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8/6/2019 Shale Gas - Berman anuary 2011
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Slide1LabyrinthConsul4ngServices,Inc. HoustonSIPES
Shale GasAbundance or Mirage?
Arthur E. Berman
Labyrinth Consulting Services, Inc.
Houston, Texas
January 20, 2011
U.S. Shale Gas
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Slide3LabyrinthConsul4ngServices,Inc. HoustonSIPES
Chesapeake is the paragon of U.S. shale gas companies
Downgrade to hold.Earnings quality and management strategy raise concerns.Profligate spending.Desire to take a big stake in every significant resource play.Growing concerns about CHK's earnings quality.Desire to see management cut back on spending. We believe that the company's accounting policies and heavy useof off-balance-sheet leverage add unnecessary complexity andobscure its true financial position.
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SlideLabyrinthConsul4ngServices,Inc. HoustonSIPES
Energy realities: the journey down the resource pyramid
Unconventional gas plays becameimportant as better plays wereexhausted.Tight sandstone & coal-bedmethane were developed first.Shale gas is at a lower level on thepyramid.Economics are marginal.
"We sit on 10 [billion] to 15 billion barrels of
oil that will change the valuation of this
company over time."
-- Aubrey McClendon, Dow Jones
Newswires, October 14, 2010
He clearly does not understand the pyramid!
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Slide5LabyrinthConsul4ngServices,Inc. HoustonSIPES
There never was 100 years of natural gas because of shale plays
Potential Gas Committee (PGC) June 2009 Report misinterpreted.Technically recoverable resources are not reserves.
Probable shale gas component is 147 tcf.Thats a lot of gas but it is not 100-years of supply.
There is clearly sufficient North American gas supply to last for a bunch ofyears; 50 years at least. And there is clearly no need for us to import LNG
(liquefied natural gas) for multiple years to come.--Mark Papa, EOG CEO, November 2010
Except that there are only 20 years of supply according to the PGC!
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Slide6LabyrinthConsul4ngServices,Inc. HoustonSIPES
Shale plays have contracted to a fairway or core area:Haynesville Shale example
The emerging core area includes~110,000 acres or about 5Townships.
This represents approximately 10%of the play area in Louisiana definedby limits of drilling (1.5 million acres
or 65 Townships).A few years ago, this was promotedas the 4th largest gas field in theworld, and the largest in NorthAmerica.
All operators claim 6.5-7.5 bcf/wellbut HKs and Excos wells are 2xhigher than CHK and EOGtheycant all be right!
Data from HPDI.
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The Barnett Shale core areas
"There was a time you all were toldthat any of the 17 counties in theBarnett Shale play would be just asgood as any other county,"
McClendon said. "We found outthere are about two or two and ahalf counties where you really wantto be.
--Bloomberg News October 14,2009
CoreArea
CoreArea
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What defines a core? An area where conditions provide the potential forcommercialsuccess
Even within the core, wellperformance is not uniform.Repeatability is a problem. IPs have improved but costs haveincreased.Complex natural system, not afactory.
Barnett H Wells 1st Year Cumulative Production
Data from HPDI.
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Barnett Shale Update: The Tarrant County Core Area
Polygon shows thebest of the Tarrant core
based on first-yearcumulative production.1,337 horizontal wellsanalyzed.
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The Tarrant County Core Area: type-well cumulative production
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
3,500,000
1 3 5 7 9 1113151719212325272931333537391357951535557596163656769717375777981838587
ThousandsofCubicFeetofGas
MonthsofProduc6on
Barne8TarrantCoreHorizontalTypeWellCumula6veProduc6on
2003 200 2005 2006 2007 2008 2009 2010
No vintage of wells isapproaching the 2.3-3.3bcf range claimed bymost operators for anaverage well.1.5 bcf is minimum forbreak even at $6.25/mcfnetback in the BarnettShale.NPV models indicatethat at least 70% of NPVin first 5 years.Too early to say muchabout 2010 or 2009wells.No clear evidence thatmore recently drilledwells are better thanpreviously drilled wells.
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Vintaged comparison of 20-month cumulative production
0
50
100
150
200
250
300
350
00,000
50,000
500,000
550,000
600,000
650,000
2003 200 2005 2006 2007 2008 2009
NumberofWells
20-MonthCumula6veProduc6on(Mcf)
YearofFirstProduc6on
Barne8CoreHorizontalTypeWells
20-MonthCumula4veProduc4on NumberofWells
Best year was 2005.Progressivedeterioration of results2007-2009.20-month cumulativecomparison normalizesthe impact of high IPwells that do notmaintain high rates.
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How are we doing on reaching reserve claims for an average well?
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
3,500,000
,000,000
1 3 5 7 9 11131517192123252729313335373913579515355575961636567697173757779818385
Cumula6veProdu
c6on(mcfg)
MonthsofProduc6on
CHK DVN ECA EOG KWK XTO
Range of Operator Average Well Claims
Data from HPDI.
