Oct 102014
 October 10, 2014  Posted by at 6:29 pm Finance Tagged with: , , , , ,

DPC School Street and Parker House, Boston MA 1906

It’s been only two months since I last -again – addressed the shale industry, but apparently it’s still not clear enough what a predatory scheme it is. Today, Bloomberg adds even more fuel to the fire. If you want to know how the combination of slip-sliding legal standards and ultra-low interest rates has perverted the US – and global – economy, you need look no further than shale.

The central point the Bloomberg article evokes is simple: does the difference between proved reserves, probable reserves and possible reserves (or resource potential), as reported by oil and gas extraction companies, constitute a lie? And the answer is just as simple: no, it doesn’t. But that’s not where the issue ends, it’s where it begins.

That is, if the difference between the two gets too wide, – potential – investors in company stocks and bonds are not getting the information they are entitled to. The industry may claim, as in the article, that investors are aware of the discrepancy inherent in the numbers, but that’s at best true for most investors, and the bigger ones. Still, the companies shouldn’t be able to use that as some unlimited excuse to claim whatever they wish. Because they can basically throw out any number they want in front of investors, no matter what it’s based on, and it’s legal.

And while there may be a kernel of truth in this bit …

“They’re running a great risk of litigation when they don’t end up producing anything like that,” said John Lee, a University of Houston petroleum engineering professor who helped write the SEC rules and has taught reserves evaluation to a generation of engineers. “If I were an ambulance-chasing lawyer, I’d get into this.”

… there’s also something missing. By the time investors can start any litigation, chances are the companies involved may be long gone. The greater public, and some of the investors, may be fooled, but the industry people themselves? They know about the depletion rates typical of shale wells, of the fact that few wells ever make their owners any real profit, and of the $500 billion(!) the industry lost over the past 5 years.

The shale industry runs on debt, not on energy. And as long as these companies can issue junk bonds at low rates, they will. But that doesn’t mean they will ever be profitable. For their owners, sure, they’re raking in dough like it’s Halloween candy, but for investors in those bonds things don’t look so rosy. Shale is a Ponzi.

And US law allows it to grow. One set of reserves gets presented to the regulator (SEC), and an entirely different one to the investor. One company, Rice Energy, tells investors it has 27 times as many reserves as it tells the SEC.

We’re Sitting on 10 Billion Barrels of Oil! OK, Two

To count as proved reserves to the SEC, companies must have “reasonable certainty” that the oil and gas will be extracted from existing wells and those scheduled to be drilled within five years. [..] The forecasts are based on fuel prices, geology, engineering and the performance of nearby wells. Planned wells must be economically and technically viable.

Whereas forecasts for investor presentations are based on a combination of hopium, wishful thinking, media savvy, creative accounting and pure fantasy. This is ‘justified’ by saying: ‘everybody knows we lie, so who cares if we lie’. Except that it’s not legally a lie.

No such rules apply to appraisals that drillers pitch to the public, sometimes called resource potential. In public presentations, unregulated estimates included wells that would lose money, prospects that have never been drilled, acreage that won’t be tapped for decades and projects whose likelihood of success is less than 10%.

Figures the company executives cite during presentations “are used in the capital allocation process, and are a standard tool the investment community understands and relies on in assessing a company’s performance and value …” [..] The presentations rarely explain how the drillers calculated the figures. The numbers sometimes change from one presentation to the next.

On account of thorough research by the companies, no doubt.

… companies use their own variation of resource potential, often with little explanation of what the number includes, how long it will take to drill or how much it will cost. The average estimate of resource potential was 6.6 times higher than the proved reserves reported to the SEC …

And 6.6 times is really lowballing it when it comes to some of these firms:

Lee Tillman, chief executive officer of Marathon Oil, told investors last month that the company was potentially sitting on the equivalent of 4.3 billion barrels in its U.S. shale acreage. That number was 5.5 times higher than the proved reserves Marathon reported to federal regulators. Such discrepancies are rife in the U.S. shale industry. Drillers use bigger forecasts to sell the hydraulic fracturing boom to investors and to persuade lawmakers to lift the 39-year-old ban on crude exports.

