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Shale Fracking Is a “Ponzi Scheme” … “This Decade’s Version of The Dotcom Bubble” … “A Lot In Common With the Subprime Mortgage"

George Washington's picture




 

In 2011, the New York Times wrote:

“Money is pouring in” from investors even though shale gas is “inherently unprofitable,” an analyst from PNC Wealth Management, an investment company,  wrote to a contractor in a February e-mail. “Reminds you of dot-coms.”

 

“The word in the world of independents is that the shale plays are just giant Ponzi schemes and the economics just do not work,” an analyst from IHS Drilling Data, an energy research company,  wrote in an e-mail on Aug. 28, 2009.

 

***

 

“And now these corporate giants are having an Enron moment,” a retired geologist from a major oil and gas company  wrote in a February e-mail about other companies invested in shale gas.

 

***

 

Deborah Rogers, a member of the advisory committee of the Federal Reserve Bank of Dallas, [and a]  former stockbroker with Merrill Lynch ... showed that wells were petering out faster than expected.

 

“These wells are depleting so quickly that the operators are in an expensive game of ‘catch-up,’ ” Ms. Rogers wrote in an e-mail on Nov. 17, 2009, to a petroleum geologist in Houston, who wrote back that he agreed.

 

***

 

A review of more than 9,000 wells, using data from 2003 to 2009, shows that — based on widely used industry assumptions about the market price of gas and the cost of drilling and operating a well — less than 10 percent of the wells had recouped their estimated costs by the time they were seven years old.

 

***

 

“Looks like crap,” the Schlumberger official wrote about the well’s performance, according to the regulator, “but operator will flip it based on ‘potential’ and make some money on it.”

In 2012, the New York Times pointed out:

The gas rush has ... been a money loser so far for many of the gas exploration companies and their tens of thousands of investors.

 

***

 

Although the bankers made a lot of money from the deal making and a handful of energy companies made fortunes by exiting at the market’s peak, most of the industry has been bloodied — forced to sell assets, take huge write-offs and shift as many drill rigs as possible from gas exploration to oil, whose price has held up much better.

 

***

 

Now the gas companies are committed to spending far more to produce gas than they can earn selling it. Their stock prices and debt ratings have been hammered.

Rolling Stone reported the same year:

Fracking, it turns out, is about producing cheap energy the same way the mortgage crisis was about helping realize the dreams of middle-class homeowners. For Chesapeake, the primary profit in fracking comes not from selling the gas itself, but from buying and flipping the land that contains the gas. The company is now the largest leaseholder in the United States, owning the drilling rights to some 15 million acres – an area more than twice the size of Maryland. McClendon [the CEO of fracking giant Chesapeake] has financed this land grab with junk bonds and complex partnerships and future production deals, creating a highly leveraged, deeply indebted company that has more in common with Enron than ExxonMobil. As McClendon put it in a conference call with Wall Street analysts a few years ago, "I can assure you that buying leases for x and selling them for 5x or 10x is a lot more profitable than trying to produce gas at $5 or $6 per million cubic feet."

 

According to Arthur Berman, a respected energy consultant in Texas who has spent years studying the industry, Chesapeake and its lesser competitors resemble a Ponzi scheme, overhyping the promise of shale gas in an effort to recoup their huge investments in leases and drilling. When the wells don't pay off, the firms wind up scrambling to mask their financial troubles with convoluted off-book accounting methods. "This is an industry that is caught in the grip of magical thinking," Berman says. "In fact, when you look at the level of debt some of these companies are carrying, and the questionable value of their gas reserves, there is a lot in common with the subprime mortgage market just before it melted down."

 

***

 

In February, Chesapeake announced that, because of low gas prices, its revenues will fall $3.5 billion short of its expenses this year.

Jim Quinn noted last year:

Royal Dutch Shell is one of the biggest corporations in the world, with financial resources greater than 99% of all the organizations on earth. Their CEO [Peter  Voser] probably knows a little bit more about oil exploration than the Wall Street systers and CNBC bimbos. His company has poured $24 billion into shale exploration in the U.S. It has been a huge failure. They have already written off $2.1 billion. They are trying to sell huge swaths of land in the Eagle Ford area. They are losing money in the shale oil and gas business. If Shell can’t make it profitable, who can?

Bloomberg noted in February:

Independent producers will spend $1.50 drilling this year for every dollar they get back.

Oil Price reported in March:

Shell’s new boss, Ben van Beurden, said bets on U.S. shale plays haven’t worked out for his company.

 

***

 

“Some of our exploration bets have simply not worked out,” Shell’s Chief Executive Officer Ben van Beurden said. It was bad management policy to commit close to $80 billion in capital on its North American portfolio and still lose money. Now, he said, it’s time to cut the loss and slash exploration and production investments by 20 percent for 2014.

 

***

 

Shell’s problems say more about the difficulties of shale exploration than they do about the company itself.

