[Graeme]

The hype cycle: How the oil and gas industry manipulates investors and the public

$this->bbcode_second_pass_quote('', 'W')hat would you expect them to say?
That's the question you should ask whenever spokespersons for the oil and gas industry (or fake think tanks funded by the industry or analysts whose bread is buttered by the industry) announce a new find that is going to be a "game-changer" (or bigger than another well-known world-class field or enough to make America energy independent again).

Prepare yourself for another hype cycle in the U.S. oil and gas industry. The industry says it has found a deposit of oil that may turn out to be the largest in the world. The deep tight oil deposit goes by the name Spraberry/Wolfcamp and is located in West Texas. It's no surprise then that the industry is trotting out the America-as-the-new-Saudi-Arabia theme once again, a theme that many including me have shown to be pure bunkum.

And, the chief executive officer of Pioneer Natural Resources Company, which is currently touting its dominant position in the Spraberry/Wolfcamp deposits, added some bunkum of his own when he told The Dallas Morning News, "We’re more like a manufacturing operation than a traditional oil drilling operation.” This is the discredited notion that in tight oil and shale gas deposits, a company can drill anywhere and extract economical volumes of oil and/or natural gas. The idea has been discredited by the record of every tight oil and shale gas deposit drilled to date, deposits which settle down into a pattern of tightly focused "sweet spots" where drillers can make money and vast areas that are not profitable to drill--mainly because the oil and natural gas are too difficult to get out.

Though there are plenty of other reasons to doubt the claims about Spraberry/Wolfcamp, no one will know for certain what's true until the area is drilled and produced. But, in order to drill it, oil and gas companies must raise billions in capital to pay for drilling and production costs. And, in order to do that, they have to get investors interested in plowing money into the drilling of actual individual wells through what are called private placements.

These placements are riskier than shares of oil and gas companies because they relate to specific drilling projects which may or may not succeed. On the other hand, such projects can be quite lucrative when they do succeed. Hence, the continuing attraction for the speculative investor.

Now, investors are not going to make such risky investments unless they believe the potential return is very high. Here's where the industry hype machine comes in. To raise the necessary capital, it is essential to get investors excited about particular oil and gas plays. The best way to do that is to create buzz in the media about the estimated size of the resources in the play. And, an easy way to do that is to invoke comparisons with Saudi Arabia and its giant oil fields as is being done in the case of Spraberry/Wolfcamp.

[ROCKMAN]

A rather bizarre and very misleading report MHO.

“The industry says it has found a deposit of oil that may turn out to be the largest in the world.” Yeah…they did discover it…70 years ago in 1943. The first of a number of straw man arguments presented in the report which attempts to claim the oil industry is touting the Spraberry as a “new discovery”. As of 2009 there were about 9,000 wells producing from the trend. Kinda difficult to imagine anyone in the oil patch saying a trend that has produced from over 20,000 wells as “new”. But that does appear to be the claim presented in the report.

Straw man #2: “It's no surprise then that the industry is trotting out the America-as-the-new-Saudi Arabia theme once again, a theme that many including me have shown to be pure bunkum.” I work with hundreds of oil patch professions with decades of experience and everyone, without exception, thinks such claims as the US becoming the next KSA as silly. Not so much because it won’t but because it has been in the KSA class of producing countries for decades. The US is the third largest oil producer on the planet. We may not be producing as much as the KSA is today but we are producing about 75% as much as they are. That doesn’t exactly make us poor relations.

"We’re more like a manufacturing operation than a traditional oil drilling operation.” This is the discredited notion that in tight oil and shale gas deposits, a company can drill anywhere and extract economical volumes of oil and/or natural gas.” Straw men galore. First, find one oil company that has ever made the claim that they can economically drill anywhere in any trend. You can’t. Second, it is a fairly mechanical operation with respect to exploration geology. “Pioneer Natural Resources Company…added some bunkum…"We’re more like a manufacturing operation than a traditional oil drilling operation.” A very apt description IMHO. Nearly all the wells drilled in every trend are based more on the lease map than then a geology map. The oil is known to be present under every lease. The question is how economically that oil can be recovered. In that sense the shales are much more like a mechanical mining operation that exploration geology. I think almost every non-technical person on this site has already figured that out.

