56 billion spending spree is non-existent and losses are mounting. That equates to significant shareholder destruction and is not sustainable in the least. In order to keep producing natural gas, companies must begin to generate profits from shales and the only way that will happen is if prices increase in which case all “benefits to the poor” will evaporate like proverbial hot air.

It is more than strange, therefore, to witness cognitive dissonance at one of the premier business journals as the authors apparently dismiss the possibility of companies spinning headlong toward bankruptcy or destruction of shareholder worth as long as they provide economic benefits…to the poor?!!! Perhaps this should be our clue that something is truly amiss.

After all, entities such as the WSJ used to promote companies engaging in business to make money. Philanthropy belonged to another realm. Surely, they are not seriously advocating a paradigm shift.

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Aug

19

Shales: “The Greatest Show on Earth”

By Deborah Lawrence Rogers

In June 2013, Southwestern Energy made a presentation at the EIA Energy Conference entitled: “Natural Gas: A National Treasure”.

While the industry continues to hype natural gas and oil production from shales as the great panacea for all our energy woes, such hyperbole needs sufficient justification. And…well…the numbers just aren’t there. At least not for anybody except Wall Street investment bankers and even they are now seriously struggling to make shales pay.

Energy companies claiming long term viability of shale production is cause for some critical thinking and critical questioning which unfortunately has been sorely lacking in the shale debate to date. After all, those companies need to convince investors about shale’s prospects to keep the money flowing in. But when one examines the numbers, whether they be significant deterioration of free cash flow at virtually every shale company, or the cost of externalities far outstripping severance tax revenue or massive writedowns of shale assets able to knock 50-60% off earnings at companies the size of Royal Dutch Shell and Exxon Mobil, one has to sit back and consider that maybe, just maybe, shales are not all they are cracked up to be.

The word “treasure” conjures up images of gold doubloons filling ancient chests, indeed spilling out. While the U.S. is currently spilling a significant surplus of natural gas into storage and the atmosphere, this has most decidedly not translated into the proverbial gold doubloons. Quite the opposite.

According to Bloomberg on August 19, 2013:

“The spending slowdown by international companies including BHP Billiton Ltd. (BHP) and Royal Dutch Shell Plc (RDSA) comes amid a series of write-downs of oil and gas shale assets, caused by plunging prices and disappointing wells.”

“Writedowns” and “disappointing wells” seem curious parameters for a “national treasure”. Unless, of course, you live in the Age of Spin.

Bloomberg continues:

“…fields bought during the 2009-2012 flurry remain below their purchase price…”.

Again, an odd parameter for a “national treasure”. Fields remain[ing] below their purchase price equates to losses. Just ask Chesapeake. The company has closed a couple of deals recently for about 1/4 of estimated value. The question should be, of course, whether the value was inflated from the start.

Bloomberg concludes:

“The deal-making slump, which may last for years, threatens to slow oil and gas production growth as companies that built up debt during the rush for shale acreage can’t depend on asset sales to fund drilling programs.”

In other words, it is no longer working to drill a few wells and proclaim a field “proved up” even though that has been a major strategy in shales. It seems, however, that the suckers who bought are experiencing a bit of buyer’s remorse.

Further, not only are operators unable to depend on asset sales to fund drilling programs, they cannot even depend on cash generated by the wells to fund operations. That was the old fashioned way of doing business which is apparently considered quite quaint these days. In June, EnergyPolicyForum exposed the folly of free cash flows and CAPEX at five on-shore shale companies. Negative free cash flow means that management is forced to move outside the company to fund operations. This means either more debt or shareholder dilution, neither of which is good for investors long term.

EnergyPolicyForum stated:

“Free cash flow of Continental Resources, a big player in the Bakken, has dropped from a loss of ($430M) to a loss of ($2.4B) since 2010. And Continental is not the only one. Devon Energy’s free cash flow has dropped from ($1.2B) to a significant ($3.5B) over the same time frame. Range Resources, who are drilling primarily in the Marcellus, booked a negative free cash flow of ($556M) in 2010 and this has deteriorated to ($1.0B). Kodiak Oil and Gas, another Bakken player, had negative free cash flow in 2010 of ($170M). It has now deteriorated to ($1.0B). Chesapeake is interesting because its free cash flow for 2012 ($3.3B) is now roughly equivalent to its level in 2010, ($3.4B). But over the last two years Chesapeake has liquidated approximately $13 billion in assets with no commensurate gain to free cash flow. Management still needs to move outside the company to generate cash to continue operations. And yet, shareholders have had their underlying assets disappear to the tune of $13B to pay down debt.”

