Insiders Sound an Alarm Amid a Natural Gas Rush

The New York Times

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Comparisons of estimates by a geologist with those of six company projections.
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June 25, 2011  Sunday NYT Page 1

	Insiders Sound an Alarm Amid a Natural Gas Rush

By IAN URBINA

Natural  gas  companies  have  been placing enormous bets on the wells
they  are drilling, saying they will deliver big profits and provide a
vast new source of energy for the United States.

But  the  gas  may  not  be  as  easy  and cheap to extract from shale
formations  deep underground as the companies are saying, according to
hundreds of industry e-mails and internal documents and an analysis of
data from thousands of wells.

In  the e-mails, energy executives, industry lawyers, state geologists
and  market  analysts  voice  skepticism  about  lofty  forecasts  and
question  whether  companies  are  intentionally,  and even illegally,
overstating  the  productivity  of  their  wells and the size of their
reserves.  Many  of these e-mails also suggest a view that is in stark
contrast to more bullish public comments made by the industry, in much
the same way that insiders have raised doubts about previous financial
bubbles.

"Money  is  pouring  in"  from  investors  even  though  shale  gas is
"inherently  unprofitable,"  an analyst from PNC Wealth Management, an
investment  company,  wrote  to  a  contractor  in  a February e-mail.
"Reminds you of dot-coms."

"The  word  in  the  world of independents is that the shale plays are
just  giant  Ponzi  schemes  and  the  economics just do not work," an
analyst  from  IHS Drilling Data, an energy research company, wrote in
an e-mail on Aug. 28, 2009.

Company  data  for  more  than  10,000  wells in three major shale gas
formations  raise  further  questions  about the industry's prospects.
There  is  undoubtedly  a  vast  amount  of gas in the formations. The
question remains how affordably it can be extracted.

The  data  show  that while there are some very active wells, they are
often  surrounded  by vast zones of less-productive wells that in some
cases  cost  more  to  drill  and operate than the gas they produce is
worth.  Also,  the  amount  of  gas produced by many of the successful
wells  is  falling  much  faster  than  initially  predicted by energy
companies, making it more difficult for them to turn a profit over the
long run.

If  the  industry does not live up to expectations, the impact will be
felt  widely.  Federal and state lawmakers are considering drastically
increasing  subsidies for the natural gas business in the hope that it
will provide low-cost energy for decades to come.

But  if  natural  gas ultimately proves more expensive to extract from
the  ground than has been predicted, landowners, investors and lenders
could  see  their investments falter, while consumers will pay a price
in higher electricity and home heating bills.

There  are  implications for the environment, too. The technology used
to  get  gas flowing out of the ground -- called hydraulic fracturing,
or  hydrofracking  --  can require over a million gallons of water per
well,  and  some  of that water must be disposed of because it becomes
contaminated  by  the  process.  If  shale  gas wells fade faster than
expected, energy companies will have to drill more wells or hydrofrack
them more often, resulting in more toxic waste.

The e-mails were obtained through open-records requests or provided to
The  New  York Times by industry consultants and analysts who say they
believe  that  the  public  perception  of  shale  gas  does not match
reality;  names  and  identifying information were redacted to protect
these  people, who were not authorized to communicate publicly. In the
e-mails, some people within the industry voice grave concerns.

"And now these corporate giants are having an Enron moment," a retired
geologist  from a major oil and gas company wrote in a February e-mail
about  other companies invested in shale gas. "They want to bend light
to hide the truth."

Others  within  the  industry remain optimistic. They argue that shale
gas  economics  will  improve  as  the  price of gas rises, technology
evolves  and  demand  for  gas  grows with help from increased federal
subsidies  being  considered  by  Congress.  "Shale gas supply is only
going  to  increase,"  Steven  C.  Dixon,  executive vice president of
Chesapeake  Energy,  said at an energy industry conference in April in
response to skepticism about well performance.

Studying the Data

"I think we have a big problem."

Deborah  Rogers,  a  member  of  the advisory committee of the Federal
Reserve   Bank   of  Dallas,  recalled  saying  that  in  a  May  2010
conversation  with  a  senior economist at the Reserve, Mine K. Yucel.
"We need to take a close look at this right away," she added.

A  former  stockbroker with Merrill Lynch, Ms. Rogers said she started
studying  well  data  from  shale  companies  in  October  2009  after
attending  a  speech  by  the chief executive of Chesapeake, Aubrey K.
McClendon.  The  math was not adding up, Ms. Rogers said. Her research
showed that wells were petering out faster than expected.

"These  wells  are  depleting  so quickly that the operators are in an
expensive  game of `catch-up,' " Ms. Rogers wrote in an e-mail on Nov.
17,  2009, to a petroleum geologist in Houston, who wrote back that he
agreed.

"This  could  have  profound  consequences for our local economy," she
explained in the e-mail.

Fort  Worth residents were already reeling from the sudden reversal of
fortune for the natural gas industry.