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Less than 6% of Barnett horizontal wells have reached economic threshold after7 years of production
Most of my oil and gas clients require payout in 2-3 years.
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Chesapeake Type Well for the Barnett Play:
69% of value produced in 1st 5 years, and 85% in 1st 10 years, Negligible value added after 20 years yet operators claim significant
EUR comes after year 20,
Actual Barnett decline rates: 45% of EUR in Year 1, 65% by end of2nd, 75% by end of 3rd.
Barnett Shale: its about NPV, not EUR
16% 11%3% 1%
69%
85%
96% 99% 100% 100%
0%
10%
20%
30%
0%
50%
60%
70%
80%
90%
100%
0%
10%
20%
30%
40%
50%
0%
70%
0%
90%
100%
0-5Years
0-10Years
10-20Years
20-30Years
30-50Years
50-65Years
CumulativeP
ercentofNetPresentValu
e
PercentofNetPresentValue
Produc6onPeriod
Chesapeake Barnett Type Curve Incremental NPV10
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Barnett Shale: testing the 40- To 65-year production life claim
19%
27%
32%
23%
35%
24%21%
9%10%
0%
5%
10%
15%
20%
25%
30%
35%
0%
2000 2001 2002 2003 200 2005 2006 2007 2008
Barnett Wells Producing < 1 MMcf/month or Dry
This cut-off only covers the cost of compression.True operating costs are approximately double.
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0
10,000
20,000
30,000
0,000
50,000
60,000
70,000
1 2 3 5 6 7 8 9 101112131151617181920212223225262728293031323333536
MCFofGasPerMonth
MonthsofProduc6on
EnCanaHorizontalBarne8WellsDeclineData
P25 P50 P75 MEDIAN MEAN
Type curves are overly optimistic: probabilistic approach acknowledges uncertainty
420 Barnett Shale wells suggest considerable variance in type-curve methodology.Mean over-predicts EUR by 10-15%.
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Hyperbolic decline model is not supportable: based on non-comparable analogues withpermeabilites that are orders of magnitude greater than shale reservoirs
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1st12monthsdominatedbyinduced
andmajornaturalfractures
(highrate,rapiddeple
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Super-Harmonic Decline: b-exponent >1.0
Super-harmonic decline reflects production from a system of continuously increasingvolume of contacted gas-in-place.
Berman/Pittinger shale gas analyses indicate late-time boundary dominated flow. Contacted gas-in-place stabilizes after initial year of steep decline. Hyperbolic decline should not model transient/transitional flow before boundary
conditions are reached.
Hyperbolic exponent > 1.0 generally reflects transient flow and may not be valid. Most SPE papers on decline-curve analysis caution against using b-exponents > 1.0. Root of hyperbole is exaggeration orjoke.
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Inducedfractures,
regionalfractures
Inducedconjugatefractures,
clustersofnaturalfractures
Microfractures,joints
ShaleMatrix
Adsorbedgas&gasinpores
Decline rate decreases as the well depletes further down the fracture pyramid
PermeabilityDecreases
PoreVolumeIncreases
Thesetwolevels
dominatefirst12
monthsofproducFon
Thesetwolevels
dominatedeclinetrend
aGerfirst12months
(exponenFalor
moderatehyperbolic)
racture-enhancedpermeabilitymaybe
sufficienttoestablishboundary-dominated
flowwithin12months
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Business results do not support enthusiasm for shale plays: these are not low-cost plays
Operator claims of profitability at sub-$5/Mcf gas prices exclude many costs. Interest expense and G&A (overhead), dry hole cost, P&A expense not considered.
$0.00
$2.00
$.00
$6.00
$8.00
$10.00
$12.00
$1.00
$16.00
Selected Company 5 Year Imputed Production Costs/Mcfe
Weighted Realized Price/Mcfe with Hedges 5 Year Calculated "Break-Even" Price
Data from company reports.
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These are not low-cost plays: the truth is quietly acknowledged
They doubt that you will notice as the traveling circus moves to liquids-rich plays!CHKs 5-year average break-even cost is $6.50/Mcf (from previous slide).
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Slide23LabyrinthConsul4ngServices,Inc. HoustonSIPES
10,000
100,000
1,000,000
0 1 2 3 4 5 7 9 10 11 12 13 14
MonthlyGasR
ate,
Mscf
MonthsfromStartofProduc6on
Type Well Comparison
Chesapeake Type Curve: EUR = 6.5 Bcf, b=1.1
Average of 44 Wells with 12 Months of
Production: EUR = 2.4 Bcf, Exponential Decline
Type curve comparison: Haynesville Shale
The difference lies in forecasting future decline trends.Particularly the hyperbolic b exponent.
Data from HPDI.
