Art Berman, geological consultant with over 37 years experience in petroleum exploration and production, returns to the podcast this week to debunk much of the hopium currently surrounding America’s shale oil output.
Because the US is pinning huge hopes on its shale oil “revolution”, so much depends on that story being right. Here’s the narrative right now:
The US, is the new Saudi Arabia
It's the swing producer when it comes to influencing the price of oil
The US will be able to increase oil production for decades to come
New technology is unlocking more oil shale supply all the time
But what if there’s evidence that runs counter to all of that?
We’re going to be taking a little victory lap on this week’s podcast because The Wall Street Journal has finally admitted that shale oil wells are not producing as much as the companies operating them touted they would produce – which is what we’ve been saying for years here at PeakProsperity.com, largely because we closely follow Art’s work:
The Wall Street Journal did some research and they got the general point that the wells are not as good as advertised.
But what they missed is just how much farther off many of these reserves are than even the discounted reserves that they’ve reported.
Bottom line: if the understatement is only 10%, that’s a rounding error and it’s not that much of an issue to the average person. But I’ve been trying for a decade to get the number that I independently develop to get anywhere close to the published numbers. In most cases, I can only get near 60% or 70% of them. So, the gap, I think is much more substantial.
The reason that The Wall Street Journal didn’t get it more right is because they don’t do any independent research and of course they didn’t talk to me, they didn’t talk to Dave Hughes, they didn’t talk to people who actually do the work, and so they’re getting one side of the story.
Click the play button below to listen to Chris’ interview with Art Berman (52m:56s).
“That’s been my experience with it all, but then the issue that I think is so hard for people to grasp and certainly was for me, is the fact that many of these companies, not just oil companies, are not in business to make money, they’re in business to get money.”
Sooooo - how is that NOT a Ponzi scheme, or at the very least immoral and unethical?
AKGrannyWGrit
Sooooo - how is that NOT a Ponzi scheme, or at the very least immoral and unethical?
Granny,
That was the "ah-ha moment" for me in this podcast. I was wondering why investors would continue to fund an investment that keeps losing money. Why do people hold gold or bitcoin? Obviously, those are losing propositions based on recent price performance. It's because they are betting on the come.
Granted, there may be nefarious shenanigans ongoing, but the everyday investors are willing to lose a little money in the short term in order to secure a sizeable quantity of the most valuable resource (oil) in the future when the price finally reflects its importance to modern society. Those investors are buying the rights to the oil in the ground.
Will their play work out? It could, but likely won't. I like Gail Tverberg's idea that price is determined by affordability. If the non-elite workers can't afford the product, less of it gets sold and consumed. It's a bell curve situation. Some will get sold at astronomical prices. If there is very little to be sold, it can be sold at high prices. If lots of product need to be sold, the price has to drop to where enough can afford it. Since the non-elites are doing the majority of consuming, they determine what the price will be.
I like to think of it as a floor/ceiling system. The producers set the floor price and consumers set the ceiling price. In other words, the producers need to receive a certain amount to make the effort of bringing a product to market worth the endeavor. Consumers need to see the price of the product as worthwhile. They have an upper limit they're willing to spend for a given unit. As long as the floor price is beneath the ceiling price, there is space for both the producer and the consumer to live. What happens when the price is too low for producers to be profitable at the same time it is too high for consumers to accept?
Look back to 2007-08 for an example of what happens when oil prices get too high. It works for a while to charge ever higher prices ... but leads to a recession. It costs other companies more to produce their products when energy prices increase. At the same time that consumers are strapped by high energy prices, the companies are also strapped and can't pay higher wages. Credit cards can soften the blow for a while, but what happens when the cards for most are all maxed out?
If shale plays are the last "best" option for our modern society, we're digging the bottom of the barrel. Can technology figure out a way to get a few percent more recovery out of these plays? Possibly. I really don't know. It better happen quickly. How long will the investors remain satisfied to lose investment money in the short term?
Grover
Thank you Grover for taking the time to post and presenting an interesting explanation!
“It’s because they are betting on the come.” https://www.urbandictionary.com/define.php?term=betting on the come
“Betting on the Come” is derived from a gambling expression and means you don’t have what you want or need, now at the moment; but, you are betting or hoping you will have what you want or need when the time comes.