62 of 73 U.S. shale drillers reported one estimate in mandatory filings with the Securities and Exchange Commission while citing higher potential figures to the public, according to data compiled by Bloomberg. Pioneer’s estimate was 13 times higher. Goodrich’s was 19 times. For Rice Energy, it was almost 27-fold.

Denver-based Cimarex Energy is one company that doesn’t report a different number to investors than it does to the SEC. “We want to have things on the books that are part of our near-term drilling plans,” Karen Acierno, a Cimarex spokeswoman, said in an interview. “A lot of people appreciate our conservative nature, a lot of investors.” Cimarex shares are up 19% in the past year.

The investor presentation by Rice Energy shows 2.7 billion barrels. Rice, which went public in January, reported 100 million barrels to the SEC in March, records show. At Pioneer Natural Resources, the number they cite to potential investors has increased by 2 billion barrels a year in each of the last five years – even as the proved reserves it files with the SEC have declined. The rising number is “a game changer for this company,” said Sheffield, the CEO. “It’s a game changer for this country.”

No kidding, there, Mr. CEO.

Investors poured $16.3 billion in the first seven months of the year into mutual funds and exchange-traded funds focused on energy companies, including drillers that create fractures in rocks by injecting fluid into cracks to enable more oil and gas to flow out of the formation. That’s almost twice as much as in the same period last year, bringing total assets to $128.2 billion, according to New York-based Strategic Insight. [..]

Lee, the University of Houston professor, said in an interview that he’s alarmed by the inconsistent and overly optimistic estimates published by shale companies. “If a lot of people get burned – and I think a lot of people can and will be burned – by these numbers in the investor presentations, there may be a push by investors to get the SEC to do something about it … ”

Horse, meet barn. The SEC won’t do anything, and it cannot change the law anyway, until these companies are dead broke and their owners longer liable for anything at all.

The US shale industry presents itself to investors as something it is not: it hugely overestimates its reserves, it carries incredible amounts of debt, there is cash flow but it doesn’t even begin to cover expenses, and its wells, which cost $8-20 million a piece to drill, even on average deplete faster than you can say ‘Christmas next year’.

Meanwhile, politics and media sing the Hossanah of energy independence, which in turn makes oil and gas prices slump to such a degree that shale becomes even less viable than it -obviously to us – already is. But as long as you’re legally allowed to overstate your reserves 27-fold, you can squeeze this balloon for another year or so, right.

It all makes me think that if people don’t see through this nonsense, they get what they deserve and perhaps need in life. But as always, it’s the little people who will end up paying up. And I don’t like that one bit. And if this is what America has become, a giant Ponzi, someone should raise their voice before it gets completely out of hand. If this kind of spiel is legal, there’s something deeply wrong with the law.

I could say much more about this, and I have, but it’s probably better if for more, you refer to for instance these past Automatic Earth articles on shale:

Get ready for the North American gas shock

Fracking Our Future

Shale Gas Reality Begins to Dawn

Shale Is A Pipedream Sold To Greater Fools

The Darker Shades Of Shale

Debt and Energy, Shale and the Arctic

Home Forums US Shale And The Slippery Slopes Of The Law

Viewing 11 posts - 1 through 11 (of 11 total)
  • Author
  • #15774

    DPC School Street and Parker House, Boston MA 1906 It’s been only two months since I last -again – addressed the shale industry, but apparently it’s s
    [See the full post at: US Shale And The Slippery Slopes Of The Law]


    Equity prices are one thing, there’s a sucker born every minute after all, but I am not sure how of if the public is participating in the credit side. I always figured bank lending was the font of most credit for the frackers and if they can’t do their own due diligence so be it. I suppose maybe there are some sorts of driller CDO’s the banks and investment banks have been peddling in which case the lack of due diligence could in theory come back to bite them. No likely of course.