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Slide2LabyrinthConsul4ngServices,Inc. HoustonSIPES
10,000
100,000
1,000,000
0 12 1 24 30 3 42 4
MonthlyGasRate
,Mscf
MonthsfromStartofProduc6on
Normalized Haynesville Production Rate DeclineAverage of 44 Wells With 12 Months or More of Data
b=1.1
b=1.0
b=0.5
b=0.25
b=0.0
EUR=4.4 Bcf
EUR=3.0 Bcf
EUR=2.6 BcfEUR=2.4 Bcf
EUR=6.5 Bcf
Group type curve analysis
EUR entirely dependent on b factorEUR = 2.4 Bcf with b = 0.0,EUR = 2.6 Bcf with b = 0.25,EUR = 3.0 Bcf with b = 0.5,EUR = 4.4 Bcf with b = 1.0,EUR = 6.5 Bcf with b = 1.1.
Insufficient data to determine b factor from group average
Trust us that the P56.5 bcfcase will be the average EUR!
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Slide25LabyrinthConsul4ngServices,Inc. HoustonSIPES
Haynesville Shale Average Cumulative Production by Operator
All operators claim EUR in the 5.0-7.5 bcfrange.
It is difficult to see how any but Petrohawkand Exco justify their claim.
Cheapeakes average well will produce lessthan 3.0 bcf which is non-commercial (need$8.70/mcf to break even).
Yet CHK continues to run 33 rigs in the play!
2.9 2.92.7
2.4
1.7 1.9 1.81.91.6
1.5
0
1
2
3
4
5
6
7
1 2 3 4 5 6 7 8 9 1 0 1 1 1 2 1 3 1 4 1 5 1 6 1 7 1 8 19 20 21 22 23 24 25 26 27 28 29 30 31
CumulativeProductionbyOperator(Bcfg)
NormalizedMonthsofProduction
EXCO HK-KCS EP ECA EOG
CHK GOODRICH J-W COMSTOCK FOREST
Data from HPDI.
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Slide26LabyrinthConsul4ngServices,Inc. HoustonSIPES
An increase in proved undeveloped reserves (PUD) thanks to SEC changes
80% of reserves are undeveloped.
Companies exploit new SECrules to book PUDs
Data from company reports.
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Slide27LabyrinthConsul4ngServices,Inc. HoustonSIPES
Discounted value of proved reserves has decreased over time
Realized prices were upwardly adjusted from SEC standard to reflecttrue monthly & annual prices.Prices reflect hedges.
Data from company reports.
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Slide28LabyrinthConsul4ngServices,Inc. HoustonSIPES
Pursuit of low-value assets has hurt the shareholder
Data from company reports.
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Slide29LabyrinthConsul4ngServices,Inc. HoustonSIPES
Chesapeake presents its value proposition
From 2009 10-K.It will take almost $9billion to develop CHKsproved undevelopedreserves.
This does not includeG&A ($0.38/mcfe) or debt
service ($0.88/mcfe).The present value of theestimated future netrevenue is just over $1
billion.Would you spend morethan $9 billion to net $1 B,
or less than 12%?Since we know that halfof CHKs reserves thatcome after Year 20 add nonet present value, the truereturn is probably about
$0.5 billion.Data from company reports.
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Slide30LabyrinthConsul4ngServices,Inc. HoustonSIPES
If these shale plays are so profitable, why do their promoters have towrite down their assets every quarter?
Based on 2009 10-K SEC filings
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Slide31LabyrinthConsul4ngServices,Inc. HoustonSIPES
The Big Short& shale gas plays
The companies were allowed to book as profit the expectedfuture value of those loans. The accounting rules allowed
them to assume the loans would be repaid.
The companies were allowed to book as assets the expected
future value of those reserves. The accounting rules allowedthem to assume the reserves would be developed.
All these subprime lending companies were growing so
quickly that they could mask the fact that they had no realearnings.
All the shale gas production was growing so quickly
that they could mask the fact that they had no real earnings.
To maintain the fiction that they were profitable enterprises,they needed more and more capital to create more and more
subprime loans.
To maintain the fiction that they were profitable enterprises,they needed more and more capital to drill more and more
gas wells.
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Slide32LabyrinthConsul4ngServices,Inc. HoustonSIPES
Natural gas abundance or mirage?The bubble is the landgas is a by-product. Recent Eagle Ford transactionsunderscore this.
Land Grab strategy anticipates growing dependency on natural gas as the primaryfuel option for North America.Push out smaller independents that cannot compete for land costs.Force policy decisions in favor of natural gas vs. coal and other options.Future price will be a surprise compared to present claims.Drilling adds value to the land by proving reserves.Near-zero intererest rates always cause bad investments.Drilling will continue as long as there is a market for tradable land & capital isavailable.The shareholder is the loser & is subsidizing cheap gas.
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Slide33LabyrinthConsul4ngServices,Inc. HoustonSIPES
Acknowledgments
Mike BodellAllen BrooksPerry FischerRobert GrayJim Halloran IHSLynn PittingerKeith Shanley
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Shale GasAbundance or Mirage?
Arthur E. Berman
Labyrinth Consulting Services, Inc.
Houston, Texas
January 20, 2011
U.S. Shale Gas