The Natural Gas Massacre Gets Bloodier

Wolf Richter's picture

Wolf Richter

The plight of natural gas driller Chesapeake Energy could almost make you feel sorry for the board of directors and CEO Aubrey McClendon. He lost his chairmanship after his conflicted entanglements and an in-house hedge fund seeped to the surface. The company announced it may run out of cash to fund its drilling operations next year. Fitch, in downgrading Chesapeake’s Issuer Default Rating and senior unsecured ratings to BB-, estimated that the shortfall this year alone would reach $10 billion—in the first quarter, the company bled $3 billion in cash—and that it would be forced to dump up to $20 billion in assets to get through this. But Chesapeake’s ability to get new money should not be underestimated during these crazy times when the Fed keeps iron-fisted control of the credit markets with its zero interest rate policy. Investors are dying for yield, at any risk. So Chesapeake got a loan of $4 billion from Goldman Sachs and Jefferies Group to bridge the current hole until some asset sales come through, hopefully. And all due to the low price of natural gas and the ugly economics of fracking.

Fracking, which allows drillers to get gas and oil from shale deep underground, triggered a revolution. Gas production in the US has been setting new highs, and as supply overwhelmed demand, prices have collapsed. Gas in storage is at a record high for this time of the year, and some doom-and-gloom prophets maintain that storage will reach capacity this fall, and that producers won’t be able to get rid of their gas and will have to flare it, pushing its price to zero.

However, natural gas for June delivery settled on Wednesday at $2.73 per million Btu on the New York Mercantile Exchange. A 44% jump from its April 19 low of $1.90 per million Btu, but still only half the five year average, and below the already low price at the beginning of the year. As this chart shows, the recent uptick isn’t much of a salvation for the beleaguered drillers.



In fracking, during the initial phase of production, high pressure blows a huge quantity of gas out the well—and the quantity of the first 24 hours, the “initial production,” is bandied about to investors and lenders, who are so impressed.

Alas, it’s the most the well will ever produce in a 24-hour period. As pressure drops, gas production drops precipitously. All wells have decline rates. But instead of declining gradually over decades, shale gas wells decline sharply over days, weeks, and months. After a year, production may be down by 80%, and after a year and a half by 90%. But the outsized production early in the lifecycle allows drillers to show a big upfront profit. To conceal the decline rates, they drill another well. And another well, and so on. The more they drill, they more they have to drill to hide the drop-off in production of the prior wells—ad infinitum! Which is impossible. But drillers kept it up long enough to get prices to collapse. And then, what caught up with them was ... reality.

The industry even has a term for it: Ultimate Economic Recovery (UER), the quantity of gas a well produces over its life. Since no shale gas wells have lived through the entire lifecycle yet, UER numbers have to be estimated, and they now appear to be much lower than the initial industry estimates that were mostly hype. Whether or not a well is profitable over its life depends on the UER, the cost of drilling and maintaining the well, and the price of gas during that time. An excellent pricing model for the Barnett Shale field determined that a well might become profitable over its life if gas is at $8 per million Btu.

Even if the model is off a bit, it shows that the industry has been fracking at a steep loss for years. But due to the way gas drillers account for their wells by front-loading profits, the pain has mostly shown up in their ballooning debt and their current negative operating cash flows. Hence, Chesapeake's dire situation. Drillers have shifted whenever possible from drilling for natural gas to drilling for oil, which is still highly profitable. And so, the rig count for gas wells has been heading south, from over 900 last fall to 600 last week (Baker Hughes).

Turns out, the shale gas revolution is an uneconomic activity even at much higher prices and is sustainable only for a limited time and only by blowing through loads of borrowed money. Now debt has piled up, cash flow is negative, and solvency risks are gathering on the horizon.

With money running out to drill new wells, the steep production declines inherent in all shale gas wells are oozing into P&L statements, and suddenly, all that debt that made so much sense a year or two ago is unmanageable. Assets have to be sold off in a hurry, drilling diminishes further, and a vicious cycle overtakes the false promises of yore. And production, which lags behind rig count movements, will drop, and drop steeply.

Meanwhile, the low price of gas has bent the demand curve: utilities are shifting massively from coal to gas for power generation. Their demand is eating through the record amount in storage and will clash later this year with diminishing production. It’s a classic example of how a price that is too low will spike, but only after a monumental massacre in the industry. Read.... Havoc and Opportunity in Natural Gas.

Since November, oil went from $90 to $110 and back to $90. Has it established a floor that will stick? Or is it getting ready to crash, given that drillers use the same technologies that brought on the glut of natural gas. For an excellent discussion, read.... Drilling Down into Oil & Gas Prices.

