Energy In Depth Makes Massive Mistakes
By Deborah Rogers
Energy in Depth (EID), a site funded by the Oil and Gas industry, published a series of articles written by Dr. Scott Cline in an effort to discredit my presentations on shale gas economics. I found EID’s articles perplexing. Perplexing because Dr. Cline and EID offer extraordinarily weak expositions which contradict their premise, demonstrate an acute misunderstanding of their own industry and advocate for actions which are not considered “best practices” in the oil and gas field.
Allow me to give the examples using EID’s own language.
EID mistake #1: “When USGS spoke about resource estimates they were talking about recoverable natural gas with existing technology…”
DR: Yes, they were. That is precisely what I always state. The USGS slashed estimates for the Marcellus by 80% because they were speaking of “recoverable natural gas with existing technology”, rather than resource numbers which describe gas that might become potentially available should the technology or economics improve. Although industry loves to tout resource numbers, using them can be argued as a deliberate obfuscation. The Department of Energy followed USGS’ lead and slashed their estimates for the Marcellus by 66% admitting that the entire Marcellus play will now account for a mere six years worth of gas at current consumption rates. Prior erroneous estimates provided by industry were based on resource numbers rather than actual recoverable reserves with existing technology.
It is also interesting to note that both Poland and India invited the USGS to evaluate their reserve estimates recently after industry projections and again such reserves were slashed by 80-90%. A pattern is clearly emerging.
EID mistake #2: “This (USGS) is a very conservative assessment and it is virtually certain to increase dramatically over time with increasing technology…I’ve seen the evidence myself and it’s clear that dramatic increases in ultimate recoveries over time are occurring…The question whether or not we have a 100 year supply (at current rates) of total domestic natural gas resources may soon turn to whether or not our total domestic natural gas resource is instead a 200 year supply…”
DR: Dr. Cline, in direct opposition to the USGS, is once again advocating using resource numbers that might “increase dramatically over time with increasing technologies”. This is an apples to oranges comparison; again a deliberate obfuscation. Further, Dr. Cline claims to be a petroleum engineer, therefore I am giving him the benefit of the doubt that he truly does know the definition of resources. In fact, the Society for Petroleum Engineers (SPE) defines resources, to which Dr. Cline is referring, as “potentially recoverable but not yet mature enough for commercial development due to technological or business hurdles.”
In other words, these are not reserves that you can necessarily count on.
EID mistake #3: “there is considerable variation in the quality of natural gas shale wells, as is also the case with conventional wells, especially when you add in the large “dry hole” risk in conventional well drilling that is not present in shale gas drilling (emphasis mine).
DR: Shale plays are not homogeneous. Dr. Cline states that there is no dry hole risk in shale development. He is mistaken. It is commonly known that each shale play has contracted to a core area. Aubrey McClendon, CEO of Chesapeake Energy told Bloomberg that “there was a time when you were all told that any of the 17 counties in the Barnett were as good as any other county. We found out that there are 2-2 1/2 counties where you really want to be.”
Further, well performance is not homogenous even in the core areas. ITG Investment Research, also quoted by Bloomberg, stated “one parcel of land may hold enough fuel to justify prices…while the adjacent land is almost worthless to drillers”. This is essentially dry hole risk.
It is curious that Dr. Cline and his colleagues at EID are unaware of this phenomenon when other industry insiders are clearly cognizant.
EID mistake #4: “Dr. John Lee, a legendary petroleum engineer…[but] she says 80% of all shale wells can be easily uneconomic…an oversimplified estimate that, in reality, varies by area and time.”.
DR: Dr. Cline and EID begin this statement describing Dr. John Lee as a “legendary petroleum engineer”. Curiously, however, they move on to dispute the facts of my presentation without apparently realizing their error.
Dr. Cline and I are in complete agreement as to the credentials of Dr. Lee. I appreciate EID verifying my use of an impeccable source. And yet Dr. Cline goes on to state: “she says 80% of all shale wells can be easily uneconomic an oversimplified estimate that, in reality, varies by area and time.”
Again, Dr. Cline is mistaken. She did not state this. Dr. Lee, the “legendary petroleum engineer” stated that “80% of all shale wells can be easily uneconomic”. Apparently Dr. Cline disputes the “legendary petroleum engineer’s” assessment. He states that Dr. Lee has made “an oversimplified estimate that, in reality, varies by area and time.”
I’ll continue to use the “legendary petroleum engineer’s” assessment in my presentations rather than Dr. Cline’s.
EID mistake #5: “She says “friends” (perhaps Chip Northrup who makes similar arguments and describes her as ”a great speaker and accomplished analyst of fracking”) colloquially call this the “Drilling for High IP Releases” phenomenon.”
DR: Again, I must point out that she did not make any such statement. All references used in my presentations are directly attributable to industry insiders, as inconvenient as that may be. The insiders which I quoted are not “friends” or even acquaintances as much as EID and Dr. Cline would have people believe such nonsense. They are people in the oil and gas industry who have spoken out on these topics to major news organizations or universities.
EID’s next mistake was my personal favorite.