The Wall Street Journal pointed out this April:

These newly public companies are spending more than they make ....

Bloomberg wrote in May:

Shale debt has almost doubled over the last four years while revenue has gained just 5.6 percent, according to a Bloomberg News analysis of 61 shale drillers. A dozen of those wildcatters are spending at least 10 percent of their sales on interest compared with Exxon Mobil Corp.’s 0.1 percent.

 

“The list of companies that are financially stressed is considerable,” said Benjamin Dell, managing partner of Kimmeridge Energy, a New York-based alternative asset manager focused on energy. “Not everyone is going to survive. We’ve seen it before.”

 

***

 

In a measure of the shale industry’s financial burden, debt hit $163.6 billion in the first quarter, according to company records compiled by Bloomberg on 61 exploration and production companies that target oil and natural gas trapped in deep underground layers of rock.

 

***

 

Drillers are caught in a bind. They must keep borrowing to pay for exploration needed to offset the steep production declines typical of shale wells. At the same time, investors have been pushing companies to cut back. Spending tumbled at 26 of the 61 firms examined. For companies that can’t afford to keep drilling, less oil coming out means less money coming in, accelerating the financial tailspin.

 

***

 

“Interest expenses are rising,” said Virendra Chauhan, an oil analyst with Energy Aspects in London. “The risk for shale producers is that because of the production decline rates, you constantly have elevated capital expenditures.”

And Tim Morgan - former global head of research at Tullett Prebon - explained last month at the Telegraph:

We now have more than enough data to know what has really happened in America.

 

***

 

If a huge number of wells come on stream in a short time, you get a lot of initial production. This is exactly what has happened in the US.

 

The key word here, though, is "initial". The big snag with shale wells is that output falls away very quickly indeed after production begins. Compared with “normal” oil and gas wells, where output typically decreases by 7pc-10pc annually, rates of decline for shale wells are dramatically worse. It is by no means unusual for production from each well to fall by 60pc or more in the first 12 months of operations alone.

 

Faced with such rates of decline, the only way to keep production rates up (and to keep investors on side) is to drill yet more wells. This puts operators on a "drilling treadmill", which should worry local residents just as much as investors. Net cash flow from US shale has been negative year after year, and some of the industry’s biggest names have already walked away.

 

The seemingly inevitable outcome for the US shale industry is that, once investors wise up, and once the drilling sweet spots have been used, production will slump, probably peaking in 2017-18 and falling precipitously after that. The US is already littered with wells that have been abandoned, often without the site being cleaned up.

 

Meanwhile, recoverable reserves estimates for the Monterey shale – supposedly the biggest shale liquids play in the US – have been revised downwards by 96pc. [Background; and see this.]  In Poland, drilling 30-40 wells has so far produced virtually no worthwhile production.

 

In the future, shale will be recognised as this decade's version of the dotcom bubble. In the shorter term, it's a counsel of despair as an energy supply squeeze draws ever nearer.

 

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Fri, 09/19/2014 - 18:55 | 5236179 iamrefreshed
iamrefreshed's picture

GW, isn't it the Joos fault?!

Fri, 09/19/2014 - 20:07 | 5236239 George Washington
George Washington's picture

Nice Number 1 ... and Technique #1.

And I'll just leave this right here ...

Fri, 09/19/2014 - 22:11 | 5236733 sonoftx
sonoftx's picture

Good article GW, I have two family members in the oilfield I will see what they say. But most of all thanks for the links on trolls very informative.

Fri, 09/19/2014 - 18:40 | 5236110 George Washington
George Washington's picture
Max interviews Bill Powers, author of “Cold, Hungry and in the Dark: Exploding the Natural Gas Supply Myth,” about the zero percent interest rate that keep people in the dark on
the high costs of fracking and the coming 70s style energy crisis due to growing demand based on fundamental lies.

Fri, 09/19/2014 - 18:14 | 5236046 Laddie
Laddie's picture

George once you realize that the goal of .gov is the destruction of the Dispossessed Majority then what is going on all makes sense. Ruin the potable water, ebola, disease ridden latin americans getting free entry, and on and on, focus one's attention on any government policy that makes absolutely no sense and then read it in the light of my opening sentence and the lightbulb goes off. And you won't hear the Sierra Club say one word about immigration ruining the environment. Why?
PAID OFF:
Los Angeles Times about David Gelbaum, one of the key funders of the venerable environmental organization. ["The Man Behind the Land" by Kenneth R. Weiss, Oct. 17, 2004]

Said Gelbaum, "I did tell [Sierra Club Executive Director] Carl Pope in 1994 or 1995 that if they ever came out anti-immigration, they would never get a dollar from me."

“Gelbaum, who reads the Spanish-language newspaper La Opinión and is married to a Mexican American, said his views on immigration were shaped long ago by his grandfather, Abraham, a watchmaker who had come to America to escape persecution of Jews in Ukraine before World War I.