Uno mas straw man: “Though there are plenty of other reasons to doubt the claims about Spraberry/Wolfcamp, no one will know for certain what's true until the area is drilled and produced”. The area has been defined by thousands of well drilled over the last 70 years. It covers large parts of six counties and has a total area of approximately 2,500 square miles. It is named for a farmer who owned the land containing the 1943 discovery well. The Spraberry Trend is itself part of a larger oil-producing region known as the Spraberry-Dean Play, within the Midland Basin. The oil in the Spraberry proved difficult to recover. After initial enthusiastic drilling, during which most of the initially promising wells showed precipitous and mysterious production declines, the area was dubbed the world's largest unrecoverable oil reserve. Unrecoverable because oil selling for less than $3 per bbl didn’t allow for much development.

And the last straw man: “Now, investors are not going to make such risky investments unless they believe the potential return is very high. Here's where the industry hype machine comes in….The best way to do that is to create buzz in the media about the estimated size of the resources in the play.” If one wants to a point finger at a buzz machine they might want to start with the US govt: In 2007, the U.S. Department of Energy ranked the Spraberry Trend third in the United States by total proved reserves, and seventh in total production. The seventh largest trend in the third largest oil producing country in the world during a time of historically high oil prices: undue buzz??? Estimated reserves for the entire Spraberry-Dean unit exceed 10 billion barrels, and by the end of 1994 the field had reported a total production of 924 million barrels. IOW the trend has to date produced over 1 billion bbls of oil from thousands of wells in a completely defined trend. Dozens of companies have spent $billions of their own capex to enhance recovery from the trend with the advent of higher oil prices. Even with these advances in horizontal drilling and frac’ng, the Spraberry retains about 90% of its original calculated reserves, largely due to the difficulty of recovery.

Direct investment in oil/NG drilling risky? Well, Da! So is directly investing in a restaurant. Or any other business. Which is why I’ve always recommended that unsophisticated investors to just buy into public companies I they want an oil/NG investment vehicle. Directly owning a piece of a well is much more than an investment. You become a PARTNER in the well. A partner with not only high potential earning but legal obligations and potential catastrophic losses. Just ask my partners that just drilled a $19 million dry hole in south La. Or ask one of Devon's partners that had a piece of a $148 million dry hole in the DW GOM...the last one OI worked on for them. Unlike a stock which you can call your broker and dump whenever you want, you can’t just throw up your hands and say “I’m out” when you’re a working interest owner. Want your worst case scenario: think of being one of BP’s partners on the Macondo blow out. For should think about that before writing a check to become a working interest owner in any well drilled by anyone. LOL.

[Graeme]

Two points. Peak oil is here. You can't argue with that. The oil industry does mislead the public via the media about oil prospects. For example, catchphrases such as "American energy independence" and " peak oil is dead". And as for Spraberry/Wolfcamp, this is what wiki says:

$this->bbcode_second_pass_quote('', 'T')he oil in the Spraberry, however, proved difficult to recover. After about three years of enthusiastic drilling, during which most of the initially promising wells showed precipitous and mysterious production declines, the area was dubbed "the world's largest unrecoverable oil reserve."[2]

[pwallmann]

http://qz.com/118825/to-bump-up-your-share-price-just-call-your-oil-find-a-giant-one/

I ran across this story and don't recall seeing it on here. While causation is probably impossible to actually draw here, the article basically outlines a Sanford Bernstein report that looks at the impact on stock prices when new finds are announced in descriptive words.

$this->bbcode_second_pass_quote('', 'O')ne big takeaway is that in 2009, major oil companies were a relatively modest lot. When they discovered a new oilfield, there was an 80% likelihood that they would simply go about their business and say very little about it. The other 20% of the time, they used embroideries such as “important,” “excellent,” “high impact” or “significant” to describe their oilfield success.

[ROCKMAN]

P – After doing this for 38 years I don’t need to see their methodology…it is what it is. What I do question is how good they did their job. The increases they report are nothing compared to hype inspired run-ups I’ve seen. Back in the 70’s boom it didn’t take anything more than a very basic plain Jane press release from McMoRan to cause their stock to jump 5%+ in a day. And I’ll repeat my favorite story about absurd investor reaction to a press release. The short story: I drilled 4 horizontal convention NG wells for a small pubco with stock trading at $0.75/share. Well cost a total of $18 million and increased company-wide production by 400%....10 mmcf/day to 50 mmcf/day. And did not add one $1 of reserve value. These wells only accelerated the depletion of the proved producing reserves. Didn’t create one more $ of cash flow then if we had just depleted the reservoirs with the existing vertical wells. The faster production resulted in somewhat improved Net Present Value of those reserves but not by $18 million. IOW by drilling those 4 wells I reduced the NPV of the company. And what did the stock do? In no time at all it went over $5/share.

