The Shale Gas Bubble –

Drilling for gas and oil has always been a gamble. In conventional wells the geologists try to identify locations where gas and/or oil collect as they seep through layers of rock. The layers of rock deep in the earth are deformed by the movement of the tectonic plates forming folds and shears that over the millennia create pockets where the liquids and gas pool.  Shale gas differs because it is distributed in porous rock and must be given pathways to flow to the well.  Enter hydraulic fracturing or “fracking” which makes cracks and props them open so gas can escape. Some places may be better than others to drill, but the bore hole needs only hit a fairly large target layer where shale gas lies trapped and then turn horizontally and follow it for as many as four miles.

Discovery is not the only “crap shoot” in the shale gas business. The profitability of the produced gas is a function of market price and demand.  Just now the prices are low. Middle Eastern suppliers, anticipating the success of shale gas and oil have dropped prices to stem the flow of cash into the shale energy sector. To some extent that strategy is working. As new sources around the globe come on line increased competition will make matters worse. The Economist Magazine predicts that there will be blood:

“No wonder that the fight over the finances of America’s shale-oil industry has turned nasty. In one corner are shortsellers, including David Einhorn, a hedge-fund manager whose scalps include Lehman Brothers. They argue that “fracking”—the business of blasting oil out of rocks using water, sand and chemicals—is a bottomless pit into which too much cash has been thrown.

The ingenuity of America’s shale industry is admirable, the state of its finances awful. (click to read more) The Economist 7/4/15

In the other corner are America’s oil pioneers, who say that shale can thrive even though the benchmark American oil price has dropped from over $100 a barrel last year to $57 today. The oilmen are backed by plenty of other investors who are still pumping money into shale firms: some $35 billion of equity and bonds has been raised since December.

Both sides have a point. It makes sense to be cheery about the long-term prospects for shale energy—and to be queasy about today’s bunch of fracking firms (see article).”

Savvy investors arrive early and leave early before the bubble bursts, but the crowd usually buys in late causing the bubble to swell and then burst.

For communities where shale gas is being developed these financial uncertainties are not good news. A bankrupt company won’t be paying out “mailbox” money, and may be tempted to cut corners in the construction of their wells. The industry can’t operate with zero impact; the best that they can promise is to minimize impact and to mitigate the damage they do afterwards. Obviously one can’t count on a bankrupt organization to keep its promises. When the money stops the roughnecks move on, the equipment gets repossessed and the locals are left with the derelicts.

If the prediction that shale gas is an investment bubble is correct, then the big losers will be the regions ravaged by the rush to cash in. The Wall Street bettors will find another game, but the local communities? C’est laissez-faire.