” ‘I asked, 'Abe, what do you think about all of these Mexicans coming here?' ‘Gelbaum said. ‘Abe didn't speak English that well. He said, 'I came here. How can I tell them not to come?'’

"I cannot support an organization that is anti-immigration. It would dishonor the memory of my grandparents."

Fri, 09/19/2014 - 18:00 | 5236008 yellowsub
yellowsub's picture

It would have been fine if it was just lost of money but the pollution is irrevisible...

Fri, 09/19/2014 - 15:02 | 5235336 esum
esum's picture

dont know what the problem is with shell... little guys like TPLM are making meny.... the big boys need bigger returns than the little guys... if shell invested $80 billion in shale and cant make money, they are fucking assholes.. i doubt the numbers and the majors go for deep drilling where the litttle guys cant play... 

Fri, 09/19/2014 - 15:48 | 5235558 tempo
tempo's picture

Its ok as long as the Wall Street 1% make billions, who cares about pollution and a million abandoned wells. Obama won the lottery with fracing and QE zirp. It allowed for implementation of a progressive social agenda.

Fri, 09/19/2014 - 16:33 | 5235715 weburke
weburke's picture

folks are being enticed to go gas, and they will not like the coming price increases

Fri, 09/19/2014 - 14:54 | 5235290 hatchaser
hatchaser's picture

5 things:

1. The Energy Information Administration has consistently raised oil production forecasts since the fracking "ponzi scheme" began; this month there was a considerable upward revision from May--date of article.

2. Fracking is not a new, unproven technique. It's earned producers financial success over-and-over for +30 years.

3. Capital costs will decline. Fracking is not new, but the intensity of work at these fields is new. Significant investment dollars--for storage, transportation, service facilities--will benefit future wells. Capital costs should be amortized accordingly.

4. Exploration companies sell their completed wells to producers. The latter's capital cost is lower than the former's--significantly. This is important, and, if I must explain why, you won't understand.

5. Tell Al I said "Hi".

Fri, 09/19/2014 - 16:02 | 5235609 disabledvet
disabledvet's picture

"Number six: a Ponzi scheme is all in your head."

There is no actual asset that exists in an "actual" Ponzi scheme. I know this because the biggest in history before Bernie Madoff happened in Syracuse, NY. "Copier leases."

Brilliant scam!

"Nothing that can't be repeated" as we all now know. Bernie's scam had been revealed to the FBI ten years before it took down a French Bank! Bwhahahahaha. "And the FBI blamed the whistleblower."

That says to me "BLOW A BIGGER BUBBLE!"

And indeed...that is exactly what has happened.

Good luck being an FBI guy in Detroit! Lotta Cooper in that state btw. "Full metal jackets" and "robo cops" probably too.

I say again "let's talk information exchanges" shall we...

Fri, 09/19/2014 - 20:49 | 5236515 WhackoWarner
WhackoWarner's picture

Are you all insane?  This type of extraction will destroy every single place it happens. Period and end of discussion.

So who gives one flying WTF about viability/profit margins.  This is deliberate destruction of habitat.

Fri, 09/19/2014 - 14:03 | 5235036 Jano
Jano's picture

Yes, I agree, the economy of fracking is terrible and does not bring the yeld, to contrary, it deplets the investment and investors lose the capital.

But tell me somebody, which fool invests since 10 years into this technology?

Or the analysts are the fools and the companies will turn it arround, at the end?

Fri, 09/19/2014 - 20:53 | 5236530 WhackoWarner
WhackoWarner's picture

PLEASE get your head out of your butt.  Who gives a flying fuck about "invests"  or 10 year returns?

This destroys the water table and removes the ability for life to survive.  So feel really comfy when you cash your Ponzi dividends that result from a lying industry that will infect water and destroy everyplace it touches down.

 

ARE you an idiot?

Fri, 09/19/2014 - 14:43 | 5235252 disabledvet
disabledvet's picture

CLR is one. One of the biggest energy companies in the world.

It's not the gas but what the gas is used for. By using it to generate electricity it's being used to create an un-economic price support.

If I know I'm guaranteed a price floor then obviously "I know what the math is" and can work back from there.

What this article doesn't talk about is BP and the Gulf of Mexico...other than to call it "the greatest thing ever" and "sure the bastards" and blah blee blah. That had the effect of shutting in all oil production in the USA...something which only changed quite recently.

Interestingly the price of natural gas collapsed as a result.

Since the Gulf of Mexico has reopened however the price of natural gas has doubled and oil has rolled over and now looks to be headed the way of whale oil.

The fact is "drilling is drilling" and this article is a total bunch of crapola.

The world is awash in product of every kind save one: levered dollars.

I reiterate my call "if not for a gold standard then certainly silver." That will get your money velocity beyond something other than totally dead in the water.

