Shale gas losing its lustre in the US?


Big Oil and Gas industry writing down billions in U.S. shale gas assets

July 29, 2012

On Friday shale gas driller Encana Corporation, the largest natural gas company of Canada announced it had written down more than $1.7 billion in shale gas assets on its books, the majority from its U.S. shale gas operations as it posted its ominous 2nd quarter operating results. Encana Chief Executive Officer Randy Eresman went on record saying to expect his company to have to take additional shale gas asset write downs in the near future. Such asset impairment write downs directly affect the industry’s operating credit lines as reduced value assets on their books results in financial lenders lending the companies less cash going forward.

Encana Corporation is also the focus of a U.S. Department of Justice price collusion investigation regarding the allegation it has conspired withChesapeake Energy to fix prices for shale gas land lease agreements with state of Michigan landowners. The investigation is ongoing.

Other shale gas development companies also wrote down major assets as continued shale gas industry aggressive claims meet the realities of the tough economics the industry never fully anticipated.

English based BG Group decreased the value of its U.S. shale gas operations by $1.3 billion also this past Friday to reflect a weaken outlook for U.S natural gas prices. Exco Resources Inc. of Texas reported a $276 million write down on its assets. Meanwhile Australian based shale gas driller BHP is embroiled in a decision to write down its U.S. shale gas operations by an estimated $US2.5 billion on the shale gas assets it acquired just last year from Chesapeake Energy for $US4.75 billion, more than half what it paid to Chesapeake Energy.

The popular view is the main culprit is the ongoing price of today’s U.S. price for natural gas of $3.08 per million British Thermal Units (MBTU), a price which dipped as low as $1.90 per MBTU back in April of this year. When the shale drilling boom began, the drillers proclaimed aggressive values for the gas held in ground as calculated in land lease agreements with landowners. Back in early 2008, the price of natural gas at the U.S. Henry Hub was being priced at more than $15.00 per MBTU. As the drilling boom took off unabated and natural gas began appearing into storage, the price the market was willing to pay for it declined month by month.

This was perhaps the best true “free market” signal to the industry which it continued to ignore until market prices all but collapsed.

Left out of such supply discussions are what appears to be the significantly higher extraction costs for shale gas when compared to conventional drilling into large pockets of natural gas. The costs for the armies of men, machines, water tankers, pumpers and frack operations along with all the diesel fuel required to drive all this heavy metal in out of the hills and mountains of Pennsylvania day in and day out has been quietly taking its toll in the form of high extraction costs. Pennsylvania Marcellus’ deeper drilling depths compared to Ohio and New York State play yet another significant cost factor.

The unavoidable hit or miss process of exploration resulting in dry or unproductive wells is significant when individual wells cost between $3.5 million to $5 million from the industry’s own public releases. Encana for example hit a number of dry wells in Pennsylvania’s Marcellus before it pulled back. Frack water tailing pond construction and related disposals costs are significant and in constant need to maintain the integrity of such ponds while trucking out the toxic frack water for disposal.

As lenders tighten up cash lending, all of these factors take on new and more challenging dimensions.

Perhaps the most baffling issue which receives little public attention remains the strange and unusual production output curves of a typical shale gas well. It’s now been extensively documented shale gas wells produce their greatest output of gas product within their first 12 to 24 months of operation and then begin rapidly and aggressively declining. As the industry attempts to decrease extraction costs by drilling more wells closer together and to drill them faster, it appears more gas is inadvertently put on the market than it can absorb.

In the 1980s, the term, “Drilling to exhaustion” first appeared when describing the industry penchant for more drilling in face of whatever ails it.

Many claim the answer lies in higher natural gas prices. More now believe it’s to mandate the use of natural gas by electric utilities and for U.S. industrial transportation in order to drive demand and raise natural gas pricing even though the industry’s central promise to the country was cheap and abundant natural gas through hydraulic fracking.

Senior U.S. electric utility executives remain wary of the natural gas industry and its long history of volatile pricing. Many in the electric utility industry refer to natural gas as the ‘crack cocaine of the power industry’. According to leaked industry emails as published by The New York Times, one energy company official stated this fear when he said, “They get you hooked and then they raise the price.” Investment in a natural gas based transportation structure is going to take billions of dollars to deploy.

The shale gas industry continues to reel under the unrelenting economic realities of today’s price for natural gas from their own self-inflicted mad rush to get as much shale gas out of the ground as possible over the last 5 years. Now this is resulting in major shale gas asset write offs. Incredibly some here in Pennsylvania now believe the answers lie in yet more taxpayer dollars to drive demand under Senator Bob Casey’s “STATE Natural Gas Act” to mandate more use of natural gas while Gov. Corbett vows to fight on for PA ACT 13 provisions to strip local townships of their ability to enact zoning restrictions against shale gas drilling in their local municipalities.

Disclaimer: The writer holds no U.S. securities in any shale gas company nor is he a member of any environmental group or anti-fracking group. He holds no financial arrangements with any of the entities and/or individuals listed in the article. He is not being paid to write by any shale gas industry group, pro or con.

To see Encana’s 2Q financials, go to: http://www.encana.com/

To learn more about Pennsylvania’s ACT 13 legislation, go to:http://www.portal.state.pa.us/portal/server.pt/community/act_13/20789

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