By John Kemp
LONDON Aug 6 Shale sceptics have seized on big
writedowns in the value of shale gas and oil properties in North
America to question whether the fracking revolution could be
running into trouble.
On Aug. 1, Shell became the latest in a long line
of oil and gas companies to reveal a multi-billion-dollar
writedown in acreage value.
It announced just over $2 billion in impairments
"predominantly related to liquids-rich shale properties in North
America, reflecting the latest insights from exploration and
appraisal drilling results and production information".
Others to acknowledge impairments of their U.S. shale assets
have included BG Group and BHP Billiton.
"Over the past few years, the oil majors have been punch
drunk on U.S. shale. Now comes the hangover," Guy Chazan wrote
in the Financial Times on Aug. 1. "Shale writedown is bad news
for U.S. shale," he warned.
Analysts at Bernstein Research, which has long sought to
inject a note of scepticism and realism into the debate about
shale's potential, expressed caution over "exploration and
drilling results that are clearly weaker than Shell had expected
(shale oil bulls take note!)"
However, writedowns by Shell and some other majors are a
sign they came to the shale boom late in the day, overpaying for
lower-quality and less well-explored assets - not that the shale
revolution is stuttering.
Until recently, the majority of writedowns have been related
to gas-rich properties, struggling amid the prolonged downturn
in gas prices.
Chesapeake Energy lost its colourful chief
executive, Aubrey McClendon, earlier this year, mostly because
of a shareholder revolt after the company overpaid and
over-expanded in gas acreage and struggled to generate adequate
returns when gas prices fell.
Sandridge saw a similar defenestration after its
highly speculative wildcat acreage failed to yield the hoped-for
bounty, and gas prices remained stuck near rock-bottom.
With no sign of a recovery in gas prices, most exploration
and development firms have shifted their attention to formations
or parts of formations rich in crude oil and condensates.
However, the impairment of Shell's liquids-rich assets has
highlighted the limitations of that strategy, and inspired
another bout of worrying over whether the recent rise in U.S.
oil production can be sustained.
In reviewing the shale boom and its aftermath, it is
important to keep a sense of proportion. Just as shale
enthusiasts ignored the problems of translating the technology
to other countries, doomsters risk being too quick to interpret
the financial difficulties of shale investors as a sign the
technology is running into trouble.
It is critical to separate the production potential of the
technology from the accounting value of the shale leases that
companies have bought.
The shale business, particularly between 2007 and 2011,
exhibited all the signs of a bubble. A disruptive new technology
unlocked enormous riches for early adopters, prompting a belated
rush by other investors and companies to join in and catch up.
The results were predictable. Late investors substantially
overpaid for leases. Costs rose. Markets became oversupplied.
Selling prices slumped. Fabulous returns turned to a trickle,
leading to writeoffs in the value of the assets.
The writedowns have been concentrated among companies that
bought into the shale boom very late, either by leasing acres
themselves, or buying companies with already-established
The story has been repeated over and over with disruptive
technologies. Minnesota University's Andrew Odlyzko chronicles
how the pattern of overpaying and over-investing in new
technologies has been manifest from the railway mania in Britain
in the 1840s to the Internet and broadband boom of the late
1990s in a superb monograph on "Collective hallucinations and
inefficient markets: The British Railway Mania of the 1840s."
But while railway investors lost the equivalent of several
trillion dollars in today's money, the mania bequeathed a
network of main lines that became the enormously useful and
valuable mainstay of Britain's railway system.
Something similar now seems to be happening with the shale
Gas and condensate producers have been victims of their own
success. Prodigious output from fracked gas wells has crashed
the price of natural gas and more recently of condensates such
as ethane, propane, butane and natural gasoline.
But oil-focused producers have fallen victim to another
problem: overpaying for acres.
Shales are heterogeneous, varying enormously between
different formations in different parts of the country, and even
over quite small distances of a few kilometres with the same
Oil and gas production from extensively drilled shales such
as Bakken, Barnett, Eagle Ford, Haynesville and Marcellus has
proved a poor guide to output from less well-known plays like
the Utica, Woodford and Conasagua.
Even within a single well-explored play like Bakken, output
can vary enormously between "sweet spots" near the centre of the
formation and outlying areas, as well as from one well to
another across sections of a couple of kilometres.
LATE BUYERS' REMORSE
Fracturing techniques must be customised for each play to
achieve the best results. It takes time and drilling a lot of
wells to get the approach right and identify the most productive
parts of the formation.
Established players such as Continental Resources in
the oldest plays have had years to hone their drilling
programmes and focus on the most promising acreage.
They bought leases early, paid modest signing bonuses and
agreed reasonable rental, royalty and overriding-royalty
payments. Since then, they have traded leases to achieve
consolidated tracts covering the best areas that can be drilled
By contrast, latecomers bought leases at vastly inflated
prices during the height of the mania, many for poorly explored
formations, in non-contiguous blocks. For a few years, shale
leasing was akin to a modern gold rush. It comes as no surprise
many of these leased acres are not worth what the companies
That doesn't mean all these shales are bound to disappoint.
It does mean more (expensive) exploration and appraisal work
will be needed. Drillers and pressure pumpers will have to
experiment with different techniques to get it right.
Some shales may never prove very productive. Others require
more investment, in some cases much more.
Meanwhile, those companies that bought acres near the top of
the boom will have to recognise they overpaid and will never
recoup all their investment in the hoped-for timeframe.