Clearly there is a pattern here of severe deterioration. But that is not all. EnergyPolicyForum continued:

“CAPEX has exploded during this time which means that companies have spent enormous sums of money drilling wells that are not providing enough cash to continue drilling operations on their own. Not even close. For instance, Continental’s CAPEX grew from $1.0B to $4.1B. Devon’s CAPEX grew from $6.4B to $8.2B. In total, these 5 companies spent approximately $56B in capital expenditure since 2010 while the free cash generated from this $56B spending spree is non-existent.”

Hardly the stuff of a “national treasure”. The object of this exercise is, after all, to convert oil and gas into actual dollars. And it is not just the larger independents who are struggling with shales. Now even the Majors are affected.

Shell wrote down the value of its North American holdings by more than $2 billion last quarter. From 2009 to 2011, Shell’s free cash flow rose and then plateaued between 2011 to 2012. But from 2012 to the latest quarter reported, there has been a steady decline. Shell’s CEO Peter Voser stated in August 2013:

“The major [shale] acreage deals are behind us now”.

The company informed investors that its North American oil and gas exploration will most likely remain unprofitable until sometime in 2014. Meanwhile they intend to divest shale assets. Further, their losses were specifically in shale oil according to the company. But as recently as 2012, an industry blog site assured:

“Shell does not publicize much when it comes to the Eagle Ford, but the company was working more than six rigs at the start of 2012 and the asset is considered core to the company’s onshore North America growth strategy.”

Quite troubling numbers for a “core” investment.

ExxonMobil also took a hit to the bottom line with earnings falling more than 50% from the same quarter 2012. Chevron, too, is struggling. Yet in spite of such glaring financial anomalies, industry propaganda machines like Energy in Depth (EID) continue to turn out hyperbole. In August 2013, during the various announcements of significant write-offs by Shell, Exxon et al, EID crowed:

“That’s right, folks…As we continue to see across the United States, the shift in production techniques comes with countless, game-changing benefits for the nation. And, not for nothing, the Saudi Prince is absolutely terrified of what U.S. shale production could do to his country’s control of the global oil market.”

It is moments like these when the phrase “the greatest show on earth” comes to mind.

Setting aside the obvious reminders of a circus barker, we are assured of the “countless, game changing benefits” and that some Saudi Prince is “absolutely terrified” of U.S. shale potential.

There is just one problem. In the center ring, the simple fact remains that operators, including some of the largest and most capable oil and gas companies on the planet, are utterly unable to translate shale gas or oil into meaningful long term investment returns.

In addition, there was another revelation which some analysts, such as the Wall Street Journal, who have been unapologetic cheerleaders for shales found “startling” by their own admission. Bloomberg stated:

“Companies were also hurt when some fields thought to be rich in oil proved to contain less than anticipated.”

It must be said that there are other analysts, including EnergyPolicyForum, who were not “startled” in the least. We called this long ago.

Interestingly, however, there is another well known quote from P.T. Barnum: “there’s a sucker born every minute”.

Not much more need be said!

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Jun

19

Huge CAPEX = Free Cash Flow? Not In Shales

By Deborah Lawrence Rogers

The oil and gas industry has made tremendous promises regarding shale gas and oil, most of which are, unfortunately, dropping by the wayside. We were promised production “for decades to come” though actual production numbers belied this. We were promised energy independence while the wells were screaming down their decline curves. We were promised jobs, while renewables were quietly booking considerably more jobs per kilowatt than oil and gas. Three times as many to be exact. Perhaps such poor performance from oil and gas is precisely the reason for the hyperbole.

Nevertheless, an interesting article from Bloomberg touches on another aspect of shale production: sustainability. Fiscal sustainability.

Bloomberg quotes Mike Tims, the Chairman of Canadian investment bank Peters and Co.:

“Increased crude output from U.S. shale isn’t “sustainable” production. Producers need to invest too much to sustain production from wells in the Bakken and Permian basins, which falls as much as 70 percent in the first year.”

This bears scrutiny.

When looking at company’s financial statements there are certain metrics that are useful in judging the health of that company. One of these is free cash flow. Not cash flow but free cash flow. Why? Because it is difficult for company management to fudge free cash. The veracity of any statement can easily be checked against bank balances. That is not to say that there is no way to manipulate it but it is more difficult.

Free cash flow can be defined as operating cash flow less capital expenditure (CAPEX) less any dividends paid.

Taking a universe of 5 shale companies, some primarily with shale gas assets and others with shale oil, it is of note that there has been a significant deterioration of free cash flow since 2010. But what is even more interesting is that some of these companies are reporting that net income has been growing though free cash is falling.

