Back in 2001 the “dot-com” bubble crushed investors. Apparently “pets.com” or whatever, wasn’t worth the zillions of dollars that investors were willing to pay.
Last week I received a disturbing correspondence that implied the shale sector may be the next bubble to pop.
Let’s use this reader mailbag to set the record straight. And in the meantime we’ll check in on one of our favorite investment ideas…
We opened the mailbag last week and found a gem! The reader comment below comes in response to a recent issue of Daily Resource Hunter titled “The Unsung Hero of the US Energy Boom”. Here it is in full:
“This is little more than hype.When the energy costs used to extract, process, and transport the natural gas are higher than the energy content of the gas when it gets to the end user you have a process that destroys capital.“This is why the SEC filings are showing that the shale producers of gas and oil are still cash-flow negative and unable to generate a true economic profit. What we have is a financial sleight of hand game that hides the real picture in the sector.“As accountants continue using the EURs as the basis of their depreciation costs companies can report small losses or even profits. The trouble is that the actual ultimate recovery rates are much lower and that many wells that have yet to be depreciated are no longer producing a positive cash flow.“That means that we will see the type of write-offs that Agora analysts accurately predicted in the tech sector. I guess the old analysts must have moved on and the new ones are more interested in hype than actual research.”
“This is little more than hype.When the energy costs used to extract, process, and transport the natural gas are higher than the energy content of the gas when it gets to the end user you have a process that destroys capital.
“This is why the SEC filings are showing that the shale producers of gas and oil are still cash-flow negative and unable to generate a true economic profit. What we have is a financial sleight of hand game that hides the real picture in the sector.
“As accountants continue using the EURs as the basis of their depreciation costs companies can report small losses or even profits. The trouble is that the actual ultimate recovery rates are much lower and that many wells that have yet to be depreciated are no longer producing a positive cash flow.
“That means that we will see the type of write-offs that Agora analysts accurately predicted in the tech sector. I guess the old analysts must have moved on and the new ones are more interested in hype than actual research.”
Time to rub my little Tuesday morning eyes!
I’ve been accused of over-hyping things in the past, but when it comes to America’s energy comeback the so-called hype is well-warranted. Let’s discuss.
Your editor agrees with some of our above reader’s commentary. No industry has a chance to prosper if you can’t produce your final product with less energy and capital than it takes to get it out of the ground — heh, barring the government-mandated ethanol industry, of course.
…not all oil and gas players are what they’re cracked up to be. But that doesn’t mean the shale industry is an over-hyped shell game.
But to be honest, poking holes in the shale boom was what we were trying to do back in 2010 and 2011. Back then we were starting to see the first wave of shale oil and gas production. It was unbelievably great.
Back then, costs were high. And production was still untested. Depletion was also a major question (depletion, fyi, is a physical phenomenon found in every well, where a deposit produces less oil or gas over time.)
Truly, a few years ago, there were more questions than answers.
And some companies since then have, indeed, been over-hyped. The prime example would be Chesapeake Energy (CHK.) Chesapeake was the industry’s darling. In the beginning of the shale craze the company bought up acreage with both fists. Fact is, at some point you could have considered them a land management company instead of an oil or gas play.
The shotgun approach, however, hasn’t panned out for Chesapeake. Over the past 5 years the company is sporting a modest gain of 39%. For reference the S&P index is up nearly 100% in that same time frame.
Another sector that we can currently lump into the shale losers pile are “big oil” players. As I’ve said before the big fully integrated companies have their hands in too many cookie jars. They’re onshore, offshore, Middle East, non-Middle East, researching biofuels, etc. — but they aren’t a pure-play shale producers.
Truly, I’ll be the first to admit that not all oil and gas players are what they’re cracked up to be. But that doesn’t mean the shale industry is an over-hyped shell game.
Today, we have much more data than we did in 2010 — questions are being answered. And the answers are reaffirming — if not outright strengthening — my excitement for America’s shale plays.
There is no accountant “sleight of hand” here. The right companies (most of which are in the oily sweetspots right now) are making money had over fist.
In fact, shale plays across the country continue to beat expectations.
“North Dakota’s rapidly rising oil output continues to defy the skeptics” Reuters reports.
“In practice” the article continues, “the shale skeptics have proved wrong on every point, revealing a fundamental lack of understanding about the geology, economics and technology of shale production.”
