Musings: Gas Shale Debate May Be Moving to Next Higher Stage
For the past 18-24 months, the debate about the economic performance of the gas shale revolution has been ongoing deep in the industry's trenches. Questions were originally raised by geologist Art Berman about the performance of natural gas shale wells writing in a column in an industry trade magazine, World Oil. The columns bothered certain managements of producers who were totally committed to gas shale developments. As additional critical columns appeared using acceptable industry data analysis of the results of producing gas shale wells, these unhappy producers voiced their criticism to the publisher of World Oil. The pressure on Mr. Berman to drop the topic increased to the point that he elected to stop writing his column. World Oil's editor also left due to the pressure on Mr. Berman.
In late June, The New York Times published an article based on a number of emails between industry, government and investment professions discussing the latest gas shale data. Those exchanges focused on whether there might be a risk that the abundant volumes of natural gas trapped in the shales would not be developed because the cost of extracting them was actually far in excess of the current or even near-term future gas price and that producers were misleading investors about gas shale economics. If E&P companies were attracting the necessary investor funds to finance their gas shale developments predicated on assumptions that later proved overly optimistic, substantial financial losses could be experienced. Many of the participants in the email chains were long-time students of the E&P industry and are aware of the history of producers destroying capital through poor management decisions.
It is important to understand that the gas shale critics have never questioned the existence of the potential gas volumes contained in the shales and documented by many industry and government agencies. The debate has always been about the profitability of extracting the gas. A side note to this concern about capital destruction is the realization that environmentalists are increasing their opposition to shale development even though natural gas is environmentally superior to coal and oil. The least dirty fossil fuel is now the target of environmentalists because its volume growth has depressed gas prices, which have undercut the growth of renewable fuels, their preferred "green" alternative.
We have recently learned in a client alert from Fulbright & Jaworski L.L.P. that the Securities and Exchange Commission (SEC) has served subpoenas on a number of gas shale producers. According to the law firm, the subpoenas seek documents and information regarding the actual performance of shale gas wells against forecasted or projected performance, the propriety of decline curves used for the wells, and the calculation and public disclosure of full-cycle margins. The subpoenas have been issued in response to the wave of recent reports on the business, in particular The New York Times June article.
This development will shift the gas shale debate away from personal attacks on the critics to one based on gas shale well production data and the quality of the company disclosure of this data. Given the amount of investment written off by producers heavily involved in gas shales over the past few years may provide fodder for the regulators and certainly for the class action securities lawyers who clearly have been alerted by the disclosure of the subpoenas.
According to an article in The New York Times on Saturday, an industry consultant said he had been invited to the Ft. Worth regional office of the SEC in June. He said the line of questioning was about the production data and margins producers reported to the government compared to data they disclosed in investor presentations.
It may be an interesting coincidence that the SEC recently asked a gas shale producer involved in the registration process for an initial public offering (IPO) to disclose the volume of fracturing fluids used per well. They also requested information on the "additional chemicals" present in the fracturing fluids used. These questions were in the SEC's comment letter on the required risk section of the S-1 registration document. The lawyers involved indicated that the producer was not planning on disclosing any of this information, but what the lawyers worried about is why the SEC would be asking these questions. There is no federal disclosure requirement about hydraulic fracturing chemicals so who is behind this request? The belief is that the Environmental Protection Agency (EPA) is encouraging the SEC's inquiry, but that is only speculation. That belief is based on the fact that the EPA asked Chesapeake Energy (CHK-NYSE) to supply information about the chemicals in the fracturing fluid involved in a spill in Pennsylvania that the agency is investigating.
The concern about the EPA and SEC inquiries is that the federal government, spurred by environmental critics of shale developments is that they might impact the pace of their development and the growth of future gas supply in the United States. The gas shale industry is not likely to face a moratorium on hydraulic fracturing such as the Gulf of Mexico experienced after the Macondo well disaster last year. The likelihood is, however, that the cost of developing gas shale resources will rise. To what level will restrictions on gas shale development rise, and how long before we know? No one knows. Might the pace of development slow as a result of the uncertainty of increased regulation? Yes, especially given the legal risks associated with possible violations. Many people have called gas shales a "game changer" but regulation could change that game in ways we haven't contemplated. Stay tuned.
Managing Director, PPHB LP