Not wishing to bore everyone with an esoteric discussion of financial statements, it is of note that when a company shows a growth in net income with a concomitant deterioration of free cash flow, it may be an indicator that management is taking aggressive steps to boost earnings artificially. Not always. But possibly.

So how much deterioration has there been in free cash flow? It is impressive.

When you adjust the figures to include capital expenditure (and dividends where appropriate), their free cash available is negative. Significantly negative.

This is highly problematic because if a company cannot generate cash from operations then it has to go outside and get the monies through borrowings or equity offerings. In other words, debt or dilution for investors.

Free cash flow of Continental Resources, a big player in the Bakken, has dropped from ($430M) to ($2.4B) since 2010, all of it negative. And Continental is not the only one. Devon Energy’s free cash flow has dropped from ($1.2B) to a significant ($3.5B) over the same time frame. Range Resources, who are drilling primarily in the Marcellus, booked a negative free cash flow of ($556M) in 2010 and this has deteriorated to ($1.0B). Kodiak Oil and Gas, another Bakken player, had negative free cash flow in 2010 of ($170M). It has now deteriorated to ($1.0B). Chesapeake is interesting because its free cash flow for 2012 ($3.3B) is now roughly equivalent to its level in 2010, ($3.4B). But over the last two years Chesapeake has liquidated approximately $13 billion in assets with no commensurate gain to free cash flow. Management still needs to move outside the company to generate cash to continue operations. And yet, shareholders have had their underlying assets disappear to the tune of $13B to pay down debt.

Clearly there is a pattern here of severe deterioration. But that is not all. CAPEX has exploded during this time which means that companies have spent enormous sums of money drilling wells that are not providing enough cash to continue drilling operations on their own. Not even close. For instance, Continental’s CAPEX grew from $1.0B to $4.1B. Devon’s CAPEX grew from $6.4B to $8.2B. In total, these 5 companies spent approximately $56B in capital expenditure since 2010 while the free cash generated from this $56B spending spree is non-existent. In fact, it is worse than non-existent because it is alarmingly negative.

This is not sustainable. It could be argued that it is not even moral. It is a failed business model of epic proportion. While companies could make the argument at one time that this was a short term downtrend, that no longer holds water because this pattern is long term.

The most troubling aspect of this is that we are fast tracking exportation of this commodity in spite of the glaring financial anomalies. It is extraordinary that some members of Congress proclaim whole heartedly for fiscal responsibility while turning a blind eye to fiscal irresponsibility among their campaign donors and promoting exportation.

I believe this is commonly known as hypocrisy. Or is it politics?

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Jun

03

Will the Eagle Ford Shale Bankrupt Local Communities? Part 2

By Deborah Lawrence Rogers

There are times in life when critical thinking simply must be applied. In spite of the rhetoric of politicians.

In my last post, I quoted the Eagle Ford Shale Task Force as admitting that DeWitt county alone needed $432 million dollars for road repair and maintenance. The problem is, of course, that the Texas Comptroller states that the entire severance tax revenue for all 24 counties of the Eagle Ford amounts to only $323 million. This equates to a shortfall of $109 million needed in funds for merely one county out of the 24. So the math clearly does not work here.

But wait…there is more!

Last week, Texas lawmakers approved a plan to spend up to $225 million from the state budget to fix damaged roads in this same Eagle Ford Shale region. After this decision was made, Sen. Carlos Uresti, D-San Antonio, made the most astonishing comment:

“Help is on the way for these counties…Working in a bipartisan fashion, the Legislature has recognized that county roads are the gateway to the oil patch and must be maintained for the state’s oil boom to continue. With this bill, we are saving the goose that laid the golden egg.”

Where do I even start?

Firstly, that “goose” cracked your concrete which is going to cost hundreds of millions of dollars to fix. This $225 million won’t even pay for half the projected damages in one county alone! Secondly, that “goose” does not need to be monetarily “saved” as it is one of the most lucrative industries on the entire planet. Thirdly, that “goose’s” golden egg is scrambled up with more costs from road repair, air toxics, water depletion and potential aquifer ruination and encroachment, none of which will be paid for by the “goose”.

If you wish to thank someone, Senator Uresti, thank your own constituents, the Texas taxpayers, because they are the real “golden goose”. They just donated $225 million dollars to repair their own roads which were ruined by the oil and gas industry.

But, hey, well done!…the oil and gas industry thanks you and your bipartisan colleagues sincerely, from the bottom of their hearts, for making their bottom line that much more profitable while spinning them to the press in such a favorable light…golden, no less! Like tungsten! Highly flattering!

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Jun

02

Will the Eagle Ford Shale Bankrupt Local Communities?

