“The average shale gas company lost 2 dollars for every dollar they spent on producing the gas in Q1 2015. Spending other people’s money makes lots of things possible but the SEC filings tell the truth.” – Art Berman, July 12, 2015.

“Marcellus: >50% IRR at $2.00 per Mcf realized price” – Cabot Oil & Gas, May 13, 2015

There is a huge disconnect between information about the shale gas industry and the reports about the economics of individual wells. There are any number of references to companies on the verge of bankruptcy and the huge debt load which is probably unrecoverable (a “silo of misery” one article called it), suggesting that the industry is in for either a massive shakeout, a big increase in prices, or more probably both. At the same time, shale gas production keeps growing and some producers laud their results. It seems the reverse of the old joke of the salesman who said he lost money on every suit he sold, but made it up on volume.

For years, I have heard that the majority of shale wells were unprofitable, that no one was making money on shale, and even had the great pleasure of hearing an analyst say the industry was doing very badly, followed by a company executive who said they were making money hand over fist. It might seem as if people were either dishonest or stupid (as no doubt many will say of those they disagree with), but it is quite possible that both the reports of low costs and profitable production, and financial distress, are true.

Harvard’s Leonardo Magueri makes the great point that breakeven cost estimates should be treated with caution. “Finding these numbers is hard, so most analysts resort to oversimplified models and use input data that do not weigh specific break-even points against specific production levels.”

How can estimates go wrong? First, combining all wells can yield very bad results. Early wells (by each company) are usually test wells, often more expensive but typically with low yields, while the operator tests production methods to gain optimal results. Second, average costs in a play ignore the variability of costs across any given play, especially if several years’ data is combined. A few underperforming wells can worsen the performance of the ‘average’ well, and five year results can give the wrong impression of current operations, given that productivity seems to be improving at a rate of 15-25% per year.

And a major shortcoming is the inclusion of land acquisition costs as production costs, when they are a transfer payment. Thus, Chesapeake Energy CHK -5.53%, at the height of its spending, paid the equivalent of $2/Mcf to acquire leases: this appears on their balance sheet as costs, but doesn’t really reflect what the industry needs to spend to produce shale gas. Similarly, Exxon might be losing money on its shale gas production because it overpaid for XTO, but that does not mean that their wells are uneconomic.

“The average shale gas company lost 2 dollars for every dollar they spent on producing the gas in Q1 2015. Spending other people’s money makes lots of things possible but the SEC filings tell the truth.” – Art Berman, July 12, 2015.

“Marcellus: >50% IRR at $2.00 per Mcf realized price” – Cabot Oil & Gas, May 13, 2015

There is a huge disconnect between information about the shale gas industry and the reports about the economics of individual wells. There are any number of references to companies on the verge of bankruptcy and the huge debt load which is probably unrecoverable (a “silo of misery” one article called it), suggesting that the industry is in for either a massive shakeout, a big increase in prices, or more probably both. At the same time, shale gas production keeps growing and some producers laud their results. It seems the reverse of the old joke of the salesman who said he lost money on every suit he sold, but made it up on volume.

For years, I have heard that the majority of shale wells were unprofitable, that no one was making money on shale, and even had the great pleasure of hearing an analyst say the industry was doing very badly, followed by a company executive who said they were making money hand over fist. It might seem as if people were either dishonest or stupid (as no doubt many will say of those they disagree with), but it is quite possible that both the reports of low costs and profitable production, and financial distress, are true.

Harvard’s Leonardo Magueri makes the great point that breakeven cost estimates should be treated with caution. “Finding these numbers is hard, so most analysts resort to oversimplified models and use input data that do not weigh specific break-even points against specific production levels.”

How can estimates go wrong? First, combining all wells can yield very bad results. Early wells (by each company) are usually test wells, often more expensive but typically with low yields, while the operator tests production methods to gain optimal results. Second, average costs in a play ignore the variability of costs across any given play, especially if several years’ data is combined. A few underperforming wells can worsen the performance of the ‘average’ well, and five year results can give the wrong impression of current operations, given that productivity seems to be improving at a rate of 15-25% per year.

And a major shortcoming is the inclusion of land acquisition costs as production costs, when they are a transfer payment. Thus, Chesapeake Energy CHK -5.53%, at the height of its spending, paid the equivalent of $2/Mcf to acquire leases: this appears on their balance sheet as costs, but doesn’t really reflect what the industry needs to spend to produce shale gas. Similarly, Exxon might be losing money on its shale gas production because it overpaid for XTO, but that does not mean that their wells are uneconomic.