The estimated ultimate recovery (EUR) for many of these shale plays are playing out far beyond the most-positive of expectations.
From a pure profit standpoint, the production that we’re seeing from the well-run companies is paying off, too. It’s much more straight-forward than you’d think — or the reader comment above would have you believe.
Think of it this way…
Most of the shale wells being produced today cost anywhere from $5-10 million. A good well can produce 500-1,000 barrels of oil per day (bpd) during its first year. This isn’t a prediction, it’s happening in the field today — we’ve got thousands of wells as proof.
So if you take production of 500-1,000 bpd and oil currently trading at $100/barrel, you’ll see that some of these wells are fully paid off within three to six months! Even in the face of natural depletion, that means all of the oil production from, say, month six onward is gravy.
It’s no wonder that rifle-focused companies in America’s shale sweetspots are cashing in.
One company that we’ve highlighted several times is Pioneer Resources (PXD) — Pioneer was on our list of companies that we feel could become “the next Exxon.”
Unlike Chesapeake or other players riding on the shale boom’s coattails, Pioneer is blazing a profitable trail in U.S. shale. This is a company that’s “walking the walk.”
Over the past five years, while Chesapeake has gained 39% and the S&P has gained nearly 100%, Pioneers shares are up 646%. If you go back to the company’s lows in 2009 the company’s shares traded as low as $12. Today they’re trading for $220 — that’s a 17 bagger.
That’s not a “pets.com” run-up, either. This company is spinning cash, lots of it. They’ve locked in the prime acreage in a few of America’s shale hotspots — plus, costs and drill time are still dropping. Indeed, Pioneer (and companies like it) are the real McCoy in America’s energy comeback.
Back to the readers comment above — and don’t get me wrong, I love the comments so please keep em coming — it’s not accurate to compare the shale boom to the dot-com bubble.
Bubbles come and go, but booms have lasting power. The gains that we’re seeing from well-run shale players are going to continue to roll higher. That’s today’s undervalued opportunity. And although natural gas has yet to join the profitable shale party, that day will also come (also providing a solid chance to profit by going against the crowd!)
Let’s raise our glasses and give hearty cheers to the Agora analysts that called the breaking of the dot-com bubble! And here’s to those that are set to make a killing from the next misunderstood opportunity: America’s shale boom.
Keep your boots muddy,
Matt Insleyfor The Daily Reckoning
Ed. Note: Clearly there are going to be competing theories when it comes to any exciting new investment story. Who’s proven right will come down to the quality of their research. And Matt does some of the most extensive and in-depth analysis around, often gaining first-hand knowledge straight from the source. He knows the intricacies of the US oil boom story better than almost anyone, and he’s leading his Daily Resource Hunter readers to some incredible chances to profit. If you’re not reading The Daily Resource Hunter, you can sign up for free, right here. Every morning you’ll get an email sent directly to your inbox that explains just what’s going on in the resource markets, complete with no less than 3 chances to learn about unique and actionable profit opportunities. And since it’s free, you’ve got absolutely nothing to lose. So don’t wait. Your next issue is just a few hours away. Sign up for FREE, right here.
Original article posted on Daily Resource Hunter
When (not “if”) things get even worse in the Middle East and oil prices soar, we’ll see a surge in the need for “safe haven” oil plays. The U.S. shale gale combined with offshore oil from the Gulf of Mexico will both provide ample investment opportunity.
Matt Insley is the managing editor of The Daily Resource Hunter and now the co-editor of Real Wealth Trader and Outstanding Investments. Matt is the Agora Financial in-house specialist on commodities and natural resources. He holds a degree from the University of Maryland with a double major in Business and Environmental Economics. Although always familiar with the financial markets, his main area of expertise stems from his background in the Agricultural and Natural Resources (AGNR) department. Over the past years he's stayed well ahead of the curve with forward thinking ideas in both resource stocks and hard commodities. Insley's commentary has been featured by MarketWatch.
“There is no accountant “sleight of hand” here. The right companies (most of which are in the oily sweetspots right now) are making money had over fist.”
OK. Which primary shale producers are making money ‘hand over fist?’ And please don’t just bring up Pioneer because the company has production from CBM and conventional reserves that are viable and do generate positive cash flows that can offset the losses in the shale space. What this debate is about is the shale space so let us stick to the shale space.