And no one lied: all the details were there in the annual report. But investors don’t need to read all those small print facts. They just have to listen to what their broker tells them. And here’s the dirty little secret: the big brokerage house don’t bother with small cap public oil companies. There’s a group of brokers generally referred to as “market makers”. Which is literally what they do: create the buyer’s market for a small pubco which investors would never know existed if it weren’t for the market makers. And the MM’s don’t just make money on their commission cut: they usually pick up a position in the company (often for little or nothing) and when they hype the company they make a lot more money on the stock flip. In my case the company didn’t need to put out spiced up press releases: the MM’s did it verbally with their clients. And they didn’t need to lie: our company increased the revenue flow by 400% in less than a year. The obvious deceit was the lie by omission. But if challenged by the SEC the MM could show proof that every investor had received a copy of the annual report. The MM isn’t responsible if the investors don’t read the details.

And how easy is it for even a sophisticated investor to get hooked? A very big and very well-known Wall Street player swallowed the hype and did a successful hostile take-over of my company. And lost his butt on the stock several years later when the company went bankrupt and disappeared for ever. If folks want to find out who is out there leading the investor lambs to the slaughter I would suggest looking closer at the brokerage houses than the companies themselves.

Just one of several reasons I’m so very glad to be currently working for a private company.

[John_A]

$this->bbcode_second_pass_quote('ROCKMAN', 'A') rather bizarre and very misleading report MHO.

[Oneaboveall]

interestingly, Naked Capitalism was discussing this subject today:

$this->bbcode_second_pass_quote('', 'J')ust like the famous Gold Rushes of the 19th century, US shale gas development is turning out to be a limited and regional market opportunity. Across the Atlantic, the high financial and human costs to fracking also mean that Europe should forget any fantasies about repeating the US shale boom.

Many US shale companies that have been beating the drums of shale “revolution” are now facing oil and gas well depletion. In February 2013 the US Energy Information Administration (EIA) warned that “diminishing returns to scale and the depletion of high productivity sweet spots are expected to eventually slow the rate of growth in tight oil production”. It was a cautious but intriguing statement.

Arthur Berman, a prominent shale skeptic who runs Labyrinth Consulting firm in Sugarland, Texas, is not surprised. “The shale gas phenomenon has been funded mostly by debt and equity offerings. At this point, further debt and share dilution are less feasible for many companies” – he wrote in The Oil Drum blog several months ago.

The average depletion rate of wells in the Bakken Formation (the largest tight oil play in the US) is reported to be 69 percent in the first year and 94 percent over the first five years (37 percent and 50 percent in the Barnett Formation). Due to the lack of reliable data on shale industry many experts (for example, Deborah Rogers from Energy Policy Forum) await possible future write-downs in shale assets. Naturally smaller investors will not hear about the write-downs in the news.

[ROCKMAN]

Mr. Feusner is probably getting exactly what CHK promised him as per the lease agreement he signed. If not he can get a lawyer and successfully sue the pants off of CHK…maybe even void their lease and take their wells away from them. Which is exactly why I suspect CHK is following the lease agreement. A lease agreement that designed to be so complex that a mineral owner didn't really understand what would happen once the wells began producing. This will always be a problem when a drilling boom hits an area that hasn’t had much activity: mineral owners don’t know what they are doing. I’ve advised many of my Yankee cousins to consultant lawyers when approached for a mineral lease.

Down here in Texas and La. when you go to get a mineral lease from a land owner you expect to be referred to their lawyer. A lawyer that has probably negotiated 100’s of mineral leases. A mineral lease is a contract with upwards of 50 to 100 technical provisions in it. I have no doubt that many Yankee mineral owners signed their leases without understanding many of those provisions. I’ve been a petroleum geologist for 38 years and I wouldn’t sign a lease without having it reviewed by an expert. But when the company landman is sitting in front of a mineral owner waving a lease bonus check that might be several times what that landowner made last year it’s easy to get a fast signature.

[kuidaskassikaeb]

Dear Rockman and Uberalles:

I'm not sure the CHK story really works as a principle for capitalism or legalism. It is CHK after all, the bad boy or big fish of fracking, and I think the story is more about them.

Bloomberg seems to agree

http://www.bloomberg.com/news/2012-08-30/chesapeake-squeezes-landowners-on-costs-amid-cash-crunch.html



$this->bbcode_second_pass_quote('', '�')��The tide goes in and out, depending on the overall economy and the specific economic prospects of the parties,” Sabino said. “Companies that are under heavy financial stress are more likely to push the envelope. Even the most honest companies, when prices and profits are dropping, will look to save money.”
Declining Value
Chesapeake lost about $9 billion in market value in the past year. Chief Executive Officer Aubrey McClendon was stripped of his chairman’s title in June amid investigations into conflicts of interest between his personal financial dealings and his management duties. Michael Kehs, a company spokesman, declined to comment on the investigations.