    This has all been thrust front and center with the oil price plunge. That is blamed on the Saudi’s and maybe that’s right since they have been stupid about over producing for 40.years, easily pumping out 100 years worth. For most of that time however that has been great for Americas myth of no limits. but now it’s a stab in the back. Or maybe both figured it would hurt Russia so along with our own feckless leaders forgot about boomtown on the high plains of North Dakota.

    It’s easy to understand the dysfunction of a monarchy. It’s sad to see how advanced it has come to a democratic republic. Still no matter how evident the stupidity of our elites is nobody ever seems to notice except within the narrow confines of partisan politics.

    V. Arnold

    Thanks, in large part to the U.S., the world has become a fools game. Those who realize this also know there is no second coming, no Klatu (The Day the Earth Stood Still) come to save us.
    There is a freeing aspect to that, which somewhat offsets the tremendous responsibility which it entails.

    I like this Frederick Douglass quote:
    “Find out just what any people will quietly submit to and you have the exact measure of the injustice and wrong which will be imposed on them.”


    “If I were an ambulance-chasing lawyer, I’d get into this.” Isn’t this fraud? I mean, the figures they give to the SEC should not be different than the ones given to investors. This is where a lawyer might have a field day.

    Watched a small bit of “The Smartest Guys in the Room” about Enron, another Ponzi. The CEO and top executives smothered in stock options and bonuses. Again, they knew the company was not making as much money as they said it was, and yet they kept telling investors that everything was fine.


    Same thing with the sub-prime originators who could have cared less that the people they were giving mortgages to would ever be able to pay for them, and the banks that bought these mortgages and securitized them, the ratings agencies…..

    The key is to keep your mouth shut in order to achieve the giant suck – suck as many people in as possible: shareholders, junk bonds. You pay yourself a fortune, cash in your stock options, and then when it all falls apart you throw your hands up in the air and pretend that you don’t know what happened. “Ho, we didn’t see this coming. Wow, our projections were really off the mark! Who knew?”

    The fact of the matter is that many know, but they’re keeping their mouths shut: bankers, politicians, accountants, media, lawyers. There was a time when this type of stuff was illegal. We have fallen off a cliff.

    V. Arnold

    US Shale And The Slippery Slopes Of The Law

    The U.S. is long past being a nation of laws, which used to be one of the positive things that separated us from most of the rest of the world.
    Reagan began it, Clinton built on it, and Bush 43 cemented it on 09-11-2001.
    The law is now anything the government says it is. And the SCOTUS is in lockstep with all of it; any questions? Not hardly…
    None so blind/compliant as those who are afraid…

    “Find out just what any people will quietly submit to and you have the exact measure of the injustice and wrong which will be imposed on them.” Frederick Douglass


    Good article on the selection process at the Ivy League universities: “The Myth of American Meritocracy – How Corrupt are Ivy League Admissions?”

    “And the best single means of becoming such an economic winner is to gain admission to a top university, which provides an easy ticket to the wealth of Wall Street or similar venues, whose leading firms increasingly restrict their hiring to graduates of the Ivy League or a tiny handful of other top colleges. On the other side, finance remains the favored employment choice for Harvard, Yale or Princeton students after the diplomas are handed out. […]

    And if such power is used to select our future elites in a corrupt manner, perhaps the inevitable result is the selection of corrupt elites, with terrible consequences for America.”

    I think we’re seeing those consequences. I don’t agree with the whole essay (as articles have stated that China does indeed have cheating as well), but it’s well written.


    Selecting for the corrupt gene? Do the elites want to make sure they get a certain type of person, easily corruptible? Someone who will play along? Of course they do. They want a wall of protection, or at least like thinkers. And if they don’t go into finance, they might choose to be a member of what Joel Kotkin calls the “Clerisy” class:

    “Oligarchs are assisted in their control by what Kotkin calls the “clerisy” class — an amalgam of academics, media and government employees who play the role that medieval clergy once played in legitimizing the powerful, and in implementing their policies while quelling resistance from the masses. The clerisy isn’t as rich as the oligarchs, but it does pretty well for itself and is compensated in part by status, its positions allowing even its lower-paid members to feel superior to the hoi polloi.”