I look at a player like Continental and see a mess. From June 30, 2012 to June 30, 2014 the company increased it debt from $2.25 billion to $4.44 billion while total revenues increased by 0.1 billion. Note that if we look at the actual production data we find that about half of all the oil coming from a shale well will be produced in the first three years. That would mean that we would expect to see half the depreciation cost written off during that period. But we do not. The typical shale company is only writing off around a quarter to a third of the cost because it avoids using the actual production data and has its accountants used the Estimate Ultimate Recovery rate instead.
But it gets worse. When companies are stating probable reserves they do not have to drill the number of wells that would be required to prove the continuity and productivity of the reservoir. That rule was changed and now the companies can use their best guess to come up with a number that they use in their reporting. Not only that but when the boe reserve is reported companies are allowed to use the approximately 6:1 BTU content ratio rather than the closer to 30:1 price ratio. That makes shale companies attractive as takeover targets for conventional players that need to hide their depletion problems as discoveries lag annual production. Such companies can afford to subsidize their shale production losses out of their conventional profits for a while and use their overvalued paper to acquire cheap conventional reserves in the market rather than take the exploration risks.
Let me end this by suggesting that the larger energy players are giving us the clearer picture. They have access to the same consultant, can hire the same quality employees, and hire the same services companies to produce shale oil and gas as the primary players. The fact that they can make money from CBM or heavy oil but not shale should tell you all you need to know but not if you hope, pray, and wish and ignore the actual data.
Personally, I would rather be looking at players in the coal and conventional space than shale at this time. If you have profits in the space congratulations. But if you leave them there while you ignore the actual production data and the accounting issues you will have nobody to blame but yourself when the shale scam is exposed for what it really is.
Thanks for your comments, much appreciated! Pioneer is a shale player. The company has huge resources in the Eagle Ford (shale) and the Permian’s Sprayberry/Wolfcamp (shale.) The other primary shale players that I’ve written about extensively — I call them the “local” players — are EOG Resources (also a big player in the Eagle Ford) and Oasis Petroleum (a pure play in the Bakken.) http://dailyresourcehunter.com/how-buying-local-in-the-oil-biz-is-paying-off/ There are certainly some losing investments out there (many of which are just too big for their own good), but if you avoid the shale sector altogether do so at your own peril!
I guess I’ll just rephrase… for what I mean with spinning cash…
If you were a company and you could drill a well for $5-10 million and the total payout of that well would be $50 million (an average estimated ultimate recovery of 500,000 barrels at $100 oil) then wouldn’t you want to “spend” as much as you could?
A company like Pioneer is doing just that. And rightfully so. Right now cash is cheap — thank Mr. Bernanke for that. And a company like Pioneer can take that cheap debt and put it into wells that’ll pay out 5 times their money, on average. These are estimated numbers of course, but it’s happening right in front of our eyes.
Although you might not follow this line of thinking, if you think the whole shale industry is bunk, a company’s stock price is nothing more than its future value. Pioneer’s share price has been ramping up over the past years because investors see the potential payout. And I agree with em.
To further my point, today’s (Oct 23rd) Wall Street Journal talks about how shale producers are getting even better at cracking the code. Headline: “U.S. Shale Producers Drilling Bigger, Faster Wells” the point of the article is that drillers getting better, more efficient at drilling more productive wells. That’s a winning equation, and Pionner is proof.
When it comes down to it, all the geology, accounting, etc, there’s only one thing that matters — will share price rise? I’ve gone on record saying that Pioneer is a proven winner — it’s up over 100% since saying “This American Energy Player Is A Buy” http://dailyresourcehunter.com/this-american-energy-player-is-a-buy/
Today, over a year later, with even more positive data coming from the field, the company is still a buy. (So are many of the other shale players on my list.)
“If you were a company and you could drill a well for $5-10 million and the total payout of that well would be $50 million (an average estimated ultimate recovery of 500,000 barrels at $100 oil) then wouldn’t you want to “spend” as much as you could?”
I would also spend as much as I could. But you are missing the point.
First of all, the average recovery from the average shale well would be closer to 80,000 barrels than it will be to 500,000 barrels. You are making claims of 1,000 bpd daily production but have no real world production data that shows that. The best wells in the core areas are showing a 300 to 500 bpd in the first year. But the average well is closer to 150 bpd.
Second, the returns you are claiming would show up in the revenue line and have a material impact. But when you see a company spend $1.5 billion on drilling supposedly high production rate wells why is their revenue only going up $100 million?