By Deborah Lawrence Rogers

The oil and gas industry has shouted from the roof tops for quite some time about the “shale revolution” and its supposed long term economic benefits. They have crowed about severance taxes and sales tax revenue and promised as much as 600,000 good high paying jobs for American workers. They have engaged in a public relations campaign with advertisements on television seemingly every five minutes telling the American people about all the great jobs they are creating and frothing a patriotic fervor with talk of energy independence. And it has worked.

There is just one problem. It doesn’t happen to be true.

Independent analyses of shale plays throughout the U.S. confirms that wells are short lived and reserves not as great as industry promises. Production numbers don’t lie which makes them very inconvenient for industry to deal with once they are available. This is why operators begin to sell or joint venture assets once production can be verified. They, and their investment bankers, recognize that such disclosure can adversely affect share prices.

Further, broken promises are not the only difficulty with shale production. Communities where drilling has occurred are now dealing with various externalities. But the companies who have generated these costs are not paying for those costs. They have off loaded that significant burden onto the tax payers and local businesses. This is true of the oil and gas industry as a whole. In fact, economists estimate that if all oil and gas externalities were included gasoline would cost in excess of $12/gallon.

The Texas Railroad Commission’s Eagle Ford Shale Task Force issued a report in March 2013 in conjunction with the University of Texas, San Antonio which is a real eye opener. Texas Railroad Commissioner David Porter crows:

“The Eagle Ford Shale has the potential to be the single most significant economic development in our state’s history.”

Now setting aside the question of whether it is appropriate for the state regulatory agency charged with oversight of oil and gas to come out as industry’s chief cheerleader, Commissioner Porter appears to have overlooked a few other details that might have a significant impact on the overall economic return to the great state of Texas.

DeWitt County is one of the core counties of the Eagle Ford which means that it has a disproportionate number of good wells. Shales are not homogenous though industry once promised us they were. Each play has contracted down to sweet spots just like a conventional play. Drilling down into the road damage costs for DeWitt county, it is admitted in the report:

“The cost of providing a county road system designed to meet the anticipated traffic demand arising from drilling another 3,250 wells in DeWitt County at 65-acre spacing is approximately $432 million.”

But the Texas Comptroller confirmed that :

“…$323 million was collected on production [in the form of severance taxes] from 24 Eagle Ford Shale counties in FY 2011.”

Please note that those severance taxes were for all the Eagle Ford counties, not just Dewitt. And still there is a significant shortfall that equates to $109 million…just for Dewitt County. But what about the road damages in those other Eagle Ford counties? No information is given. But the report states:

“According to Task Force member and DeWitt County Judge Daryl Fowler, DeWitt County’s experiences with truck traffic and road quality are a typical example of what is occurring throughout the Eagle Ford Shale play.”

The report continues with the admission:

“Road and bridge maintenance budgets doubled or tripled in many counties and forced elected officials to exceed tax rollback ceilings in order to meet expanded maintenance needs.”

Coming to the rescue, the authors suggest:

“severance taxes could be viewed as a self-regulating funding source that is almost immediately available to meet road financing needs in oil and gas producing areas of the state”.

Well, yes…except the severance taxes don’t cover the cost! Not even close!

Interestingly, and humorously to my mind, the report went on to state:

“The question has been raised whether the county property tax…can or should continue to shoulder such a large share of the burden for financing local road needs”.

Good question, boys! But I think you might need to use more than 10 fingers to figure this out!

Then the report stated:

“Some roads require annual maintenance at $70,000-80,000 per mile. However, other roads need basic reconstruction at a cost of up to $920,000 per mile, and roads that already handle the traffic meant for an FM system can cost up to $1.9 million per mile to rebuild when the costs of additional right-of-way, engineering, fence building, and utility moving are considered.”

A further admission:

“…infrastructure costs far outpace a county’s ability to raise revenue from a local property tax, even with the increasing tax base created by the new mineral wealth.” [emphasis mine]

The conclusion:

“Although we cannot know when things will occur, it is apparent to county government officials that the financial needs of providing a public road system capable of supporting the industry and the local needs are far greater than what DeWitt County’s $15 million total annual revenue can provide.”

That’s a problem. A very expensive problem. Not only can DeWitt county’s paltry $15 million not provide it but all the severance tax revenue for the Eagle Ford cannot provide it. But it is only a problem for the tax payers. Not for the companies that generated the costs. In other words, these companies have effectively managed to privatize profits while socializing their costs.

Returning to Commissioner Porter’s opening statement:

“The Eagle Ford Shale has the potential to be the single most significant economic development in our state’s history.”

He may be right! It may prove to be the very economic development which bankrupts 24 counties of the Eagle Ford!

This is what comes of cozy relationships between regulatory agencies and the industries they oversee.

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