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Zero Govt's picture

"Chesapeake got a loan of $4 billion from Goldman Sachs and Jefferies Group to bridge the current hole until some asset sales come through, hopefully. And all due to the low price of natural gas and the ugly economics of fracking."

Yes, what a 'squeeze' ...wonder who is turning the vice.. Goldmans to the 'rescue'

adr's picture

If the speculating criminals get ahold of nat gas again we could be looking at $10 per mcf in short order. Of course it will have nothing to do with supply an demand. That price will also throw the economy into sharp contraction, but all the speculative traders are looking for is a quick buck. To hell with the consequences.

$2.50 per MCF is a good price based on current fundamentals.

$7.00 per mcf as a breaking point for shale gas?? WTF that isn't even close. If you take out the last five years of unrealistic commodity pricing insanity natural gas has never been over $7.00. $7 per MCF wholesale would translate into retail prices of $10 per mcf or higher making the average monthly heating bill over $300. Yeah good luck with that.

Augustus's picture

"IF" the speculators control all energy prices, why did they let NG price drop to an unprofitable to produce level in the first place.  Are they ust being nice to give you a break and reducing the price from $10 to $2.50? 

And then there is the oil price decline.  Who would have thought the criminals would ever allow you to get oil for less than $150 a bbl.  What is your theory?  Did they hear the voice of the Lord or Allah telling them to not charge the hapless consumers so much money? and if they did, are they still criminals when they go out of business because of the low NG prices?

covert's picture

you forgot to include volume and psar in your chart! slipping?



Buttertooth's picture

I work making slings for the gas drilling equipment in PA.  There has absolutly been a very sharp reduction in the quantity of slings I have made in the last 3-6 months.  I have been told the drill rigs are headed to Ohio.

jtlien's picture

I was intrigued by the low natural gas prices and decided to convert my house nat gas.    I live in a city of 50,000 in the midwest.  I talked to our utility and they said it would cost $5000 to connect me up.   To be generous they would only charge me $2000.   This despite the fact that the house is within one hundred feet of the curb.   So the utility wants me to buy the infrastructure for them.  They even charge nat gas users a fee of about $20/month for "transportation fee".   So they want me to buy the infrastructure that will last them a 100 years and then charge me a monthly fee as well.  This is thier thinking when interest rates are at an all time low.   Maybe the nat gas drillers need to find a way to get their product directly to the users.

Augustus's picture

The local utility company should be able to do a tap and meter set for a fairly small charge.  Then contract with someone else to run the line from there to the house.  It should be less than $10 a foot for the line and the installation.  A ditchwitch should do the job for the 100 ft.  Every utility company has a regulated fee structure for billing out various parts of the costs of service.  That $20 a month should cover the costs of the lines installed to deliver it to you from the high pressure main line tap, where ever that is.  Generally, cost of gas is billed seperately and should be declining.  With that NG furnace the conversion efficiency should be in the 95% range.  The best setup if you have mech heating load and depending upon geographic location is to get a heat pump with the NG backup.  You get a new efficient airconditioner out of the deal too.  It will use electricity for heat from the HP until temp gets to, maybe, 35 deg.  Then the NG will supply the heat from an automatic switchover.  The COP for the HP will be in the neighborhood of 3 when on electricity.  It avoids the need for the expensive and inefficient resistance coils and electricity for the colder times.  Pretty darned neat and comfortable.  Just don't let someone oversize it.

AGuy's picture

The Price of NatGas is going to soar in a few years. Fracking need prices to rise between $12 to $18 per mmbtu to be profitable. Consider that in 6 months Frack wells decline to 50% and within 18 months the well is depleted. Fracking is like the creative mortgages during the housing bubble. They created all sorts if bogus mortgages, like interest-only mortgages and the 50 year mortgage to keep the bubble going for a wee-bit more.

Perhaps, just perhaps, the NatGas company know the deal and doesn't want to invest their money in something that not going to be profitable for them over the long term. It would suck for them to invest thousands of dollars to hook you up, only to find in a few years you revert back to oil or wood and they are out a bundle.



adr's picture

Never convert your house to NatGas using a forced air furnace, unless you like paying $150-$300 a month to heat your home. Stick with a boiler and radiators. Better yet get a wood burning stove.

The NatGas utilities are as criminal as any bank.

rumblefish's picture

given the correlation between metals and Oil, are you that expectg oil to fall expect metals to follow?

orangegeek's picture

WTI oil is bearish.


Should see oil below $75 per bbl in the months to come.

Zero Govt's picture

..and another Elliot Wave loon

..who says on the Dow Jones, "We have noted resistance (orange line) where, if broken, it will alter the wave count."