This is an assumption. It assumes the motivation for acquiring money is a specific outcome, perhaps a big oil discovery. However there has been no evidence presented to support betting on the come. Art Berman said
“That’s been my experience with it all, but then the issue that I think is so hard for people to grasp and certainly was for me, is the fact that many of these companies, not just oil companies, are not in business to make money, they’re in business to get money.”
IF companies were betting on the come then its reasonable to assume they were trying to make money. So that discounts the original statement. Perhaps the business of acquirung money and acquiring oil are only loosely related? Perhaps THE business is to acquire money. Making money and “getting” money are vastly different.
Chris, I really like Art Berman as a guest. He speaks clearly, has a good sense of humor, entertains your questions without a second thought, and answers them very well. So, five stars! Hell, his description of the difference between shale and conventional oil alone was worth the time of listening to this podcast, and I’m going to incorporate his analogy when I talk about it with everyone in my world, too. Really, excellent podcast!
As to the technology thing, I think what you guys talked about is key; remembering that there is a major difference between technology that exists and technology that is reliable, dependable, and affordable. Just this morning, as I was coming in to teach my World History I kids - a lesson about the Sui and Tang Dynasties in China that absolutely required me to use my computer - my laptop, which is normally in excellent shape because I know how to keep it so, literally went into a death loop where it couldn’t start but wouldn’t shut down. As you might imagine, I was glad I had a plan B that did not rely on that technology. But, as you point out, there’s a big difference between a teacher’s tech not working as intended and oil extraction technology not working as intended, because no civilization will tremble at the former, while the latter…
“That’s been my experience with it all, but then the issue that I think is so hard for people to grasp and certainly was for me, is the fact that many of these companies, not just oil companies, are not in business to make money, they’re in business to get money.”
Sooooo - how is that NOT a Ponzi scheme, or at the very least immoral and unethical?
AKGrannyWGrit
Granny-
It is unethical and immoral, but as I’m sure you know, if money can be made on it and no one is willing to call them on it, they’ll do it. That’s not conspiratorial thinking. Humans will do whatever they can get away with doing, and nowhere moreso than when the rewards are highest.
As to why investors are willing to invest in the shale space, I wonder how much of that “chasing the only yield left” dynamic plays in here? Art, Chris or others of that knowledge level would know better than I.
It certainly makes sense for “forward thinking” companies to look at current trends and developing technologies that make the best use of available resources. Art’s observations and concerns are well warranted; and his predictions for an increase in the future price of LNG may have been noted by some of these companies. The most recent announcement by VW and Ford to combine efforts towards an enhanced use of self-driving and electric vehicles seems to me to be a response to available and future resources. https://www.bbc.com/news/business-46880937
Heavy oils from Canada and other heavy crude sources may be more viable for diesel vehicles and ships to haul cargo rather than people. Much of the current supply of lighter hydrocarbons comes from shale plays( which are currently keeping the price of gasoline down because of the glut produced from these plays) and probably won’t be used to produce electricity(but great for pickups and SUV’s). More and more coal fired generators are converting to LNG, so, guess what; where is the price going there? Art is very correct in saying that we are dumping LNG, currently, and will be paying the higher price for it later.
But, the nagging problem still remains, "are we using the availble resources efficiently? As long as we continue to use dollars to measure the useful value of resources, we will be stuck in this revolving door of waste and inefficiency driven by the moguls of “un-earned capital”.
IF companies were betting on the come then its reasonable to assume they were trying to make money. So that discounts the original statement. Perhaps the business of acquirung money and acquiring oil are only loosely related? Perhaps THE business is to acquire money. Making money and “getting” money are vastly different.
Granny,
My post was focusing on the investors who buy bonds of the oil companies rather than those running the oil companies. Art's idea that the oil companies are more focused on getting money instead of making money wasn't lost on me. (Where do they get the money?) The oil companies are in some Red Queen race where they are running as fast as they can just to stay in place. Are they more concerned about maintaining market share than being profitable? I don't know.
Since the price of energy has such importance in economic affairs, it wouldn't surprise me to learn that the federal reserve is funnelling funds surreptitiously as well. The price of money is just one component of running a successful business. Lower any component of a business' operational cost and it improves the bottom line and hence, the overall economy. Since the price of energy gets set on the edge, a little more supply drives the clearing price down of all of it. (DaveFairtex wrote a post or two about this phenomenon a while back. Hope I read it right.)
