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.
“…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.
“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.
“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!