By John Kemp
LONDON, Aug 6 (Reuters) - Shale sceptics have seized on bigwritedowns in the value of shale gas and oil properties in NorthAmerica to question whether the fracking revolution could berunning into trouble.
On Aug. 1, Shell became the latest in a long lineof oil and gas companies to reveal a multi-billion-dollarwritedown in acreage value.
It announced just over $2 billion in impairments"predominantly related to liquids-rich shale properties in NorthAmerica, reflecting the latest insights from exploration andappraisal drilling results and production information".
Others to acknowledge impairments of their U.S. shale assetshave included BG Group and BHP Billiton.
"Over the past few years, the oil majors have been punchdrunk on U.S. shale. Now comes the hangover," Guy Chazan wrotein the Financial Times on Aug. 1. "Shale writedown is bad newsfor U.S. shale," he warned.
Analysts at Bernstein Research, which has long sought toinject a note of scepticism and realism into the debate aboutshale's potential, expressed caution over "exploration anddrilling results that are clearly weaker than Shell had expected(shale oil bulls take note!)"
However, writedowns by Shell and some other majors are asign they came to the shale boom late in the day, overpaying forlower-quality and less well-explored assets - not that the shalerevolution is stuttering.
LIQUIDS DISAPPOINT
Until recently, the majority of writedowns have been relatedto gas-rich properties, struggling amid the prolonged downturnin gas prices.
Chesapeake Energy lost its colourful chiefexecutive, Aubrey McClendon, earlier this year, mostly becauseof a shareholder revolt after the company overpaid andover-expanded in gas acreage and struggled to generate adequatereturns when gas prices fell.
Sandridge saw a similar defenestration after itshighly speculative wildcat acreage failed to yield the hoped-forbounty, and gas prices remained stuck near rock-bottom.
With no sign of a recovery in gas prices, most explorationand development firms have shifted their attention to formationsor parts of formations rich in crude oil and condensates.
However, the impairment of Shell's liquids-rich assets hashighlighted the limitations of that strategy, and inspiredanother bout of worrying over whether the recent rise in U.S.oil production can be sustained.
SHALE MANIA
In reviewing the shale boom and its aftermath, it isimportant to keep a sense of proportion. Just as shaleenthusiasts ignored the problems of translating the technologyto other countries, doomsters risk being too quick to interpretthe financial difficulties of shale investors as a sign thetechnology is running into trouble.
It is critical to separate the production potential of thetechnology from the accounting value of the shale leases thatcompanies have bought.
The shale business, particularly between 2007 and 2011,exhibited all the signs of a bubble. A disruptive new technologyunlocked enormous riches for early adopters, prompting a belatedrush by other investors and companies to join in and catch up.
The results were predictable. Late investors substantiallyoverpaid for leases. Costs rose. Markets became oversupplied.Selling prices slumped. Fabulous returns turned to a trickle,leading to writeoffs in the value of the assets.
The writedowns have been concentrated among companies thatbought into the shale boom very late, either by leasing acresthemselves, or buying companies with already-establishedacreage.
The story has been repeated over and over with disruptivetechnologies. Minnesota University's Andrew Odlyzko chronicleshow the pattern of overpaying and over-investing in newtechnologies has been manifest from the railway mania in Britainin the 1840s to the Internet and broadband boom of the late1990s in a superb monograph on "Collective hallucinations andinefficient markets: The British Railway Mania of the 1840s."
But while railway investors lost the equivalent of severaltrillion dollars in today's money, the mania bequeathed anetwork of main lines that became the enormously useful andvaluable mainstay of Britain's railway system.
Something similar now seems to be happening with the shaleindustry.
CUSTOM FRACKING
Gas and condensate producers have been victims of their ownsuccess. Prodigious output from fracked gas wells has crashedthe price of natural gas and more recently of condensates suchas ethane, propane, butane and natural gasoline.
But oil-focused producers have fallen victim to anotherproblem: overpaying for acres.
Shales are heterogeneous, varying enormously betweendifferent formations in different parts of the country, and evenover quite small distances of a few kilometres with the sameformation.
Oil and gas production from extensively drilled shales suchas Bakken, Barnett, Eagle Ford, Haynesville and Marcellus hasproved a poor guide to output from less well-known plays likethe Utica, Woodford and Conasagua.
Even within a single well-explored play like Bakken, outputcan vary enormously between "sweet spots" near the centre of theformation and outlying areas, as well as from one well toanother across sections of a couple of kilometres.
LATE BUYERS' REMORSE
Fracturing techniques must be customised for each play toachieve the best results. It takes time and drilling a lot ofwells to get the approach right and identify the most productiveparts of the formation.
Established players such as Continental Resources inthe oldest plays have had years to hone their drillingprogrammes and focus on the most promising acreage.
They bought leases early, paid modest signing bonuses andagreed reasonable rental, royalty and overriding-royaltypayments. Since then, they have traded leases to achieveconsolidated tracts covering the best areas that can be drilledefficiently.
By contrast, latecomers bought leases at vastly inflatedprices during the height of the mania, many for poorly exploredformations, in non-contiguous blocks. For a few years, shaleleasing was akin to a modern gold rush. It comes as no surprisemany of these leased acres are not worth what the companiespaid.
That doesn't mean all these shales are bound to disappoint.It does mean more (expensive) exploration and appraisal workwill be needed. Drillers and pressure pumpers will have toexperiment with different techniques to get it right.
Some shales may never prove very productive. Others requiremore investment, in some cases much more.
Meanwhile, those companies that bought acres near the top ofthe boom will have to recognise they overpaid and will neverrecoup all their investment in the hoped-for timeframe.