EID mistake #6: “…even if a natural gas play is in production decline, it does not necessarily mean the play is over..it simply means the well development rate is not keeping up with current production declines…so where is that treadmill?”
DR: Dr. Cline is clearly unaware that he just defined the drilling treadmill.
Well development rate is not keeping up with current production declines. These companies have to keep up prolific and continuous drilling (i.e. Dr. Cline’s “well development rate”) in order to keep production from falling (i.e. Dr. Cline’s “production decline”). If you have little to no cash on your balance sheet and very high debt then production is how you meet debt service. If you stop drilling, production falls and so does cash flow and hence it becomes difficult to meet debt service. This is not a difficult concept to grasp.
But I should like to thank EID again for their admission that well development rates are not keeping up with current production declines.
EID mistake #7: “So using a b value in excess of 1 for the early flow regime is widely accepted and used [emphasis mine], but it is not blindly used in isolation.”
DR: I would like to thank EID for this admission as well. Using “b” factors in excess of 1 is widely accepted and used. Dr. John Lee, the “legendary petroleum engineer”, even gave a presentation to SPE on this very topic. Dr. Lee stated that the common method used is to “use a best fit “b” until predetermined minimum decline rate is reached, then impose exponential decline”. Dr. Lee pointed out , however, that “any extrapolation with best fit “b” is unrealistic…[and] leaves too many degrees of freedom [which] inevitably leads to subjective judgment.”
The “legendary petroleum engineer” clearly disagrees with EID and confirms that Dr. Cline’s method “is unrealistic…[and] leads to subjective judgment.”
My point entirely.
Further, it is not considered “best practices” by SPE, the pre-eminent organization of Dr. Cline’s profession, to use b factors in excess of 1 for the above mentioned reason. And yet, EID and Dr. Cline are advocating just such action which calls into question their professionalism.
Should EID wish to complain to SPE that their best practices do not fit with EID’s agenda, I will patiently await SPE’s decision. In the meantime, I will continue to use the recommendations of the Society of Petroleum Engineers in my presentations rather than those of Dr. Cline and EID.
EID mistake #8: “Admittedly because this is such a gray area [i.e. reserves being claimed by companies but not independently verified], subject to scrutiny by the SEC, there are and will continue to be conversations between the SEC and companies each year…but this is expected and indicates openness and cooperation.”
DR: Here are the facts as stated in my presentations: no third party independent audit is required and some companies are in violation of the five year rule. They have received letters from the SEC, of which I gave excerpts. Dr. Cline spins these letters as “conversations between the SEC and the companies… [which are] expected and indicates openness and cooperation.”
On the contrary, violation of SEC rules is not “expected”.
These “conversations” were engaged in because SEC identified anomalies in the public filings. In fact, some of the these companies were pushing the edge of the envelope to such an extent that their estimates for proved undeveloped reserves (PUDs) were said to be “mathematically impossible”. In other cases, companies were directed to immediately revise their filings to reflect well lives that were “more reasonably certain to occur”. And lest Dr. Cline and his colleagues at EID are tempted once again to claim that she said this, I should like to make it patently clear that those comments come directly from the SEC and are publicly available for scrutiny.
EID mistake #9: “The greatest fear for a CEO, and top management in general, is the impairment charge where reserve values are written down and charges against income occur. Therefore, companies tend to be very conservative with their volume estimates to avoid such an embarrassment.”
DR: Dr. Cline and I are both in agreement that impairment charges are “embarrassments”. And yet impairment charges are being taken by shale gas companies at alarming rates currently. Reuters recently stated “huge write downs on natural gas fields point to cuts to come in oil and gas producer’s reserves from untapped fields at the end of this year, which will constrain their ability to borrow more money and may herald asset sales.”
Dr. Cline took great pains with his exposition, blinding the reader with esoteric definitions. I will make it simple. The bottom line is that the asset must be “marked to market” after a ceiling test. In other words, if the assets were greatly overvalued on company books or reserves were vastly overestimated to their actual value, this shows up as an impairment. They are indeed an embarrassment.
If the companies, as EID would have us believe, have truly been “very conservative with their volume estimates to avoid such an embarrassment” and yet are now taking billion dollar plus impairment charges then it boggles the mind to think what a “liberal” estimate by these companies might have produced.
In closing, I feel compelled to address one last statement by Dr. Cline and EID. It is as follows: “I don’t know of anyone that could have predicted this price collapse…”
This is an astonishing statement!
Are we to understand that Dr. Cline and his colleagues at EID had absolutely no inkling that prices were collapsing?
Current supply is four times greater than current demand. The rest of us have been aware of oversupply in the natural gas market for years now. It is an unfortunate fact that if you glut a market with supply, prices ALWAYS go down.
It must be noted that even as long ago as 2009 several shale companies announced production cuts in an attempt to shore up declining prices in natural gas. Production cuts, however, never materialized in any meaningful way due to high levels of debt and the price has continued to erode for the last three years. It is very curious indeed that EID was wholly unaware of such price declines.
And yet, perhaps it is not so curious after all. Given the myriad mistakes which Chesapeake Energy made in its public filings with the State of Pennsylvania recently, it is perhaps not so surprising that an entity funded by Chesapeake Energy might also make many, many mistakes.