Fri, 09/19/2014 - 16:03 | 5235616 disabledvet
disabledvet's picture

See above. "Why so depressed that the criminals have won?"

We have a pill for that "Hitler Fever" of yours!

Fri, 09/19/2014 - 13:06 | 5234734 MIDTOWN
MIDTOWN's picture

Major players sending lots of fracking equipment into E KY coal towns where land is cheap and labor is desparate for work.

Fri, 09/19/2014 - 13:41 | 5234932 Apply Force
Apply Force's picture

...crushing the E KY coal-stripped environment even further.  None of this frack-debt will ever need be repaid - liquid energy is TBTF to the USA.  Once energy can not be extracted at the flow rate we need to hold this Gordian knot together, watch the fuck out!

Fri, 09/19/2014 - 12:47 | 5234644 delivered
delivered's picture

I'm by no means an expert but do understanding accounting and finance and would like to point out two key issues. First, the availability of cheap/easy capital as noted in numerous posts (driven by the Fed and other CBs) has certainly contributed to the perceived economic value of fracking. Hell, with free flowing money, just about any business can stay afloat for quite some time as rates, terms, struture, etc. are all extremely favorable during the "salad days". But once a business actually realizes that debt has to be, dare I mention, repaid, the combination of very highly capital expenditure requirements and debt service payments basically consume all cash/liquid resources. 

Second, I've studied/analyzed a number of fracking company financial statements and have noticed that the annual capital expenditures (i.e., the cost of acquiring and drilling) compared to revenue growth and cash flow (both EBITDA and free) supports a number of the comments made in GW's article. That is, there is a constant need to drill more and more to maintain a base line production level so what I'm guessing is that the capitalized well devlopment costs are being "managed" by the accountants to keep an inflated asset on the books (which probably should be written down based on high production decline rates after 12 months). What would be interesting to evaluate is the actual oil production in units (or barrels) compared to production development costs over time. This might be the canary in the coal mine that really helps quantify the economics of the fracking industry.

So let's combine the end of easy/cheap money, with accountants "managing" fracking company assets, and a declining price of oil and most likely what you are setting up is a major shakeout in the industry. No doubt the weak are going to get creamed in this environment and the strong, just waiting to acquire resources but only at the right price, will get even stronger. 

Fri, 09/19/2014 - 12:08 | 5234458 falak pema
falak pema's picture

According to HSBC's new report conventional fossil fuel will be rare in 2050.

Its time to think alternatives bigtime.

Fri, 09/19/2014 - 11:52 | 5234363 lasvegaspersona
lasvegaspersona's picture

opps wrong article..

Fri, 09/19/2014 - 11:03 | 5234093 numapepi
numapepi's picture

When a cigarette company tells me their product is good for me, I question their assertion due to their self interest, when Rolling stone, NYT etc... claim we must stop drilling, I question their assumptions due to their affinity for communism...

Fri, 09/19/2014 - 10:08 | 5233760 Ban KKiller
Ban KKiller's picture

Short term greed for long term pain.

Fri, 09/19/2014 - 09:58 | 5233711 SmallerGovNow2
SmallerGovNow2's picture

I don't disagree with what you are hinting at here GW.  I've looked at the economics of the fracking industry and i don't see how it will work.  However, some of the sources used are suspect green, anti anything that might affect the environment, sources (NYT, Rolling Stone).  Hard to weed through and find the truth sometimes (or what the agenda is behind it).  But i do thank you for the post.  The shale play certainly has the look and feel of a ponzi scheme especially with oil anywhere south of $100/barrel... 

Fri, 09/19/2014 - 12:49 | 5234654 El Vaquero
El Vaquero's picture

Here is a talk from somebody who up until the beginning of this year was a bean counter for the oil industry:

 

http://energypolicy.columbia.edu/events-calendar/global-oil-market-forec...

 

You can say that it's from a .edu and question the source, but then you can go through his talk and presentation (there is a link to his slides) to see what the actual sources were, because the .edu was just a forum for presentation.

Fri, 09/19/2014 - 10:27 | 5233866 JohnGaltsChild
JohnGaltsChild's picture

GW is a deeply imbedded troll. There are monster wells springing up all over Eastern Ohio with staggering results. GW is either full of liberal missinformation, full of himself, or full of Eastern Ohio cow pies. 

Fri, 09/19/2014 - 11:26 | 5234240 Okienomics
Okienomics's picture

I have to agree with your deep troll theory on GW. A stroll through his posts reveals a "West is evil and you should be terrified all the time of everything" consistency. But then again, it guess that's ZH in a nutshell (I'm really wondering, who the hell are the Tylers anyway?).. I took a look at GW's historic posts and went to the oldest available to see what he was covering and how it turned out. Here's a gem from the very last page of available posts.... Glad he ended the piece with "I am not a financial advisor..."

http://www.zerohedge.com/article/dollar-heading-or-down

More recently he warned that tall buildings in the US, UK and west in general should be avoided because they're all death traps. He's offered up a lot of anti-west, anti-American fodder. I'm not sure the real GW would be quite so one-sided about how horrible America is. In fact, despite having strong opinions about much of what GW discusses, I still believe in America. Probably not a popular sentiment on ZH, but there it is.