[ROCKMAN]

k - all so true. And no matter how thoroughly you try to write leases and operating agreements there always some wiggle room on interpretations. And as you point out when a company gets into financial trouble they start making interpretations in their favor. This is just a problem for land owners but also companies the JV with and the state tax collectors.

But also understand that there is no such thing as a "standard lease deal". There might be 5 different owners of a 100 acre mineral lease and they may all sign different lease agreements with different provisions as well as different royalties. Just because CHK is paying someone less than their neighbor doesn't mean they are getting what hey are owed.

So it all goes back to what your lease reads. With sophisticated minerals owners in Texas you'll never get to net out marketing fee etc. from the royalty payment. The situation is somewhat analogous to all those mortgage contracts folks signed during the boom when they didn't really understand the terms of the contract. I know it harsh but in the world of contracts if you don't protect your own interests you have no right to expect anyone else to do it for you. In 38 years I've never been involved in a single legal dispute with a mineral owner. But I have been between companies at least a dozen or two times.

[rockdoc123]

$this->bbcode_second_pass_quote('', 'J')ust because CHK is paying someone less than their neighbor doesn't mean they are getting what hey are owed.

[kuidaskassikaeb]

Dear Rockguys:

I'm not going to say that you are wrong in general. I don't think you are. Just looking at the news articles about leasing was confusing. but in particular case of CHK I have to wonder.

$this->bbcode_second_pass_quote('', 'p')recisely and what most people miss is that CHK was "first in" on most of the major shale plays. As a consequence they negotiated deals that as time went on were no longer competitive.

[rockdoc123]

$this->bbcode_second_pass_quote('', 'I') was wondering if they aren't making the payments because they can't, and this is a case of paying the credit card or the mortgage. I obviously don't know the answer, but that was my question.

[ROCKMAN]

k - I know it's a simplistic answer but if CHK is obviously violating the lease contract they'll lose any challenge from a mineral owner. Especially in La. Their courts, as in Texas, are very much the advocates for land and mineral owners. I've seen a number of very unfair judgments against companies in the favor of land and mineral owners.

I suspect that Texas accountant thought just because she knew a lot about accounting she knew mineral lease contract law. I’m guessing she didn’t. If I had someone offer me a lease for my minerals I would have it reviewed by an expect despite the fact I’ve worked in the industry for almost 4 decades. Playing “jailhouse lawyer” may be the cheap way to go but won’t always get the job done right. She may have thought she knew how her royalty would be determined but she was wrong. But again if CHK violated her contract she’ll win the suit and damages with no problem. Nailing an operator’s hide to the barn door is valuable in a state where land and mineral owners elect most of the judges.

[Graeme]

How Oil and Gas Drillers Avoid Paying Royalties to Landowners

$this->bbcode_second_pass_quote('', 'I')n many cases, lawyers and auditors who specialize in production accounting tell ProPublica energy companies are using complex accounting and business arrangements to skim profits off the sale of resources and increase the expenses charged to landowners.

Deducting expenses is itself controversial and debated as unfair among landowners, but it is allowable under many leases, some of which were signed without landowners fully understanding their implications.

But some companies deduct expenses for transporting and processing natural gas, even when leases contain clauses explicitly prohibiting such deductions. In other cases, according to court files and documents obtained by ProPublica, they withhold money without explanation for other, unauthorized expenses, and without telling landowners that the money is being withheld.

Significant amounts of fuel are never sold at all—companies use it themselves to power equipment that processes gas, sometimes at facilities far away from the land on which it was drilled. In Oklahoma, Chesapeake deducted marketing fees from payments to a landowner—a joint owner in the well—even though the fees went to its own subsidiary, a pipeline company called Chesapeake Energy Marketing. The landowner alleged the fees had been disguised in the form of lower sales prices. A court ruled that the company was entitled to charge the fees.

Costs such as these are normally only documented in private transactions between energy companies, and are almost never detailed to landowners.
“To find out how the calculation is done, you may well have to file a lawsuit and get it through discovery,” said Owen Anderson, the Eugene Kuntz Chair in Oil, Gas & Natural Resources at the University of Oklahoma College of Law, and an expert on royalty disputes. “I’m not aware of any state that requires that level of disclosure.”

