Shale Gas Overhyped says Petroleum Industry Analyst Henry Groppe
EDIT: (12/23) For an update on the (un)economics of shale gas production go here, and for an update on the NY Dept. of Environmental Protection’s decision to prohibit hydrofracing, announced on 12/22 go here. And for background, go here.
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Henry Groppe – of Groppe Long & Littell is betting that natural gas prices will double by summer. Why? Because like me, he does not buy the shale gas hype, and recognizes that shale gas has entered the seventh fold of production!
But who is Mr. Groppe, and why should we listen to his prognostications? As The Globe and Mail reports:
In 1980, when oil approached $40 a barrel and forecasters predicted $100 oil was inevitable, Mr. Groppe said crude would fall below $15 by the mid-1980s. It did.
In 1998, when crude dipped to barely above $10 and some prognosticators were hailing a new era of cheap energy, Mr. Groppe said oil was set to soar. By early 2000, it had topped $30 a barrel.
And two years ago, when it threatened to reach $150 a barrel and forecasters said $200 and more were just over the horizon, Mr. Groppe predicted we’d be back at $60-$70 in the second half of the year. By October, he was right again.
Now, he says, a slow-but-gradual decline in North American natural gas reserves – regardless of shale – means an average price in the $8 range is inevitable to trigger the “demand destruction” necessary to keep the supply-demand picture in balance. Eventually, he says, that price will creep up toward $10 by the end of the decade, as gas production slowly depletes.
I recommend reading the original article as it gets into some of the (un)economics of shale gas production that I left out of the “Shale Gas is a Giant Loser” post. It sounds like Mr. Groppe has been listening to Art Berman, an independent petroleum geologist, consultant, and (former) columnist for the industry journal World Oil. Mr. Berman has been covering the shale gas story for years. Art recently penned an article titled “Facts are Stubborn Things” which was pulled at the last minute after World Oil received pressure from a top executive at Petrohawk Energy (a major shale gas player). After the article was pulled, Art quit his gig as a columnist, and World Oil editor Perry Fischer was fired. Fortunately, ASPO-USA ran the article – which discusses the (un)economics of shale gas production. Further insight into Art’s arguments are articulated in the presentation (.pdf warning) which he gave at the 2009 ASPO-USA conference.
In short, Art argues (and empirically shows) that:
1) decline rates for hydrofraced shale gas plays are far more accelerated than those of conventional plays, but the models that the industry uses to forecast future production use historic data trends. In this case, the production curve for a conventional gas play is wide and gentle, while hydrofraced shale is very steep and very short.
From Chris McGill's presentation (http://c2c.ucsb.edu/summit2006/presentations.php)
As Art puts it, “It does not seem logical that type-curve methods should be more reliable than individual well decline-curve analysis. If the pattern of well decline is empirically exponential, it makes no sense that it should be treated as hyperbolic for conceptual reasons or because of a preference based on production from higher permeability reservoirs that are not comparable to those in the Barnett or other recent shale gas plays.”
2) Because the decline rates are inaccurate, the estimation of total reserves is likely far too high. On the economics, Art shares additional insights. Here I am quoting at length the article cited and linked above: “Shale plays typically begin with a leasing frenzy whereby major players accumulate hundreds of thousands of acres, often at astronomical bonus prices. Next, a drilling campaign ensues driven more by lease expiration schedules-typically in the 3- year range-than by science. Only after considerable capital has been destroyed in this manner are the core areas recognized. This “Braille method” is completely opposite to the customary approach to E&P projects, where a cautious approach based on science is used to high-grade focus areas.”
Oddly enough, the so-called ‘Braille method’ is industry ‘best-practice’.
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The Seventh Fold
Great article, thanks! Interesting too that many of the shale players have been shifting their budgets toward oil. (At current prices, much of the shale resource really is uneconomical.) Seems that as conventional gas declines further, bottom-up estimates for near term production (from rig counts, etc) will become sketchier – which I’d think is likely to impact pricing volatility almost no matter what the ultimate reserves end up being.
This is an interesting debate. What are you views now, given the last few injection numbers?
My view on shale gas has not changed. Executing a total cost-benefit analysis, I believe the risks associated with hydrofracing are far too high and regulation is simply non-existent. I also don’t believe that the economics are there yet. Someday soon (but not today) hydrofracing will likely become economical, though – after all, natural gas production has entered the seventh fold, yet demand still grows.
Of course, the economics came around for deep offshore E&P, too. And what happened there? The greatest offshore oil spill in U.S. history, that’s what happened. The Deepwater Horizon disaster highlights both the high risks of playing deep and the risks associated with lax regulatory oversight.
I hear shale bulls decry that there are thousands of hydrofaced plays, and there’s not been a major disaster. Well, the deepwater bulls said the same thing. So, from an environmental, social, and economic perspective, the risk of polluting a major freshwater reservoir is simply far too great to warrant the blind rush to produce shale gas.