Fri, 09/19/2014 - 19:34 | 5236275 TheGreatRecovery
TheGreatRecovery's picture

I think GW's central theme is "power corrupts".

When three people say "America", I believe they mean three different things.

America was created by people ("the Founding Fathers") who were lucky enough to live during one of those few brief periods in history during which the citizenry were able to procure weapons almost as good as those used by the Rulers.  I think the Founding Fathers understood that.

But they weren't angels.  The first thing they did was screw the Revolutionary War veterans, by paying off in full speculators who had bought the veterans' paychecks at pennies on the dollar, without warning the veterans.  The second thing they did was screw the States which had supported the war effort up-front, by paying in full the other States which had merely borrowed other people's money to "support" the war effort.  And, in doing that, they also screwed the individuals whom those States had borrowed from, by, again, not warning them.  The third thing they did was create their day's version of the Federal Reserve, which they called the Bank of United States.  (though Jefferson refused to extend its Charter, and when that Charter ran out, during Madison's term, the British immediately started the War of 1812)  And, of course, they failed to outlaw slavery (though some of them tried to).  Or, later, honor treaties with the various Native North American Nations (though some of them tried to).  Not angels.

I think that a lot of us believe in a lot of fairy tales.  We need fairy tales.  We crave fairy tales.  I think that real-life heroes are never perfect, but fairy tales are stories that make them look perfect.  I think that, pretty much always and everywhere, the Rulers own the press, and they pay the press to write and disseminate for popular consumption fairy tales about what the Rulers actually did, and in those fairy tales the Rulers are heroes, and their competitors are villains.  But, as Machiavelli told us, the Rulers were almost invariably villains themselves.  Machiavelli: "in every City there are two groups of people, the Rulers, who are always thinking up new ways to steal from the Ruled, and the Ruled, who are always thinking up ways to avoid the newest thefts invented by the Rulers."

So what is "America"?  On the one hand, gangs of pretty-well organized criminals.  On the other hand, the individual in the office, whose wife and children can put peer pressure on him, hopefully.

Fri, 09/19/2014 - 13:33 | 5234888 Keegan11
Keegan11's picture

That said, at least in this "article"- which is really just a headline with quotes from real articles - only the headline of the story is GW. Debt laden pigs that are many a shale driller is fact. Make you're own prognostications I suppose.

Fri, 09/19/2014 - 16:07 | 5235629 disabledvet
disabledvet's picture

"I love looking for life forms! ( singing)....'life forms! Pretty little life forms'"

Commander Data with an emotion chip installed.

Fri, 09/19/2014 - 11:52 | 5234380 lasvegaspersona
lasvegaspersona's picture

the 'tall buildings are death traps' theme was satire...

in case you missed that...

Fri, 09/19/2014 - 13:35 | 5234908 Apply Force
Apply Force's picture

trolls and bots have trouble with satire and sarcasm - too finessed for their pay grades

Fri, 09/19/2014 - 08:55 | 5233446 Magooo
Magooo's picture

There will be no green shoots.  There will be no recovery.

 

This is AS GOOD AS IT GETS.

Fri, 09/19/2014 - 09:41 | 5233629 Cpl Hicks
Cpl Hicks's picture

Oh, no, it gets better. Much better!

Hilary in 2016!!!!

Fri, 09/19/2014 - 10:41 | 5233963 CHX
CHX's picture


To summarize:

There are no green shoots.  There is no recovery. 

This was as good as it got. Downward is forward from here, with Killery to come after Obummer.

 

Agreed. 

Fri, 09/19/2014 - 08:53 | 5233443 Magooo
Magooo's picture

Toil for oil means industry sums do not add up (FT.com)

Rising costs are being met only by ever smaller increases in supply

The most interesting message in this year’s World Energy Outlook from the International Energy Agency is also its most disturbing.

Over the past decade, the oil and gas industry’s upstream investments have registered an astronomical increase, but these ever higher levels of capital expenditure have yielded ever smaller increases in the global oil supply. Even these have only been made possible by record high oil prices. This should be a reality check for those now hyping a new age of global oil abundance.

According to the 2013 WEO, the total world oil supply in 2012 was 87.1m barrels a day, an increase of 11.9mbd over the 75.2mbd produced in 2000.

However, less than one-third of this increase was in the form of conventional crude oil, and more than two-thirds was therefore either what the IEA calls unconventional crude (light-tight oil, oil sands, and deep/ultra-deepwater oil) or natural-gas liquids (NGLs).

This distinction matters because unconventional crude has a higher cost than conventional crude, while NGLs have a lower energy density.

