Is the United States the "Saudi Arabia of natural gas," as President Barack Obama has said? Or has the energy industry used fuzzy math to hype its estimated reserves to entice buyouts and Wall Street investment? Tough to say for sure, but last month the U.S. Energy Information Administration scaled down its estimate of shale gas reserves ... by half. That's huge. And its implications for this industry could be seismic.
Not that they aren't already in a tight spot. The frackers did a magnificent job of cracking the Barnett Shale. They've been ruthlessly efficient in extracting the gas. And that, dear readers, is their biggest problem. They glutted the market. Now the market price makes it almost pointless. Gas production in the Barnett, apparently, is at an all-time high. But the number of rigs punching new holes in North Texas' hide has dropped. Instead, they're working the liquid-rich shale plays while the price of oil is good.
The falling price of natural gas has exposed some systemic weaknesses.
That is, in part, the subject of a Rolling Stone piece centered around shale cheerleader Aubrey McClendon and his industry juggernaut Chesapeake Energy. As almost anyone with land on the Barnett Shale knows, his company came in hot and heavy during the early days of the shale boom, snapping up vast tracts before too many of its competitors wised up.
The shale play heralded the democratization of the oil field. Shale rock is fairly evenly distributed, so companies relied less on geologists to pinpoint reserves. Instead, they launched blitzkrieg, Wall Street-fueled land-grabs. "Chesapeake was the first gas-exploration company to issue high-yield junk bonds, which gave it a steady cash flow to pay for leasing and drilling," writes RS's Jeff Goodell.
Chesapeake made its real money not by pumping natural gas, but buy flipping leases to bigger outfits at outlandish premiums. The model made him one of Fortune 500's highest-paid execs. But it came with a price: To feed the machine, Chesapeake had to acquire more and more land, and that land had to produce. Before long, it became the biggest leaseholder in America. But if it didn't drill that land in three years, Chesapeake had to forfeit it. So the company drilled and drilled, taking on vast amounts of debt, glutting the market and driving down the price of natural gas in the process.
Certainly here in the Barnett Shale, but now in Pennsylvania and New York State, Chesapeake also encountered more obstacles. As fracking moved out of the expansive pastures and into close-quarter cities, the industry ran face-first into tougher city-by-city ordinances regarding spacing from houses and schools, effectively shrinking the amount of acreage they could frack (Or, in cases like Southlake, the subject of a November cover story, stopping them from doing it entirely). Coupled with low gas prices, it made whole swaths of the shale uneconomic to produce. Ultimately, for these reasons, McClendon's model is unsustainable. Goodell quotes Texas energy consultant Arthur Berman as say, "In fact, when you look at the level of debt some of these companies are carrying, and the questionable value of their gas reserves, there is a lot in common with the subprime mortgage market just before it melted down."
IMoody's Investors Service recently downgraded Chesapeake's $11 billion in debt it used to finance its leasing and drilling binge. In apparent distress, the company put its Permian oil fields in West Texas on the auction block last month. In January, Chesapeake announced it was shifting its rigs from shale gas plays to oil-rich fields. It's even selling future oil and gas production on a field in the Texas Panhandle for cash.
If none of Chesapeake's gambits pan out -- and the price of natural gas doesn't rise from its $2.50 per mmBTU depths -- as Rolling Stone points out, it won't just be their stockholders left holding the bag. Chesapeake and companies like it could face the mineral equivalent of a margin call. And shale gas's promise as a game-changing bridge fuel may turn out to be as vaporous as vented methane.
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