"alter" as in got it wrong which is a regular occurance, so regular you wonder why you can't beat a 50/50 coin toss... ask Rob  Prechter who has been getting it wrong on Gold and Silver and all the US stock markets but still won't shut up

unionbroker's picture

a lot of the shale gas wells produce other product, condensates that sell for extremely attractive prices, one must do their homework to determine the true valuations of these wells and companies. Not as straightforward as some people might think 

marketcycles79's picture

Natty gas....the commdoity that cannot catch a bid. 

Making money is important no? Not following the herd?

Using roadmaps to predict the most probable outcomes?


Not trading on fear or emotion. Using patterns and cycles developed independently over time.

Zero Govt's picture

Oh no, an Elliott Wave pattern recognition loon

when the High Priest of pattern recognition, Rob Prechter, is wrong more often than a 50/50 coin toss doesn't that tell you something???

John Law Lives's picture

This is an interesting (and timely) article.  The reported weekly injections of natural gas into storage over each of the past four (4) weeks have been well below the 5-year average.     (click on Gas Storage on the website)


Week Ending     Data Released      Injection (bcf)     5 Yr. Avg. Injection (bcf)

27-Apr-12         03-May-12                   28                             85

04-May-12        10-May-12                   30                             84

11-May-12        17-May-12                   61                             90

18-May-12        24-May-12                   77                            101

oddjob's picture

Injections will be close to zero as we reach storage capacity.

MrPalladium's picture

As long as there is additional storage capacity available, the fact that the weekly adds are far below the historical average means either that demand is rising or that supply is falling. While supply has been firm, the falling additions mean that demand is rising. Note the steep drop in rig counts over the last four months:

Falling NG prices and full storage are bets on a cooler than average summer. How is that bet looking so far?

And how about this one:

I am taking the other side of that bet. I think that the recent rise in NG prices has legs. Waiting for a sell off and a higher low on the daily chart before going all in.

MrPalladium's picture

Yes, and it is due to increasing demand - primarily for electricity generation. Most investors miss entirely the significance of your post.

Augustus's picture

The original shale economics were pretty good.  Leases were darned cheap as no one had figured out how to recover the shale oil or gas.  One year's revenues paid for the well, maybe 18 months.  Then they went nuts.  Raised royalty rates to 20% or more and paid some lease signing bouses of $5,000 to $10,000 an acre.  Hogs ruined the economics because they were able to borrow against reserves that still have unknown values.  McClendon was the leader of the swine herd.

Omen IV's picture

your numbers are in the ball park of my experience 33 years ago in the Niobrara shale in the southern part of the powder river basin east of douglas

drilled to 10,000 feet - $1.3 million to complete - 700 bbls a day and 1.8mmcf for 18 months at $42 bbls in the fall of 79' - shah just deposed - paid for the well in less than 18 months then declined quickly to settle in at 18 / 28 bbls a day and 250mcf at 1300 BTU's - so good amount of liquids - for 30 years - but prices for gas most of that time were very poor - even still it paid for several kids education and a lot of braces and camps - we had 10,000 contiguous acres - longer story of a farm out gone bad

but it sounds like the directional drilling cost versus the improved production from that approach yield the same general economics today at $90 bbls 


ddtuttle's picture

Decline rates are one thing, but the break even point for most shale gas wells is about $7.00/mcf for the life of the well.  At $2.00 they're all loosing money.  What the early producers did was sell partial ownership to European, Asian and Middle eastern investors in exchange for exposure to the technology.  This has made the  early wells profiatble, but now the jig is up.  Less wells will be drilled at this price, and old wells will be shut-in sooner.  Eventually the price will rise and equilibirum will be restored around $7.00, which is still cheap compared to oil.

As far as fracking is concerned this is total luddite eco-paranoia. We've been fracking oil wells for over 100 years.  Today we even frack water wells (without the chemicals, of course).  The rush to tap shale gas brought in some incompetant drillers who didn't do their geology, or ignored it.  Proper use of the technique is about as safe as anything else.  BTW: methane gets into water wells naturally too; the flaming faucet is not unique to fracking.

In the end prices will support shale gas, and it will help the US with CO2 emission, pollution, and energy independence.



Idiot Savant's picture

As far as fracking is concerned this is total luddite eco-paranoia. We've been fracking oil wells for over 100 years.

Really? Wake me up when companies willingly disclose the chemical composition of their fracking fluids. You're also discounting the amount of water that's required to frack wells.

"This is a common industry tactic, to claim that hydraulic fracturing [HF] has been used for 60 years.

This is deliberately misleading.