The IEA’s long-run cost curve has conventional crude in a range of $10-$70 a barrel, whereas for unconventional crude the ranges are higher: $50-$90 a barrel for oil sands, $50-$100 for light-tight oil, and $70-$90 for ultra-deep water. Meanwhile, in terms of energy content, a barrel of crude oil is worth 1.4 barrels of NGLs.

Threefold rise

The much higher cost of developing unconventional crude resources and the lower energy density of NGLs explain why, as these sources have increased their share of supply, the industry’s upstream capex has increased. But the sheer scale of the increase is staggering: upstream outlays have risen more than threefold in real terms over the past 12 years, reaching nearly $700bn in 2012 compared with only $250bn in 2000 (both figures in constant 2012 dollars).

Coinciding with the rise in US tight-oil production, most of this increase in upstream capex has occurred since 2005, as investments have effectively doubled from $350bn in that year to nearly $700bn in 2012 (again in 2012 dollars).

All of which means the 2013 WEO has the oil industry’s upstream capex rising by nearly 180 per cent since 2000, but the global oil supply (adjusted for energy content) by only 14 per cent. The most straightforward interpretation of this data is that the economics of oil have become completely dislocated from historic norms since 2000 (and especially since 2005), with the industry investing at exponentially higher rates for increasingly small incremental yields of energy.

The industry has been able and willing to finance such a dramatic increase in its capital investment since 2000 owing to the similarly dramatic increase in prices. BP data show that the average price of Brent crude in real terms increased from $38 a barrel in 2000 to $112 in 2012 (in constant 2011 dollars), which represents a 195 per cent increase, slightly greater in fact than the increase in industry capex over the same period.

However, looking only at the period since 2005, capital outlays have risen faster than prices (90 per cent and 75 per cent respectively), while in the past two years capex has risen by a further 20 per cent (the IEA estimates 2013 upstream capex at $710bn versus $590bn in 2011), while Brent prices have actually averaged about $5 a barrel less this year than in 2011.

Iran not a game changer

That prices have fallen slightly since 2011 while capex has risen by a further 20 per cent is a flashing light on the industry’s dashboard indicating that its upstream growth engine may finally be overheating.

Without a significant technological breakthrough reversing the geological forces that have driven the unprecedented increase in upstream investment over the past decade, prices will have to rise further in real terms from here or else capex – and with it future oil production – will fall.

It should also be emphasised that this vast increase in capex has occurred during a prolonged period of record-low interest rates. Once interest rates start rising again, this will put further pressure on the industry’s ability to make the massive capital outlays required to keep supply growing.

Of course, the diplomatic breakthrough achieved with Iran over the weekend could provide some much needed short-term relief to the market, as Iran’s exports could ultimately increase by up to 1.5m barrels a day if and when western sanctions were to be fully lifted. But this would not change the dynamics of the industry’s capex treadmill in any fundamental sense.

Even if global oil demand only grows at 1 per cent a cent a year, those extra barrels would be would be fully absorbed by the market within about 18 months. And that is probably how long it would take for Iran’s production and exports to return to pre-sanctions levels in any case.

Alternatively, if we take the IEA’s estimate that global production of conventional crude oil from all currently producing fields will decline by 41m barrels a day by 2035 (that is, by an average of 1.9m barrels a day per year), then Iran’s potential increase of 1.5m barrels a day would compensate for just 10 months of natural decline in global conventional-crude output.

In short, behind the hubbub of market hype about a new age of oil abundance, the toil for oil is in fact now more arduous and back-breaking than ever.

This should worry everybody, because with the evidence suggesting that consumers are reluctant to pay much above $110 a barrel, it is an open question what happens next to the industry’s investment plans and hence, over time, to the supply of oil.

Mark Lewis is an independent energy analyst and former head of energy research in commodities at Deutsche Bank; Daniel L Davis, a lieutenant colonel in the US Army, is co-author

 

 

Big oil counts the cost of tapping new discoveries – FT.com

 

“One hundred dollars per barrel is becoming the new $20, in our business.” With that pithy analysis, John Watson, chief executive of Chevron, summed up the oil industry’s plight.

 

As companies pursue the ever more challenging oil reserves that they need to increase or merely sustain their production, their costs have risen to the point that the most expensive projects, such as deepwater developments or liquefied natural gas plants, need an oil price of at least $100 a barrel to be commercially viable.

 

Now a growing number of oil executives are saying that has to change. As discussions at the IHS Cera Week conference in Houston made clear, cost-cutting is back at the top of the industry’s agenda.

 

The issue has come to a head after three years in which the price of crude has drifted down, in part because of the extra supply coming on to the market from the US shale oil boom, while costs have continued to rise.

 

The result has been a squeeze on margins, declining returns on capital, and underperforming share prices.

