Betting Against Shale Natural Gas Plays Using Puts

The shale gas story, which I summarize: “New drilling techniques and discoveries have vastly expanded the available recoverable natural gas, expanding reserves so much that we no longer have to worry about running out, and we will even be able to increase sustainable production over the long term.” In other words, it sounds too good to be true. In fact, it sounds like another version of the perennial paean, “Technology will save us,” or, in another less pithy variant, “Technology will allow us to continue doing things the way we’ve always done them.”
Technology may indeed save us from peaking fossil fuel supplies and climate change, in the sense that it may allow our society to adapt the quick loss of this massively energy intense resource that we’ve been completely reliant on for the last 150 years. However, it is wishful thinking to hope that technology will allow us to keep on doing things the way we’ve been doing them for the last few decades.

Wishful thinking is very seductive, because it allows us to avoid confronting the present reality of our problems today. As such, it’s intensely popular, and I nearly always expect that a large number of investors, spurred on by happy-talk media, will buy it, both figuratively and literally in the form of shale gas company stock (and solar stocks for that matter.)

So, if there is a chance that shale gas companies are over hyping the potential and playing down the risks and costs of their technology, the herd of investors and analysts is most likely underestimating the probability of this chance. I don’t know what the probability is, but I do know that if I can buy insurance against the chance Art Berman is right, the premium for that insurance will probably be low enough to make the deal attractive.

In the stock market, puts are insurance against the chance that the underlying stock will fall below the strike price. If shale gas has been over hyped, the most exposed shale gas players will see large falls in their stock prices when the truth becomes accepted wisdom. If shale gas actually holds as much promise as the companies are saying, such puts will expire worthless, but investor losses will be limited to the price (or “premium”) paid for those puts.

In Mexico, I felt a traditional short was the best way to play the country’s exposure to peak oil. Mexico is exposed to a nearly inevitable decline in oil production, which will take a continuing and growing toll on the economy. The only real question with Mexico is how much and how quickly declining oil production will have its effect on the Mexican economy.

In contrast, shale gas companies are facing an unknown chance of a catastrophic risk to their entire business model.

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