The Shale Boom's Hard Sell Begins Pushing Up Against Reality

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University of Houston energy economist and head of independent energy company Hillhouse Resources, Ed Hirs - COURTESY
University of Houston energy economist and head of independent energy company Hillhouse Resources, Ed Hirs

What This Means for Us

San Antonio and the surrounding area have already benefited greatly from the Eagle Ford play. In September, Dr. Thomas Tunstall, research director of the UTSA Institute for Economic Development, released a study indicating that the Eagle Ford had generated $87 billion in economic output, supporting 155,000 jobs and providing $4.4 billion to state and local governments in 2013 alone.

Tunstall doesn't believe Eagle Ford production is in trouble at $80 a barrel, but expects production cuts should it get close to $70. Overall he's bullish on the prospects for the Eagle Ford, noting that it's a relatively new play that's already producing 1.5 million barrels a day and has consistently beat projections.

"I was skeptical. It wasn't until I started running the numbers that I came around," Tunstall said. "All I know is the production is continuing to outstrip on what I would've thought were pretty aggressive forecasts."

Even if some of the companies working the Eagle Ford run into trouble with financing, that doesn't mean there will be the kind of bloodbath that resulted from the financial crisis. "I'd be cautious about predicting some sort of collapse even though these companies look shaky," Berman said. "What happens if a particularly shaky company gets into distress, probably somebody is going to buy them, maybe at a discount."

Aside from the risk this poses for those involved in the oil and gas trade, the fall in price of petroleum and natural gas will be a boon for many people's pocketbooks. Gas priced below $3 per gallon is sure to encourage economic growth and low natural-gas prices have already encouraged other types of investment, such as the building of several new U.S. steel mills.

Landowners who have leased to drilling companies will likely feel the pain of lower production. Chesapeake is facing multiple lawsuits over allegedly exorbitant "gathering" fees they've deducted from landowner royalty payments. More companies could try to pass their costs along to lessees.

Production cuts could also mean lower tax revenue than municipalities are counting on. Rogers points to North Dakota, which has taken in $3.5 billion from drilling in the Bakken play to cover what their Department of Transportation estimates as $7 billion in road damage.

"There's some economic benefit when shale comes to town, it's just not long-run," Rogers said. "Is the economic benefit you're going to receive really going to be enough to offset all the environmental degradation and road damage? From the numbers I've run, you don't make enough money off it."

Looking Out Toward the Horizon Line

No one can say for sure how long the shale boom will last, even accounting for the troubled financials of some companies. The well-respected International Energy Agency forecasts that shale production will peak just three years from now. Even they see a production plateau in the offing, citing "a rising percentage of supplies that require a higher break-even price; increased focus on cash flow rather than acquiring new acreage by producing companies; higher interest rates that increase financing costs for new drilling; and reduced resource estimates."

According to Canadian geologist J. David Hughes, average well production in the Eagle Ford increased only marginally in the last year, indicating that producers have begun to saturate the sweet spots. "Well quality is peaking," he said. "[But] there are still lots of places to drill in the sweet spots."

Hughes studied every well in every shale play for last month's report, Drilling Deeper: A Reality Check on U.S. Government Forecasts for a Lasting Tight Oil & Shale Gas Boom. He echoes the I.E.A. 2017 shale peak and foresees a similar peak for the Eagle Ford. UTSA's Tunstall doesn't think the field will peak until 2020, at 2.6 million barrels. Even Hughes' more pessimistic view predicts Eagle Ford production will peak at 1.7 million before sinking back to the current level of 1.5 million by 2024.

The problem is that while everyone acknowledges the quick depletion rate of unconventional wells, many, including Tunstall, forecast well lives of 20 or 30 years, in line with conventional wells. This form of drilling has been around for less than a decade and evidence is scarce, but Hughes notes that even though depletion rates stabilize at 10-15 percent after the fourth year that's more than the single-digit average rates of conventional wells of the same age.

Fort Worth native Rogers suggests we simply look to her hometown, where the Barnett play kicked things off. "The city of Fort Worth got approximately $50 million for 40 shale wells in 2008," she recalled. "Everyone was convinced they were going to be 'shale-ionaires.' But by the end of 2012, the city got about $20 million, but now we have 400 wells. They just can't keep it up.

"So you have all these pretty big pad sites and there's no reclamation plan in place," Rogers said. "Land could have been used for activities that would've generated taxes for a long time to come, and now it's used up in five to seven years and then there are no taxes generated off it. It's just useless land."

Eagle Ford producers are adding around 3,500 wells annually and the total number is expected to reach 40,000 wells. Since 1992, Texas has spent more than $60 million to clean up approximately 5,000 oilfield sites, and has $19 million on hand. Clearly, they'll need a lot more money for reclamation before it's all said and done.

Municipalities, too, must prepare for the inevitable bust.

"It's clear what the energy companies want to get out of this and they're happy to help where they can, but the real impetus for sustainability has to come from the community leaders," Tunstall said.

That's why it's important to keep the shale boom in context and not get caught up in the hype. Berman would rather not be the bearer of bad news, but somebody needs to stop the emperor from streaking around town.

"People ask me, 'What's your motive? Do you like to bum everyone out?" he said. "That's not what I like to do. My point is that the same way we make bad investments when money's cheap, we make bad decisions when we think we have a situation licked and under control. I'm just trying to give an accurate picture of what's really going on."

*Correction, November 5, 2014, 4:14 p.m.: Art Berman was incorrectly quoted as saying $67 billion instead of $6 to $7 billion. The latest figure he gave the author was $8 billion in negative cash flow.

**Correction, November 5, 2014, 4:14 p.m.: The original version of this story misidentified Ed Hirs as a consultant. Hirs is a University of Houston energy economist and head of independent energy company Hillhouse Resources.

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