 

Chevron and ExxonMobil’s shares have both risen 11 per cent in the past three years, and Total’s by 8 per cent, while Royal Dutch Shell’s have fallen 2 per cent. In the same period the S&P 500 index rose more than 40 per cent.

 

Futures prices show oil is expected to fall further, with five-year Brent at about $91 a barrel, suggesting that the pressure on oil producers’ profits will intensify.

 

Shares in companies such as Schlumberger and Halliburton, which provide services to the big oil groups, have over the past five years comfortably outperformed their customers. Under mounting pressure from their shareholders, oil companies are being forced to act.

 

In part, the roots of the industry’s cost problem lie in part in the increasing technical difficulty of the new projects being developed, such as large LNG plants or offshore oilfields in deep water. They demand complex equipment such as drilling rigs, specialised materials such as sophisticated steel pipes, and highly-skilled engineers, all of which are in limited supply.

 

As Peter Coleman, chief executive of Woodside Petroleum of Australia, put it when explaining the soaring cost inflation in the country’s LNG projects: “Everybody jumped into the pool at the same time, and we’re all trying to fight for the same floatable toys.”

 

Paolo Scaroni, chief executive of Eni of Italy, argues that his rivals’ rising costs also reflect their failure to discover more easily-developed resources. Companies such as Exxon and Shell have been adding production in the oil sands of Canada and US shale, which generally have higher costs per barrel because of the need for techniques such as hydraulic fracturing to extract the resources from the shale, or processing to separate the oil from the sand.

 

Exploration is more risky, but offers higher returns, Mr Scaroni says. Because with oil sands and shale the resources are known, “you are sure of everything, but the point is profitability is lower than if you make a discovery”.

 

Christophe de Margerie, chief executive of Total, adds another explanation: companies – including his own – have lost sight of the need to control costs. When oil prices are rising, managers are tempted to relax on cost control because their projects will still be profitable.

 

“If you have $110 [per barrel], and the budget is at $100, it’s easier. You can say ‘we’ve made it’. But what about the ten dollars? Where are they? Gone with the wind,” he says. “That’s not the way engineers or commercial people should behave.”

 

All the large western oil companies have reached similar conclusions. Andrew Mackenzie, chief executive of BHP Billiton, the mining and energy group, suggests the oil companies have reached the same point the miners were at a couple of years ago: facing up to the need to improve productivity in an environment of weaker commodity prices.

 

Total, Chevron and Shell have announced cuts in capital spending, and were joined on Wednesday by Exxon. Several companies have been “recycling” projects: delaying them to try to work on improving their economics.

 

BP’s Mad Dog phase 2 development in the Gulf of Mexico, Chevron’s Rosebank oilfield in the Atlantic west of Shetland, and Woodside’s Browse LNG project in Western Australia are among the plans being reassessed.

 

Mr Coleman told the Houston conference that as originally planned Browse had an estimated budget of $80bn, which was “not a commercially acceptable risk”.

 

The prospect of an investment slowdown already appears to be having an impact. David Vaucher, an analyst at IHS, says the firm’s survey of oil and gas production costs shows they levelled off last year, in a sign that the industry is moving into a more sustainable balance.

 

Day rates for drilling rigs have started to fall, even for advanced deepwater rigs. The prospect of further falls has helped send shares in Transocean, one of the largest rig operators, down 20 per cent in the past 12 months.

 

However, Mr Vaucher observes that costs tend to be easier to raise than to cut.

 

At Total, Mr de Margerie still sees a lot of work to be done. He is promising a cost-saving plan throughout the company, a new process for designing projects to build in cost control right from the start, and reshaped relationships with service companies.

 

“You need to create a new culture,” he says. “Yes, safety first, yes environment. But also at the same time, yes cost is important. And to achieve a project with lower cost is good.”

 

http://www.ft.com/intl/cms/s/0/b7861cc8-a51b-11e3-8988-00144feab7de.html#slide0

Fri, 09/19/2014 - 08:53 | 5233439 Magooo
Magooo's picture

INDEPENDENT US OIL PRODUCERS SPEND $1.50 DRILLING FOR EVERY $1.00 THEY GET BACK

http://www.bloomberg.com/news/2014-02-27/dream-of-u-s-oil-independence-slams-against-shale-costs.html

 

SHALE DRILLERS FEAST ON JUNKE DEBT TO STAY ON TREADMILL

http://www.bloomberg.com/news/2014-04-30/shale-drillers-feast-on-junk-debt-to-say-on-treadmill.html

 

SHAKEOUT THREATENS SHALE PATCH AS FRACKERS GO FOR BROKE

http://www.bloomberg.com/news/2014-05-26/shakeout-threatens-shale-patch-as-frackers-go-for-broke.html

 

DREAM OF US OIL INDEPENDENCE SLAMS AGAINST SHALE COSTS

http://www.bloomberg.com/news/2014-02-27/dream-of-u-s-oil-independence-slams-against-shale-costs.html