In  early  2008, energy companies were scrambling in Fort Worth to get
residents  to  lease  their  land  for  drilling  as they searched for
so-called  monster  wells.  Billboards  along  the highways stoked the
boom-time  excitement:  "If  you don't have a gas lease, get one!" Oil
and  gas  companies  were in a fierce bidding war for drilling rights,
offering  people  bonuses  as  high  as  $27,500  per acre for signing
leases.

The  actor Tommy Lee Jones signed on as a pitchman for Chesapeake, one
of  the largest shale gas companies. "The extremely long-term benefits
include  new  jobs  and  capital investment and royalties and revenues
that  pay  for  public  roads,  schools  and  parks,"  he  said in one
television  advertisement  about  drilling in the Barnett shale in and
around Fort Worth.

To  investors,  shale  companies  had a more sophisticated pitch. With
better  technology,  they  had  refined  a "manufacturing model," they
said,  that  would  allow  them  to  drop a well virtually anywhere in
certain parts of a shale formation and expect long-lasting returns.

For  Wall  Street, this was the holy grail: a low-risk and high-profit
proposition.  But  by late 2008, the recession took hold and the price
of  natural  gas  plunged  by nearly two-thirds, throwing the drilling
companies' business model into a tailspin.

In  Texas,  the advertisements featuring Mr. Jones disappeared. Energy
companies   rescinded   high-priced   lease  offers  to  thousands  of
residents,   which  prompted  class-action  lawsuits.  Royalty  checks
dwindled. Tax receipts fell.

The impact of the downturn was immediate for many.

"Ruinous,  that's  how  I'd  describe  it,"  said the Rev. Kyev Tatum,
president  of  the  Fort  Worth  chapter  of  the  Southern  Christian
Leadership Conference.

Mr. Tatum explained that dozens of black churches in Fort Worth signed
leases  on  the promise of big money. Instead, some churches were told
that  their  land may no longer be tax exempt even though they had yet
to make any royalties on the wells, he said.

That  boom-and-bust  volatility  had raised eyebrows among people like
Ms.  Rogers,  as  well  as energy analysts and geologists, who started
looking closely at the data on wells' performance. 

In  May  2010,  the Federal Reserve Bank of Dallas called a meeting to
discuss  the  matter  after  prodding from Ms. Rogers. One speaker was
Kenneth  B.  Medlock  III,  an  energy  expert at Rice University, who
described  a promising future for the shale gas industry in the United
States. When he was done, Ms. Rogers peppered him with questions.

Might growing environmental concerns raise the cost of doing business?
If  wells  were  dying  off  faster than predicted, how many new wells
would need to be drilled to meet projections?

Mr. Medlock conceded that production in the Barnett shale formation --
or  "play,"  in  industry jargon -- was indeed flat and would probably
soon decline.

"Activity  will shift toward other plays because the returns there are
higher," he predicted. Ms. Rogers turned to the other commissioners to
see  if  they  shared  her skepticism, but she said she saw only blank
stares.

Bubbling Doubts

Some  doubts  about  the  industry are being raised by people who work
inside energy companies, too.

"Our  engineers  here  project  these  wells  out  to  20-30  years of
production  and in my mind that has yet to be proven as viable," wrote
a  geologist  at  Chesapeake  in a March 17 e-mail to a federal energy
analyst.  "In fact I'm quite skeptical of it myself when you see the %
decline in the first year of production."

"In  these  shale gas plays no well is really economic right now," the
geologist  said in a previous e-mail to the same official on March 16.
"They  are  all  losing  a little money or only making a little bit of
money."

Around  the  same  time  the geologist sent the e-mail, Mr. McClendon,
Chesapeake's  chief  executive,  told  investors,  "It's  time  to get
bullish on natural gas."

In September 2009, a geologist from ConocoPhillips, one of the largest
producers  of natural gas in the Barnett shale, warned in an e-mail to
a  colleague  that  shale  gas  might  end  up as "the world's largest
uneconomic  field."  About  six  months  later,  the  company's  chief
executive,  James  J. Mulva, described natural gas as "nature's gift,"
adding  that  "rather  than  being  expensive,  shale gas is often the
low-cost  source."  Asked about the e-mail, John C. Roper, a spokesman
for  ConocoPhillips,  said  he  absolutely  believed that shale gas is
economically viable.

A  big  attraction  for  investors  is  the increasing size of the gas
reserves that some companies are reporting. Reserves -- in effect, the
amount  of  gas  that  a  company says it can feasibly access from its
wells  --  are  important because they are a central measure of an oil
and gas company's value.

Forecasting  these reserves is a tricky science. Early predictions are
sometimes lowered because of drops in gas prices, as happened in 2008.
Intentionally  overbooking  reserves,  however,  is illegal because it
misleads  investors.  Industry  e-mails,  mostly  from 2009 and later,
include language from oil and gas executives questioning whether other
energy companies are doing just that.

