Is the shale gas bubble bursting?
Andy Lees writes:
Shale gas, or at least cheap shale gas has been a bubble which appears to be bursting. Exxon Mobil bought Phillips Resources last week picking up 317,000 acres for exploration in the Marcellus shale basin for USD1.7bn which it says will leverage regional upstream synergies and acreage holdings with XTO Energy which it bought last year for about USD30bn. Exxon, already the largest producer of natural gas in the US, said the two companies had proved reserves of 228bn cubic feet equivalent of natural gas with the Phillips companies adding about 50m cubic feet per day of natural gas. Last year Exxon paid around USD700m to buy Ellora Energy picking up its position in the Haynesville shale in Louisiana and Texas.
Reuters highlights that the price paid for Phillips shale acreage is barely half the price such acres were fetching last year. "The large glut of gas that depressed prices is finally starting to clear" and with Shell mulling a new petrochemical plant in the region, demand may be about to start rising.
Recall in February Chesapeake sold its 75% stake in the Arkansas Fayettevlle shale field for USD4.75bn to trim its USD15bn debt. That was a 17% discount to the USD1.9bn BP and Chesapeake had paid for a 25% stake in the same field in 2008. Gas prices had to rise as the producers simply didn’t have deep enough pockets, a theme summed up by Lazards at the time; "We believe 2011 will be the breaking point, where producers run out of assets to sell to fund growth that is driven by spending 80% more than discretionary cash flow. Natural gas E&Ps are running on borrowed time"…
The weak players are being forced out. They are simply saddled with too much debt which they cannot finance, and with each successive frack the operating costs rise. Remember the decline rate of production is around 80% in the first year, 3 times that of conventional gas, with each successive frack the EROIE declines and you need about twice as many shale wells in the same size as with conventional gas, so the costs will keep soaring.
The oil majors are happy to purchase the reserves and have sufficient cash flow to keep the prices low and force the weaker players out. They are effectively subsidising cheap gas production now as a method of accumulating the assets at low prices. As they accumulate sufficient market share they will clearly slow production forcing prices higher. Prices are already up 98% from their 2009 lows and inventories are 10.44% below this time last year and 2.6% below their 5 year average (although they did rise heavily in those 5 years).
Andy also points to reasons to think the international natural gas market is looking even more vulnerable. What impact will this have on the price of natural gas? If you have fewer players operating wells, then the supply should be lower. It sounds to me like the rush to buy up natural gas acreage has strained balance sheets in a way that will force up prices down the line.