Pickering: A conspiracy among gas drillers or those who write about them?

Following is a commentary from Dan Pickering, Chief Energy Strategist of TPH Asset Management, an arm of the energy merchant bank Tudor, Pickering, Holt & Co.

I had to sigh this weekend as I began to receive emails and phone calls regarding the New York Times article entitled “Insiders Sound an Alarm Amid a Natural Gas Rush.” I encourage you to read this article and its companions.

I don’t agree with many of the conclusions that are drawn, but it does serve to illustrate what critics of the energy industry are saying. And there is no doubt that the author (and evidently the New York Times) are indeed critics.

Having spent most of my professional career writing about energy issues, I understand and appreciate the power of the pen. Writing persuasively and interestingly can make a difference. In a world where the news cycle is 24/7 and people are swamped with information, anecdotes are king. The Times article wields cherry-picked anecdotes like a samurai with a sword.

One snippet is as follows:

“Money is pouring in” from investors even though shale gas is “inherently unprofitable”, an analyst from PNC Wealth Management, an investment company, wrote to a contractor in a February email. “Reminds you of dot-coms”.

Wow. That is good stuff. Captivating. Entertaining. But is it the truth? Or is it an opinion?

I’m not sure that PNC actually has any dedicated energy analysts (I couldn’t find any on their website). So perhaps that cool quote came from a high net worth broker? Maybe he/she is a genius with reams of analysis on shale gas decline. Or maybe the observations are based on reading blogs and internet postings. One can’t tell from the anecdote.

Which should I trust more? – the February 2011 $4.7+ billion purchase of Fayetteville shale gas assets by BHP Billiton or the February 2011 anecdotes from an unnamed broker of unknown quality. Follow the money is usually a good credo.

The New York Times also captured the eye-opening and alarming comments of Deborah Rogers, a member of the advisory committee of the Federal Reserve Bank of Dallas.

Her research indicated Barnett shale wells were declining faster than expected. Fascinating. A Dallas Fed adviser has spotted an important issue. But is it the truth? Or is it an opinion? Would I be just as fascinated if the article quoted Deborah Rogers, proprietor of Deborah’s Farmstead, a small Fort Worth family dairy that produces goat cheese? That’s her bio from the 2008 Dallas Fed press release.

Maybe Ms. Rogers is a closet petroleum engineer and excellent decline curve analyst. Maybe not. But 2011 Barnett shale gas production is at higher levels than 2009, with rigcount down by two thirds. That is not an anecdote seized by a newspaper reporter, it is a wellhead fact.

The Times article does make one statement that is dead on. The article says “these companies have been making predictions based on limited data and a certain amount of guesswork, since shale is a relatively new practice.”

Indeed, natural gas comes from reservoirs 1-4 miles deep in the earth. It seeps out through pore spaces so tiny they can’t be viewed with the naked eye. As such, almost everything about shale gas is an estimate. It is only natural that individuals inside and outside the industry are skeptical, curious, questioning and uncertain – as the anecdotes in their emails prove.

The debate is healthy. Early estimates about various shale plays were too conservative in some instances and too aggressive in others. The Western Barnett turned out disappointing. The Marcellus is better than people initially thought. That isn’t fraud or deception, it’s the oilpatch.

It is this author’s opinion that recovery per well in gas shales will be closer to industry forecasts than the dire predictions of gas shale skeptics. But we can’t know for sure. Real money is made BEFORE estimates turn into facts. Just like the stock market.

Gas shale drilling has been wildly successful – just look at the quadrupling of US shale gas production in the past 5 years. Right now, this is the same hollow success of long-distance telephone carriers – volumes way up, prices way down.

Even as oil prices returned to triple digits, an oversupply of gas has cratered gas prices. I believe that most new drilling for shale gas is uneconomic or marginally economic at current $4?-4.50/mcf prices. So does the industry! The gassy Haynesville shale rigcount is down by ~30% from the peak. It will fall further during 2011 and 2012 as leasehold drilling requirements are fulfilled.

Cheap prices, falling gas-focused drilling, a recovering economy, eventual LNG exports — this is why industry executives are getting more bullish on the gas macro. However, even with optimism growing, most E&P companies are still hedging 2012 gas production at $5/mcf and/or selling down gas properties to fund oil drilling. Midstream companies are building gas pipelines like crazy. Several new LNG export projects are underway.

These actions by a myriad of companies, hundreds of executives and thousands of employees indicate the industry believes in both the short-term and long-term viability of shales. They are speaking with their capital budgets, their bonus pool, their acquisition budgets…not with their keyboards and chatroom postings. If there is any conspiracy or hidden agenda, it’s amongst those writing articles, not drilling gas shale.

For the record, our alternative investment strategies have essentially no directional investment in gas shale producers. As an investment thesis, I believe US natural gas is trapped in limbo between yesterday’s news and a recovery story. Oil is the hot ticket and I’ll be writing about the recent SPR news over the next day or two.

Dan Pickering is the Head of Asset Management and the Chief Energy Strategist at TPH Asset Management, LLC (“TPHAM”) which is an operating company of Tudor, Pickering, Holt & Co., LLC, separate from Tudor, Pickering, Holt & Co. Securities, Inc. (“TPHCSI”) and is not associated with the research division at TPHCSI. Mr. Pickering is a registered representative of TPHCSI. The views expressed herein by Mr. Pickering do not constitute research, investment advice or trade recommendations and may not represent the views and/or opinions of TPHAM’s portfolio managers or the research division at TPHCSI.
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