It doesn't take too much twisting and torturing of logic to make this fit within their mode of operation. Who would have thought it was okay for the federal reserve to buy mortgage backed securities (MBS) before they did it? If buying MBS is okay, why not oil company bonds?
Slippery slopes can be fun as long as stopping isn't necessary.
Grover
In this rural depression, I would bet that 50% or more of agricultural commodities are produced by entities that are technically insolvent. As long as these operations continue to have access to more credit they will continue to produce more grain, meat, and dairy than can be profitably sold. An economist from Minnesota has determined that the average corn farmer there is losing $38/acre growing corn. How many more acres does it take to find a profit?/sarc (Monsanto, through seed and chemical inputs, is making much more per acre than the farmer who is taking all the risk.)
As a last resort to obtain credit for planting, the USDA through the FSA guarantees operating loans for farmers to produce even more of an already large surplus of every major commodity. So, market clearing through supply and demand can’t possibly work. This will continue until there is a major drought, or some other catastrophe emerges to bring some sense back into the marketplace. Until then it’s full speed ahead, profit or no.
My point is that access to credit is much more important than profitability in determining who stays in business, at least in the short term. Not right, but that is the system we have, until it collapses.
Grover wrote I like Gail Tverberg’s idea that price is determined by affordability. If the non-elite workers can’t afford the product, less of it gets sold and consumed. It’s a bell curve situation. Some will get sold at astronomical prices. If there is very little to be sold, it can be sold at high prices. If lots of product need to be sold, the price has to drop to where enough can afford it. Since the non-elites are doing the majority of consuming, they determine what the price will be.
I agree and it’s even worse than that. How many production companies and distribution companies can survive on decreasing volumes year after year. The current business model is based on volume (and growth). If the volume drops too much even a high price will not keep businesses viable. If infrastructure crumbles away even the wealthy will not be able to buy petrol. I suspect this is another potential tipping point - beyond a certain volume / price point the game just doesn’t work.
Great insights on the previous comments. One thing that popped out in my mind when the idea of oil companies being in the business of getting money v making money was brought up is the railroads. I recently learned in the heyday of railroads is that most of the railroad operators lost money but the owners of those operations also owned the construction companies that were contracted to build the railroads at highly inflated prices causing in part the operators to lose money but still funnel capital to the owners. So the railroad operators obtained massive amounts of land at cheap prices from and protected by the various governments then funneled that capital to the construction of the railroad where the real money was made. So to finish my point, I would not find it surprising to find that the owners of some level of oil company are making money hand over fist while the vast majority of the space is losing money throughout this effort. At some point this story will break down and many investors will be left with hat in hand while a few of the “smart” ones will be extremely enriched in the process.
Great insights on the previous comments. One thing that popped out in my mind when the idea of oil companies being in the business of getting money v making money was brought up is the railroads. I recently learned in the heyday of railroads is that most of the railroad operators lost money but the owners of those operations also owned the construction companies that were contracted to build the railroads at highly inflated prices causing in part the operators to lose money but still funnel capital to the owners. So the railroad operators obtained massive amounts of land at cheap prices from and protected by the various governments then funneled that capital to the construction of the railroad where the real money was made.
So to finish my point, I would not find it surprising to find that the owners of some level of oil company are making money hand over fist while the vast majority of the space is losing money throughout this effort.
At some point this story will break down and many investors will be left with hat in hand while a few of the “smart” ones will be extremely enriched in the process.
That's a good point worth repeating. The "picks and shovels" companies are making money, a lot of money, in the shale space.
Those would be:
Water suppliers
Water disposal companies
Sand suppliers
Truckers and haulers
Pipeline operators
Frackers
Drillers
Service technicians
Land/lease owners
And a hundred others not named here. Real money is flowing into real pockets. Lots of it. That money is coming from both operations and investors. The investors may never see that money again.
One really dumb point I see shale boosters trying to make lately (presumably to lure more "investors" to the table) is that nowthe shale companies are drilling really effective and productive wells. If you just look at the wells being drilled now these producers are breaking even at cheap oil prices and producing monster wells.
Of course these boosters are usually leaving out such things as SG&A, land costs and other clearly assignable costs, but even if they are more honest than the average booster by including these, they are almost universally leaving out all of the previously betrayed capital.