    V. Arnold – the above Enron article I linked uses the word “Enroned” (the verb) to denote that you got paid off to keep quiet. I highly doubt whether the poor (food stamps, cell phones, free housing, welfare, medical, etc.) would keep quiet if they weren’t being Enroned. The middle class is being squeezed, but hanging on (Enroned here and there), and the upper classes and elite are being Enroned all over the place. Of course, they make damn sure they dole out just enough dividends and keep stock prices rising.

    Almost everybody is getting something, just enough to keep quiet or not get too upset, and the elite are laughing all the way to the bank.

    That quote ought to read: “Find out just what any people will take to keep quiet and you have the exact measure of what they will receive.”

    When it all goes away, let’s see if the people continue to quietly submit.

    V. Arnold

    @ Raleigh
    That quote ought to read: “Find out just what any people will take to keep quiet and you have the exact measure of what they will receive.”

    When it all goes away, let’s see if the people continue to quietly submit.
    Your “re-quote” still says the same thing that Douglass said so much better; don’t fuck with true greatness.

    As to what it will take to wake up the U.S.? I dunno, I gave up after 57 years of bullshit and compliance I just could not bear (Vietnam excepted). That coupled with advancing old age helped me make the break.
    You remain hopeful and optimistic if it helps you get by; I have higher expectations for my life and refuse to be tied to any government. Given all governments are crap/corrupt, why oh why would anybody give them purchase over their lives?
    Nationalism is folly of the highest order.
    Think deep, long, serious, and with a very broad brush; the world is not what you believe.

    John Day

    John Michael Greer, the Archdruid, has a look at the breakdown phase of empire, as the complex class structure, too expensive to support, breaks down, and sophisticated elites are replaced by unsophisticated warlord/gangster types.
    “Clerisy class” takes a hit here.


    V. Arnold – I guess what I was thinking of with the Douglass quote was of a totalitarian government, one ruled by force. I was just trying to make a differentiation between force and taking handouts (in my mind). But, you’re right, whatever it is, they all get people to quietly submit.

    I hear Vietnam is lovely. Did you renounce your U.S. citizenship? Did you take your family, if you have one, or did you go yourself? What would you do if things started to fall apart in Vietnam? Would you quickly come back to the United States, or would you go elsewhere?

    John Day – thanks for the link to the great article. You know, you can read this stuff over and over again (which I have), but sometimes it just doesn’t want to penetrate into the mind. Maybe that’s why I continue cutting and pasting the same types of articles on a daily basis, just so it gets in (you know, teach what you need to know). I guess we all remember a better time and keep thinking (hoping?) it will return, but maybe there’s no turning the clock back. I guess I’m grieving. So sad for our children.

    V. Arnold

    @ Raleigh

    Yes, Vietnam is beautiful, but I’m not in Vietnam. In April of 2003 I was offered a job with an American toy company in a rural area of Thailand, close to the Myanmar border.
    I came alone. I wasn’t married at the time. No, I did not renounce my citizenship, a U.S. passport is still more of a benefit than a liability (M.E. excepted). I cannot imagine a reason to ever return to the U.S.
    The political situation here is unstable, but that’s been the norm for the last 82 years.
    Anything is preferable to living in a country that kills and tortures with impunity anywhere it deems necessary. Its thuggery has replaced any semblance of diplomacy. Moral bankruptcy is an ugly thing to behold.
    Internal politics aside, Thailand, outside the large cities and tourist areas, is quite lovely and rich in culture and the cost of living is remarkably low. The language is difficult but learn-able with some effort.

Viewing 11 posts - 1 through 11 (of 11 total)
  • You must be logged in to reply to this topic.