But back to the economics… This comes from a Bernstein Research report on Haynesville:
“The Haynesville Shale remains, in our minds, a case of severe shale overhype. With its headline-grabbing initial production rates that far exceeded those of any prior shale play, the emergence of the Haynesville was heralded as the end of gas scarcity, with companies suggesting it would be one of the largest gas fields ever and would contain decades of low cost supply. But the problem was, and remains, that despite the high IP rates, declines were high and costs were high, too.”…
“But if the Haynesville’s costs are really so high and return on capital is below the cost of capital at today’s gas price, why are operators continuing to drill there? A primary reason is the need to hold acreage, which operators leased at high prices with short terms.”
So what we’re looking at is a land-grab situation (except that mineral rights can, and most often are, owned by individuals that don’t own the land). The markets expect players to be in shale precisely because of the high IP. This forces shale producers to lease the rights to drill. Typically the leases are short (three years), which means producers have three years to set up shop and extract as much gas as possible. Of course, this drives up supply and down goes the price of gas. This is good for consumers, but not so good for producers (and to a lesser extent the owners of the mineral rights).
Of course, this phenomenon is nothing new. One needs look no further than the stories of Spindletop and Titusville. In both cases, investors made similar land-grabs, production shot up (in the short term) prices tanked, and many went bankrupt. Shortly thereafter, overproduction caused the premature demise of the fields, shortages, and price spikes. In today’s dollars, prices would fluctuate from below $10 per bbl to over $100. And that is no way to run an industry!
In addition to the obvious environmental (read: public good) need for regulation, regulation can benefit producers as well. Between 1930 and 1970, the Texas Railroad Commission effectively controlled prices through production quotas. In doing so, the TXRC removed much of the risk of investment. While windfalls were hard to come by, profits certainly were not.
Of course the long history of stable prices is in large part responsible for the lingering addiction, the impacts of which we feel so intensely today… but that is a topic for another discussion altogether.
Thanks for the question.
DA
I know this is an old article but do you still believe that nat gas prices to up from here and by how much.
Sonny Mehra 9/18/10
Welcome to the fold, Sonny.
My views on shale gas have not changed, and I am certainly not willing to ‘bet’ that the price for NG will rise or fall in the short run, which I presume is the time frame that you are interested in. I won’t speculate on price because 1) demand in large part depends on economic recovery and the weather, 2) supply depends on decline rates (which are all over the board for shale) and new production (which I haven’t kept a close eye on), and 3) there are far too many other factors (like inflation) that influence price.
My bet is that prices will be volatile and unpredictable.
The bigger point, though, is that shale production is a sign that NG production has entered the seventh fold. It is becoming ever more costly to produce that extra cubic foot… and these costs are measured both in financial and energetic terms. This is a sign that we need to think about energy in a new way. Scarcity needs to enter our economic calculations. And as a society we need to make a concerted effort to use our resources more efficiently.
The largest gas field yet to be discovered is neither a conventional nor a shale play. It’s conservation.
Cheers,
DA
Mr. Groppe predicted $8 gas by the end of summer. Fall is in the air and gas prices are still around $4. What are his views now about natural gas prices?
Good question! I can’t speak for Mr. Groppe, and I don’t know how he would answer your question.
Personally, I think the best advice that I ever received was handed down from an energy guru and investment manager who said “never predict the price”. I generally heed that great advice with the exception being my prediction that oil would bounce back strong from the $30 range that it hit in January of ’09… but that was a softball!
As for today’s NG, I am not surprised by the price… but I would have said the same if the price was $8. From a supply side, we simply do not know what decline rates are going to look like on shale plays. Art Berman argues quite convincingly that initial flow rates will be high, but that they will drop precipitously, and this makes perfect sense in my mind. But in a land-grab situation, it is possible that more new production is coming online than is falling off. It is also possible that natural shale gas production rates and URR will be higher than Art believes. Only time will tell.
As for me, my only price prediction is for increased volatility – and volatility moves in both directions.
Thanks for reading,
DA
Where does Mr. Groppe stand at this time about natural gas prices? He predicted $8 gas by the end of summer but here we are in September and they linger around $4. What are his now current views about nat gas?
Apologies, Gary, I am not aware of Mr. Groppe’s current position.
The problems of predicting price are compounding. First, you need some estimate of future demand. Where will the economy go? How severe will the winter be? Will the split among energy demand remain constant? Will coal and other NG alternatives capture a larger or smaller share of the energy market?
Second, you need some reliable estimate of future supply. And here we have a problem. We don’t have enough shale gas production data to be able to predict with a high degree of certainty what decline rates will be. Currently, industry players are using type-curve methods which may prove to be inappropriate for shale gas. We do know that at least some shale gas plays have very different production characteristics, so I’m inclined to look at forecasts that use these models with a suspicious eye.
More importantly, the reason why I posted this blog which links to the G&M article on Groppe is to point out that NG has reached the seventh fold. The financial and energetic costs rise rapidly as we enter the seventh fold because production moves from conventional sources to unconventional sources.
In addition, reaching the seventh fold also means that environmental (and therefore social) risks rise as well. Deepwater drilling proponents used to say that a BP-like spill was impossible. Hydrofracking proponents say that aquifers are safe, despite mounting evidence that this statement may in fact be in error.
So, imagine what will happen if an important aquifer becomes compromised. I imagine that a moratorium and investigation would ensue… and this would likely have powerful impacts on NG prices.
Thanks again for reading, and please see my previous response to this same question that you asked a few days ago.
DA