As if the debt already on the books and all of the equity already obtained could be overlooked and we can just assess things from this moment in time forward.
No, we cannot. An enterprise has value based on BOTH it's accumulated assets/liabilities AND its forward prospects. Something the Johns-Manville investors learned the hard way.
No reason to re-learn that lesson, the financial anlysis is easy enough to perform.
One narrative is that US oil companies, displaying the usual plucky ingenuity, are finding ways to extract more and more oil from shale at lower and lower costs.
A different narrative says that they’ve been overstating the results and buring cash to maintain that illusion.
A prominent oil field servicing company, Schlumberger, with serious skin the game and every reason to spin things positively, also has to report to its own shareholders about future prospects.
They laid a couple of decent sized eggs in their most recent quarterly statement:
The first red highlight I’ve put in calls out the fact that more than half (54%) of total Capex is currently eaten up simply to cover the ferocious decline rates of the prior drilled wells. It should be noted that since the shale operators are currently cash flow negative as a group, that this represents a number far higher than 54% of cash flows.
Then they go on to observe that by 2021 total capex required to offset declines will rise to 75%!
If the price of oil remains where it is, there’s no doubt that this will represent more than 100% of cash flows from operations. Obviously any business concern that is spending more than 100% of its cash flows to generate more cash flows is a bankrupt concern. None of this even includes the idea of paying back debt and equity already secured. That’s extra.
The second red box highlights the fact that the precious sweet spots, termed “Tier 1” agreage, are already seeing significant parent-child well interference. In other words, it’s all drilled up.
When the companies then are forced to move to Tier 2 acreage, the spots are decidedly less sweet, and there are lower returns (i.e. less oil to be gathered) per well drilled.
Someday, when thoughtful future humans look back on all this, they’ll wonder why there was such a haste to rip all this tasty oil and gas out of the ground that it was done with economic losses and at such a furious pace that much of the associated gas had to be “flared” (burned uselessly into the atmosphere) because there was no infrastructure to gather it.
So it was burned.
The “unavoidable treadmill effect” is gathering speed in the shale space, and the only way out of it would be for the Federal reserve to begin buying up this bad debt and equtiy and letting it die on its books. They might do this, of course, as a “necessary” step to prevent reality from intruding unpleasantly on their dreams of infinite growth. We shall see.
All of this reminds me, sadly, of this:
I really enjoyed that posting. Thanks Chris.
One of my favorite quotes in the quarterly statement box: “…we could be facing a more moderate growth in U.S. shale production…” So, moderate means (whatever you think)? Less than robust? OK, but not bad? I guess it depends on what the definition of is is.
I also felt like a little word play on one sentence: “One narrative is that US oil companies, displaying the usual plucky ingenuity, are finding ways to extract more and more money from investors with lower and lower IQ’s.”
Art Berman - I’ll tell you what, smart money never ever doubted the concept of peak oil, and the reason they’re putting their money in these companies is because they’re long on oil, and they know what you know and what I know and that is, it’s only a matter of a very short time, maybe a few years, maybe less, maybe more before oil prices go to the moon, and then the investment will prove to be an incredibly lucrative one. Can’t wrap my head around that statement. It just doesnt make sense when paired with the following. A lucrative investment when faced with the future as seen by M King Hubbert - the insanity is incomprehensible! M. King Hubbert -
So long as oil is used as a source of energy, when the energy cost of recovering a barrel of oil becomes greater than the energy content of the oil, production will cease no matter what the monetary price may be.
Hmmmmm
Isnt it interesting that other podcasts and articles get a bunch of responses yet oil/energy is the basis of our civilization and yet only gets a few comments.
AKGrannyWGrit
DennisC WroteQuoted:
I also felt like a little word play on one sentence: “One narrative is that US oil companies, displaying the usual plucky ingenuity, are finding ways to extract more and more money from investors with lower and lower IQ’s.”
I knew the game was over when the big oil companies cancelled all of there expensive drilling projects and opted to drill wall street with stock buybacks. Shale was just the side show.
That said, I have been making good use of the low energy prices to put myself on track to be self reliant.
Isn’t the shale oil boom largely a result of advances in drilling technology and well development methods (automation of drilling rigs, better directional control, faster deployment/mobilization of drilling operations, shortening of time required to drill and complete a well, fracking, etc.)?
