QE and the profitability of fracking
Last edited Sun Oct 13, 2013, 10:39 AM - Edit history (1)
Interesting column in today's Financial Times. John Dizard, a very sharp observer of all things financial, has been waiting for a while for natural gas prices to spike as fracking gas wells' production declined. These wells are subject to very sharp rates of decline once the gas starts getting extracted, forcing companies that do this to rapidly move on to new unexploited wells. This means they are always up against a wall, having to reinvest whatever profit they get out of current wells into new wells. It's a vicious treadmill.
The mystery has been why natural gas prices didn't spike as drillers realized how little real profit there was in fracking and cut back. The answer as to why turns out to be surprising:
US shale is a surprisingly unprofitable miracle
that a decline in gas drilling forced by a shortage of exploration and production sector cash flows would result in a very rapid rise in price to cover the full cost of production.
Well, prices have risen, but not as fast as I imagined.
That is due to high production from two sources that increased at greater rates than most industry people – and I – expected: “associated” gas, from oil or gas-liquids directed drilling, and gas wells in the Marcellus Shale...
As Mr Voser told the FT: “[Shale well] decline rates are very high, so after 18 months your production drops very sharply, which means you have a business model of constant investment.”
That is demanding enough for a highly diversified investment grade company such as Shell; if your company is junk-rated, it is much harder...
What really surprised the industry was the continuing supply of new capital from lenders and return-short investors. This interrupted what would have been a typical oil and gas drilling cutback phase.
In other words, yes, there is a big Marcellus effect, but it may turn out to have been superhyped by quantitative easing. We will see what happens if the oil price falls and interest rates ever rise.
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