The Natural Gas ‘Ponzi Scheme’ by seeking alpha, August 28, 2012
From “Ponzi Scheme” to Huge Writedowns
Around the same time, Arthur Berman issued an eye opening report on the overly optimistic estimates that the natural gas industry is using for shale gas reserves. According to Berman: Type curves that are commonly used to support strong hyperbolic flattening are misleading because they incorporate survivorship bias and rate increases from re-stimulations that require additional capital investment. Comparison of individual and group decline-curve analysis indicates that group or type-curve methods substantially over-estimate recoverable reserves. Berman goes on to state, Our analysis of shale gas well decline trends indicates that the estimated ultimate recovery (EUR) per well is approximately one-half of the values commonly presented by operators.
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Berman asserts that based on actual data over the past 10 years from existing wells, the decline in production is actually exponential and therefore liable to run out much faster than estimated. Additionally, he shows that the actual reserve amounts are far lower than estimates and the costs of extracting the shale gas is far greater than gas companies are stating in their prepared remarks to investors. In many ways, this is no different than the mortgage backed securities banks were peddling to investors in the first half of the 2000’s. The estimated life of the mortgage products was projected to be 30 years because the average house was expected to rise 2 to 3 percent per year ad infinitum (offsetting any potential credit risk from subprime borrowers). In the same way, natural gas companies are assuming that the reserves will last 100 years because the decline rates are linear rather than exponential. Berman concludes “Our work on the three most mature shale plays has profound implications. Facts indicate that most wells are not commercial at current gas prices and require prices at least in the range of $8.00 to $9.00/mcf to break even on full-cycle prices, and $5.00 to $6.00/mcf on point-forward prices. Our price forecasts ($4.00-4.55/mcf average through 2012) are below $8.00/mcf for the next 18 months. It is, therefore, possible that some producers will be unable to maintain present drilling levels from cash flow, joint ventures, asset sales and stock offerings.
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After Berman issued this report, he was naturally attacked as lacking credibility by Chesapeake (CHK) and other publicly traded natural gas companies. Back in March 2012 The Rolling Stone also issued a scathing article on what appears to be a massive scam surrounding shale gas, which quoted Mr. Berman and also saw some backlash from the natural gas companies.
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One Year Later: So now that we’re a year removed from the above referenced New York Times article and the Berman report, what has changed? Well, Berman was estimating that with $4 to $4.50 natural gas, the shale gas plays would see huge economic losses in 2012. However, the price of natural gas has averaged around $2.50 for much of 2012, making these even less economical than Berman estimated. We have seen several publicly traded companies write down the value of their shale gas assets tremendously. Here are links to several companies that have written-down assets: BHP (BHP); BG Group (BRGYY); Apache(APA); Pengrowth (PGH); Encana (ECA); Ultra Petroleum (UPL).
It remains to be seen if the entire shale gas industry is a Ponzi scheme. More likely is the possibility that it is overhyped by Wall Street and Natural Gas firms, who bought up large plots of land and issued optimistic projections to suck other companies and investors into buying that same land from them at higher prices. … Consumers will be stuck with natural gas cars that cost more to fuel than cars that take unleaded gas and they will be left with home heating bills that will be skyrocketing. …
In 5 years Congress will shamefully trot out the executives of these companies, putting on a show for the public as they publicly condemn them for what turned out to be a giant investment scam. However, none of them will be willing to admit they were warned when ahead of time by the likes of Arthur Berman, The New York Times, The Rolling Stone, and other sources. It will all play out just like every other scandal we have seen over the past 13 years, from the dot com bubble to the housing boom to the Madoff Ponzi Scheme, etc. Given all of the bubbles we have been through over the past 13 years, we all know to be cautious when we hear the words “This time is different.” [Emphasis added]