 

THE FRACKING PONZI SCHEME

http://www.forbes.com/sites/insead/2013/05/08/shale-oil-and-gas-the-contrarian-view/

 

WHY AMERICA’S SHALE BOOM COULD END SOONER THAN YOU THINK

http://www.forbes.com/sites/christopherhelman/2013/06/13/why-americas-shale-oil-boom-could-end-sooner-than-you-think/

 

SCIENTISTS WARY OF SHALE OIL AND GAS AND U.S. ENERGY SALVATION

http://www.sciencedaily.com/releases/2013/10/131028141516.htm

 

U.S. SHALE OIL BOOM MAY NOT LAST AS FRACKING WELLS LACK STAYING POWER

http://www.businessweek.com/articles/2013-10-10/u-dot-s-dot-shale-oil-boom-may-not-last-as-fracking-wells-lack-staying-power

 

 

 

Fri, 09/19/2014 - 09:18 | 5233541 rubiconsolutions
rubiconsolutions's picture

"INDEPENDENT US OIL PRODUCERS SPEND $1.50 DRILLING FOR EVERY $1.00 THEY GET BACK"

It's called EROEI and there's no way around it. No free lunch. 

Fri, 09/19/2014 - 12:43 | 5234631 El Vaquero
El Vaquero's picture

$1.50 spent for every $1.00 they get back is not EROEI.  FRNs should not be equated to energy, especially since oil is traded in paper markets, and thus is manipulated.  It's just bad economics.  Make oil $130/bbl and it won't be so bad for the frackers, if you ignore what it'll do to the rest of the economy.  What the actual EROEI is on the shale plays is not clear, but it is not anything like drilling a 200 ft well and having oil come gushing to the surface. 

Fri, 09/19/2014 - 09:39 | 5233618 RaceToTheBottom
RaceToTheBottom's picture

I guess they will have to make it up in volume......  LOL

Fri, 09/19/2014 - 10:15 | 5233794 conscious being
conscious being's picture

Milo Mindbender is running the Fed.

Fri, 09/19/2014 - 18:36 | 5236114 ILLILLILLI
ILLILLILLI's picture

Now that's an obscure reference...

Fri, 09/19/2014 - 08:51 | 5233432 Magooo
Magooo's picture

The economy is a surplus energy equation, not a monetary one, and growth in output (and in the global population) since the Industrial Revolution has resulted from the harnessing of ever-greater quantities of energy.

But the critical relationship between energy production and the energy cost of extraction is now deteriorating so rapidly that the economy as we have known it for more than two centuries is beginning to unravel.

http://ftalphaville.ft.com/files/2013/01/Perfect-Storm-LR.pdf

See:  the Killer Equation starting on p.59.... rather fascinating reading....

Fri, 09/19/2014 - 12:39 | 5234601 El Vaquero
El Vaquero's picture

The economy stops dead without energy, but the monetary side allows us to distort things.  When those distortions become realigned with reality, it is going to be a violent process, because we're not looking to what the future actually has in store for us, but rather what we want the future to be.  There's nothing wrong with trying to mould your own future, but we must be realistic about it.

Fri, 09/19/2014 - 08:49 | 5233424 zuuma
zuuma's picture

As soon as I saw:   "New York Times wrote:"...

I lost faith in any objectivity.  That rag is just a PR dump for obamunism.

Even if they occasionaly print something that's true, it's hard to accept - given their solid track record as lefty shills.

 

Fri, 09/19/2014 - 10:58 | 5234063 numapepi
numapepi's picture

Even a stopped clock is right twice a day.

 

Fri, 09/19/2014 - 08:39 | 5233387 national treasure
national treasure's picture

another BLACK PR piece from "George Washington" - another KGB propaganda project

Fri, 09/19/2014 - 08:27 | 5233344 CRYBABY
CRYBABY's picture

Nice article/post: appreciated....particularly as our fcuking idiot politicians over here are starting to rub their hands at the prospect of a new Uk energy boom

Fri, 09/19/2014 - 08:09 | 5233273 AdvancingTime
AdvancingTime's picture

Thanks for a very interesting look into this industry that has become another myth of hope.

As to the subject of the Ponzi Scheme I often forget that what may seem familiar to me and many Americans is not always common knowledge, the story behind the term is very interesting. To those who are unfamiliar with the term Ponzi Scheme or just would like to know more on where it originated and such see the article below that is titled Ponzi Scheme 101.

 http://brucewilds.blogspot.com/2013/04/ponzi-scheme-101.html

Fri, 09/19/2014 - 07:59 | 5233255 TrumpXVI
TrumpXVI's picture

B-b-b-but, here in Pennsylvania, the Democrats have PROMISED us that we can fund our over blown public school budgets by taxing the shale gas drillers!

That CAN'T be all wrong....can it?

I mean, CAN IT!?

Do NOT follow this link or you will be banned from the site!