To keep royalties low, companies sometimes set up subsidiaries or limited partnerships to which they sell oil and gas at reduced prices, only to recoup the full value of the resources when their subsidiaries resell it. Royalty payments are usually based on the initial transaction.

In other cases, companies have bartered for services off the books, hiding the full value of resources from landowners. In a 2003 case in Louisiana, for example, Kerr McGee, now owned by Anadarko Petroleum, sold its oil for a fraction of its value—and paid royalties to the government on the discounted amount—in a trade arrangement for marketing services that were never accounted for on its cash flow statements. The federal government sued, and won.

The government has an arsenal of tools to combat royalty underpayment. The Department of Interior has rules governing what deductions are allowable. It also employs an auditing agency that, while far from perfect, has uncovered more than a dozen instances in which drillers were “willful” in deceiving the government on royalty payments just since 2011. A spokesman for the Department of Interior’s Office of Natural Resources Revenue says that over the last three decades, the government has recouped more than $4 billion in unpaid fees from such cases.

There are few such protective mechanisms for private landowners, though, who enter into agreements without regulatory oversight and must pay to audit or challenge energy companies out of their own pockets.

ProPublica made several attempts to contact Chesapeake Energy for this article. The company declined, via email, to answer any questions regarding royalties, and then did not respond to detailed sets of questions submitted afterward. The leading industry trade group, the American Petroleum Institute, also declined to comment on landowners’ allegations of underpayments, saying that individual companies would need to respond to specific claims.

[ROCKMAN]

Again the problem isn't so much companies violating the lease terms. There is an entire industry of law firms that solely specialize in this area. The problem will likely be the companies presenting lease agreements too complex for the mineral owners to understand. I meant it when I said I would never sign a lease without having it reviewed by an expert. And I know a lot of the tricks. At least in La. And Texas if an operator violates a lease agreement he'll lose in court every time.

[kuidaskassikaeb]

Dear Graeme:

I have to agree with you. The methods used seem to me to be transparently fraudulent, although CHK seems to be by far the biggest abuser.

The method of selling gas at a low price to a subsidiary to calculate Rayalties can not possibly be legal.

Since some people think there ain't any problems in TEXAS

$this->bbcode_second_pass_quote('', 'T')arrant County landowners, including Fort Worth investor Ed Bass and the Trinity Valley School. Bloomberg News reported last year that Chesapeake faced at least eight lawsuits in five states alleging underpayment of royalties. And last year, Chesapeake settled litigation with Dallas/Fort Worth Airport, agreeing to pay the airport $5.3 million in additional royalties to settle claims that the airport was underpaid.

Read more here: http://www.star-telegram.com/2013/04/20 ... rylink=cpy

[ROCKMAN]

K - As noted in your post CHK appears to be getting nailed in the courts at every turn. As I said earlier at least in Texas and La. the courts are very sophisticated in such matters. We actually have "technical judge" that are trained to handle complex oil/NG contract disputes. We also have a lot of law/accounting firms that exist solely to litigate such matters. And more than a few expert witnesses like the Rockman ready to hire out to such firms. If CHK has been playing loose with the contract terms they'll eventually pay a high price. But why do they do it? Many times I've seen pressure put on accounting groups to make weak interpretations of such contracts and tax/royalty laws. Typically taken the approach because of the "we need the help now and will deal with the consequences latter" mindset. And often those pushing this approach are hoping they aren't there when those chickens come home to roost.

[kuidaskassikaeb]

Rockman:

Yeah that kind of makes sense to me.

[ROCKMAN]

k - I don't think the oil patch is probably any worse than other businesses. It boils down to human nature more than what type of business you're in. People cheat/lie. I've refused to sign off on bogus reports. I've lost two contracts because I wouldn't swear falsely. As a general rule those that push breaking the rules do their best to get someone else to sign the paper work. A bit of dark humor: Here...sign this...I don't want them coming after my butt. LOL. Usually said as a joke but there is some truth behind it.

Too many details to go into but last time I was on a witness stand I answered the question from the other sides attorney honestly. The reaction: the court room went very silent. Even the court reporter stopped typing and looked at me. I do have a tendency to provide blunt answers...oil field trash, ya know. LOL. Though tempted I couldn't muster the nerve to look at the judge and see his reaction. Their attorney just stood there a few moments and walked back to his table saying nothing else. It is amazing how surprised some folks are when you don't lawyer up and carefully parse your answers.

Cost the other side $2.4 million. As they say: Don't do the crime if you don't wan to do the time. LOL. And yes...I really have enjoyed taking companies down at the knees when the they cheat. The public has a bad opinion of the oil patch when we don't break the rules. We don't need assholes making it worse.