Third, the Bakken math is very clear. When you have more than 4,000 new wells in three years to bring up the number to just over 6,000 you do not expect to see your average production rate decline if the EURs were what you think they are. This is why you don’t see ANY of the primary shale producers showing positive cash flows or a manageable level of debt on their balance sheets.
“A company like Pioneer is doing just that. And rightfully so. Right now cash is cheap — thank Mr. Bernanke for that. And a company like Pioneer can take that cheap debt and put it into wells that’ll pay out 5 times their money, on average. These are estimated numbers of course, but it’s happening right in front of our eyes.”
Pioneer has other streams of revenue from CBM and conventional production. Getting a clear picture of their shale operations is difficult. That having been said, let us look at the company.
The stock is overvalued compared to many other companies. We begin by looking at a P/E ratio is at 57 in a high priced environment and the dividend is 0.04%. Almost everyone is bullish on the shares. That does not look like a bargain. Let us move on to net income. Well, that does not look too good since in 2012 it was way down from 2010 and 2011. Shouldn’t all that drilling in a rising oil price environment have caused earnings to go up?
How about the balance sheet? Well, I look and see $1.5 billion of new debt taken on from 2011 to 2012. At least some of this debt should have been new wells that increased oil production in a rising oil price environment. So why didn’t the net income go up? And why was free cash flow at a negative $1.2 billion in 2012 AFTER $2.3 billion in capital investments were made in 2011 and $1.2 billion in in capital investments were made in 2010? Given what you said about high IPs, good prices, and short paybacks we expect far less debt and positive cash flows to star appearing. After all, this company has been in this space for years.
And note that I have not yet bothered to talk about depreciation values. If the EURs are high but the real production data falls far short then the depreciation schedule is wrong. The P/E is not very high; it is actually negative if the proper accounting were used. From what I see there is no evidence that Pioneer is better run that Exxon, BP, Shell, or Encana. All those lost their shirts in shale and wrote down assets. Pioneer will too.
“Although you might not follow this line of thinking, if you think the whole shale industry is bunk, a company’s stock price is nothing more than its future value. Pioneer’s share price has been ramping up over the past years because investors see the potential payout. And I agree with em.”
I have been around the block a few times and suspect that have sweaters in my closet that are around your age. That means that I have heard similar statements during many bubbles. The price is high because everyone is looking for a way to get rich and financing is very cheap. The Fed’s easy money policies are allowing too many lousy bets not only to stay afloat but to attract high valuations by the same type of investors who bought the dot.com nonsense about the future and accused anyone who was a skeptic of not understanding the new era science. Sorry my friend but I am too old and too weary of such nonsense to allow myself to fall for it.
“To further my point, today’s (Oct 23rd) Wall Street Journal talks about how shale producers are getting even better at cracking the code. Headline: “U.S. Shale Producers Drilling Bigger, Faster Wells” the point of the article is that drillers getting better, more efficient at drilling more productive wells. That’s a winning equation, and Pionner is proof.”
The WSJ used to write stories about tech stocks and housing stocks too. You can have the story but I want to money. Show me the earnings. Show me the balance sheets and cash flows. If you can’t then all you are left with is the hype. I know that is not easy to accept but it is what it is.
“When it comes down to it, all the geology, accounting, etc, there’s only one thing that matters — will share price rise?”
Are you saying that it is a good short term speculation because people are excited or that it is a good investment? There clearly is a difference and since my interests is about investing in energy companies instead of gambling on sentiment I am not very interested in the greater fool argument.
“I’ve gone on record saying that Pioneer is a proven winner — it’s up over 100% since saying “This American Energy Player Is A Buy” http://dailyresourcehunter.com… Today, over a year later, with even more positive data coming from the field, the company is still a buy. (So are many of the other shale players on my list.)”
The stock price did go up. It can still go up. But the company did not make money from shale and is not about to make any money from shale because shale is not economic.
Again, I appreciate your comments so keep em coming!
Heh: “I have been around the block a few times and suspect that have sweaters in my closet that are around your age.”
From my end, I’ll put this string to rest, for now.
In the meantime, I’ll set a reminder on my calendar to check back in on this discussion in five years. That way we won’t have have a he said/she said… 500,000/80,000 barrel argument.
Point is, we both know opinions are a dime a dozen so we’ll just see who’s right down the road…
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