The  e-mails  do  not  explicitly accuse any companies of breaking the
law.  But  the  number of e-mails, the seniority of the people writing
them,  the variety of positions they hold and the language they use --
including  comparisons  to  Ponzi  schemes  and attempts to "con" Wall
Street -- suggest that questions about the shale gas industry exist in
many corners.

"Do  you  think  that there may be something suspicious going with the
public  companies  in  regard  to  booking  shale  reserves?" a senior
official  from  Ivy  Energy,  an  investment  firm specializing in the
energy sector, wrote in a 2009 e-mail.

A  former  Enron  executive  wrote  in 2009 while working at an energy
company: "I wonder when they will start telling people these wells are
just  not  what they thought they were going to be?" He added that the
behavior  of  shale  gas companies reminded him of what he saw when he
worked at Enron.

Production  data,  provided  by  companies  to  state  regulators  and
reviewed  by The Times, show that many wells are not performing as the
industry  expected.  In three major shale formations -- the Barnett in
Texas,   the   Haynesville   in  East  Texas  and  Louisiana  and  the
Fayetteville,  across  Arkansas  --  less  than 20 percent of the area
heralded  by  companies  as  productive  is  emerging  as likely to be
profitable  under current market conditions, according to the data and
industry analysts.

Richard  K.  Stoneburner,  president  and  chief  operating officer of
Petrohawk  Energy,  said  that  looking at entire shale formations was
misleading  because  some  companies drilled only in the best areas or
had  lower  costs.  "Outside those areas, you can drill a lot of wells
that will never live up to expectations," he added.

Although  energy companies routinely project that shale gas wells will
produce  gas  at  a  reasonable rate for anywhere from 20 to 65 years,
these  companies  have  been  making such predictions based on limited
data  and  a  certain  amount  of guesswork, since shale drilling is a
relatively new practice.

Most  gas  companies claim that production will drop sharply after the
first few years but then level off, allowing most wells to produce gas
for decades.

Gas  production  data reviewed by The Times suggest that many wells in
shale  gas  fields do not level off the way many companies predict but
instead decline steadily.

"This  kind  of  data  is making it harder and harder to deny that the
shale   gas   revolution  is  being  oversold,"  said  Art  Berman,  a
Houston-based  geologist  who  worked for two decades at Amoco and has
been one of the most vocal skeptics of shale gas economics.

The  Barnett shale, which has the longest production history, provides
the   most  reliable  case  study  for  predicting  future  shale  gas
potential. The data suggest that if the wells' production continues to
decline  in  the current manner, many will become financially unviable
within 10 to 15 years.

A review of more than 9,000 wells, using data from 2003 to 2009, shows
that  --  based  on  widely used industry assumptions about the market
price  of  gas  and  the cost of drilling and operating a well -- less
than 10 percent of the wells had recouped their estimated costs by the
time they were seven years old.

Terry  Engelder,  a  professor  of  geosciences  at Pennsylvania State
University,  said  the  debate over long-term well performance was far
from  resolved.  The  Haynesville  shale  has  not  lived  up to early
expectations,  he  said,  but  industry  projections  have become more
accurate  and  some wells in the Marcellus shale, which stretches from
Virginia to New York, are outperforming expectations.

A Sense of Confidence

Many people within the industry remain confident.

"I wouldn't worry about these shale companies," said T. Boone Pickens,
the  oil  and  gas industry executive, adding that he believes that if
prices rise, shale gas companies will make good money.

Mr.   Pickens   said  that  technological  improvements  --  including
hydrofracking  wells  more  than once -- are already making production
more cost-effective, which is why some major companies like ExxonMobil
have recently bought into shale gas.

Shale  companies  are also adjusting their strategies to make money by
focusing  on  shale wells that produce lucrative liquids, like propane
and butane, in addition to natural gas.

Asked about the e-mails from the Chesapeake geologist casting doubt on
company  projections,  a  Chesapeake  spokesman,  Jim Gipson, said the
company  was  fully  confident  that  a  majority  of  wells  would be
productive for 30 years or more.

David  Pendery,  a  spokesman  for  IHS,  added  that though shale gas
prospects had previously been debated by many analysts, in more recent
years costs had fallen and technology had improved.

Still,  in  private  exchanges,  many industry insiders are skeptical,
even  cynical,  about the industry's pronouncements. "All about making
money,"  an  official  from  Schlumberger,  an  oil  and  gas services
company,  wrote  in  a  July 2010 e-mail to a former federal regulator
about  drilling  a  well  in  Europe,  where  some United States shale
companies are hunting for better market opportunities.

"Looks  like  crap,"  the Schlumberger official wrote about the well's
performance,  according  to  the regulator, "but operator will flip it
based on `potential' and make some money on it."

"Always a greater sucker," the e-mail concluded.

Robbie Brown contributed reporting from Atlanta.

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