The new hydraulic fracturing that has brought about so much attention in the last few years is

different in many ways from the historic fracturing:

1) the pressure used is much higher and the duration of the frack job is longer. Today HF employs

typically 13,500 pounds of pressure per square inch, whereas earlier HF was less than 10,000 pounds

per square inch."

2) the volume of water used: two to seven million gallons per frack, with Multi Stage Fracks lasting

up to three or four days, at 1,000 gallons per minute

3) the combination of HF with horizontal drilling, a huge new aspect, and

4) the complexity of the chemical cocktail used in the process.

Augustus's picture

Pressures are higher because the zones are deeper and need more pressure to fracture.  Pressure gradient is simply higher at greater depth.  It is not done with more pressure than the fracture gradient for the depth, they don't want it to frack up, just out.

The reason the jobs las several days is so that the well can be fracked in stages.  They don't sit there and pump for days, just equipment on site for several days.  The water is not "stored and lost" as it is returned when the frack job is flowed back.  It goes back into the evaporation cycle and will be rainfall again.

There is nothing complex about the cheicals used.  Recipes are proprietary because they are intended to decrease shale swelling and bacteria growth in formation.

The collected nonsense of the luddite anti-human green movement is astounding.  It is about the same as the justifications for the Salem witch burnings.  It must be a paid sponsorship that is getting this junk distributed.

Zero Govt's picture

the fracking fearmongers (eco loons) don't know jack shit (as usual, as always) and have no evidence to back-up their claims except the circumstantial

the industry is not going to use techniques that cause mini-earthquakes or land subsidence, they're above ground and dont want it caving in now do they?

Seize Mars's picture

"...At $2.00 they're all loosing money..."

Dude. It's "losing," not "loosing."


mick_richfield's picture

Who is down-arrowing this guy for correcting a dumb mistake?

Your to stupid to be on are website!

otto skorzeny's picture

yeah-only the Fed can "loose" money-duh

MrPalladium's picture

Sounds to me like th price of NG is headed much higher, and soon.

otto skorzeny's picture

because-as we all know- the laws of supply and demand and price discovery are non-existent

thurstjo63's picture

And that's not even counting the billions in damage to the water supply in most regions! Another idiotic decision from politicians!!!

Augustus's picture

There has been little, if any, damage to the water supply.

The environutters have spent millions to get the idea distributed however.  What was you compensation for the ?

Matt's picture

So who is responsible for the decommissioned wells once the companies operating them are out of business?

Augustus's picture

The companies have provided bonds or letters of credit for plugging costs with the various state agencies.

fattail's picture

Why do they have to flare it?  why can't they just cap the well until the price goes back up?

Augustus's picture

When the oil is produced some gas comes with it in many wells.  If no pipeline the the gas gets flared. 

ohreally's picture

i contribute about 1 btu of natural gas every day, and the cost of that natural gas is zero.  

Matt's picture

Well, the value is also pretty close to zero, since it would take a million days to get to, what, $2?

xtop23's picture

The scene at the end where he comes clean, and destroys the preacher, is how I envision the world's central bankers.

They really are that cruel if not more. Just because they do it with 1's and 0's via a convoluted bureaucracy doesn't decrease the amount of lives they destroy.

Perhaps it's even less humane because they don't have to get their hands dirty.

Convolved Man's picture

Fractured Nursery Rhyme


Aubrey be nimble.
Aubrey be quick.
Aubrey jumps over a candle stick.
He lets out some gas.
Blows off his ass.
Now Aubrey has no balls or dick.

otto skorzeny's picture

you forgot to work into your rhyme something about him conning CHKs board into buying millions of dollars of antique SW US maps with company $

Salt's picture

Fracking Reserve Requirements, coming soon to a neighborhood near you. Storage maintained via the Bernanke Gas Bag. 

sangell's picture

So buy coal stocks now as they are super low and the gas price cannot last.

ceilidh_trail's picture

A bit early, but I am long coal. Sooner or later, rationality will return- be it gas petering, exports improving, or domestic energy shifts after the current crop of pols goes byebye. Just hope I can continue to stand the pain...

DosZap's picture

So buy coal stocks now as they are super low and the gas price cannot last.

You got that right, more and more trucks,vehicles  are being built for LNG.................

It will be the fuel of the future in the USA.We have more than anyone in the world also, a really great thing.

duo's picture

I think you have until the election to play coal.  Perhaps coal stocks are a reverse indicator of Obama's poll numbers.

narapoiddyslexia's picture

Coal is toast. Or, rather, toasting as we speak.

eddiebe's picture

Another big win for the banksters and a bust out for the producers and investors. Now of course the banksters come in and mop up a prime asset they get to buy for next to worthless FRN's while investors and producers alike sell in despair and disgust trying to hold on to a bit of capital.