Rebuttals To Our Shale Play Research

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Putting the Skeptics shale hypothesis to permanent rest ($4.50/mcf) TPH E&P Research Team

Tudor, Pickering and Holt
October 19, 2009

Taking the high road – After much internal debate, we have opted to take the high road and not call out these shale skeptics by name. While it would make us feel better, it would probably give more credibility and attention to some individuals than is warranted.

The calm before the storm. First, let us say that this is not a personal attack on these skeptics. We’ve met them. They seem like nice folks. While we believe their analysis is incorrect in almost every way, we do believe that they are sincere in their efforts. With those niceties out of the way, let’s put our cards on the table. We were willing to let sleeping dogs lie in our disagreement with their conclusions. The world is made up of differing opinions and the beauty is that the market is efficient in sorting them out (for example, it was pretty quiet in February from the $200/bbl oil crowd). However, we simply get too many questions about these skeptic’s work to ignore it…particularly since a recent Denver presentation questioned our own work on the topic. Two can play this game..and we say GAME ON!

Technical credentials. In any technical discussion, one must establish technical credibility. The TPH equity research team is staffed with engineers that have worked at Shell, Tenneco, Arco, Exxon Mobil, reservoir consultant Holditch & Associates and reserve auditor Netherland & Sewell. Dave Pursell has taught petroleum engineering courses at Texas A&M. Not only do our guys know words like non-linear flow and pseudo-steady-state..they actually understand what they mean. We’ve done decline curve work for 10-20 years. Our A&D team on the ibanking side has another group of engineering talent just like us – and they make technical assessments of reserves for a living. We know how to do this type of work.

Depth of analysis on this topic. Within the past six months, we’ve looked at 32 subsegments of US production, including individual analyses of various historical shale results (Barnett, Fayetteville, etc). The culmination of the analysis was our US Natural Gas Supply Study. We’ve got data coming out of our ears…we haven’t published it all (and won’t), but it confirms the technical work being done by literally hundreds of industry folks.

10 Reasons Why Skeptics Are Wrong:

1. Technical stuff matters – The skeptics claim Estimated Ultimate Recovery (EUR) in shales is much lower than stated by industry, analysts and reserve engineers. This is because their decline method is technically flawed and is biased to under-estimate recovery. They suggest that it is appropriate to assume Barnett Shale wells exhibit exponential decline after one year (and not apparent hyperbolic behavior). Reality – it takes many years for a very tight (low permeability) gas reservoirs to exhibit exponential decline behavior. Thus, hyperbolic decline can and should be used to approximate/extrapolate EUR’s. Whew – got through that explanation without a mind numbing discourse of transient vs. pseudo-steady-state flow.

2. Type Curves work – Skeptics further suggest that it is inappropriate to use type curves because it makes the data look smoother than it really is…and suggest that all wells should be analyzed individually. This is wrong for multiple reasons: (1) It is accurate/widely accepted to use normalized curves as long as there is a relatively stable well count and vintage/area effects are accounted for. (2) Projecting individual wells without checking the type curve trends will lead to overly pessimistic projections (see Reason #4). Type curves actually normalize for a negative bias that might be driven by individual well declines. (3) Reserve auditors project EUR’s on a by-well base…supplemented with type curves. Their by-well analysis is consistent with the type curve methods reported by companies. The answer is generally the same either way if the work is done correctly!

3. High Terminal Decline Rate is wrong – Skeptics state that terminal declines will be high in shale plays (>15%). Without 10-20 years of Barnett history (the oldest shale play), this cannot be disproved. However, there are literally thousands of data points (actual well production) that show low terminal decline rates in tight gas reservoirs. Read the technical papers. Look at the data. Enough said.

4. Reality bites – We loaded the skeptics Barnett ~1bcf EUR type curve (which are called optimistic) into our Barnett Shale model. We applied their type curve to the ~3,000 wells drilled in 2008. During 2008, actual Barnett production grew by 1.2bcf.day. The skeptics “optimistic” EUR curve estimated growth of only 0.7bcf.day – which says it underpredicted actual incremental production by 0.5bcf/day or 70%. This is only for one year. If we went back to 2005/2006 and applied the type curve to all Barnett wells drilled, there is NO WAY this low type curve would match actual Barnett production of 5bcf/d. Scoreboard!

5. Like a fine wine, wells can get better over time – Skeptics also indicate that Barnett well performance has not improved over time. Au contraire, mon frère! In the Barnett and Fayetteville, reported well production shows higher y/y rates and higher projected EURs due to improved technology and better understanding of the reservoir (its called a learning curve). The skeptics decline-curve methodology (assuming the wells exhibit exponential behavior after one year) biases newer wells to have lower EUR’s than older/mature wells. Industry has shown consistent positive performance-based revisions in shale plays…wells get better and reserves increase over time.

6. Peak rate IS a good indicator of EUR – Skeptics are incorrect in stating that there is no correlation between peak rate and EUR because his decline curves/EUR’s are wrong. Clearly, peak rates alone shouldn’t be used to forecast EURs, but we find on average a strong correlation between IP and EUR (a widely accepted premise in tight gas analysis). Read the technical papers. Look at the data. Enough said again.

7. Economic new math – Skeptics also believe that the Barnett/Fayetteville will recover less gas than people think (and by extrapolation, other shales like the Haynesville will also disappoint). With less gas from shales, the marginal costs of supply will be high – some skeptics say as high as $8/mcf. We agree that if shale disappoints, gas prices will be quite high. Yet some skeptics run economic analysis of shales at $4/mcf gas prices..to prove that the Barnett is uneconomic. Circular logic here (queue Vince Vaughn in Wedding Crashers – Erroneous! Erroneous!). If recovery is low and prices are therefore high..you MUST use the higher price when evaluating shale economics.

8. Data Quality? Skeptics rely on Barnett monthly data reported to the Texas RRC. Because of the high amount of downtime in the Barnett due to completing offsetting wells, high line pressures, and other issues early in production, monthly data biases lower estimates of recovery. For these periods, the Texas RRC reports look artificially low because they reflect only partial months of production. The daily production data shows a much different story…CHK’s Analyst Day presentation shows this clearly.

9. Collusion? No. You, sir, are simply wrong – Skeptics discuss a conspiratorial angle and incorrectly suggests there is collusion between E&P companies, Wall Street analysts and engineering companies: “E&P companies that claim success, investment companies that promote their stock and activities, and engineering companies that certify assets must be held accountable for their conclusions…” We’re plenty happy to be held accountable for our conclusions..we publish them daily. The skeptics conspiracy angle is categorically wrong. The truth is much less sensational. Simply, many people representing hundreds of companies analyze the data and come to a different conclusion. It is laughable to think that: A) thousands of people are conspiring to make the Barnett/Fayetteville seem better than it is or B) all of these people are just incompetent.

10. Don’t go away mad…just go away – One skeptic stated that “Lack of material response either means they do not take my position seriously, or they do not contest it”. A Chihuahua can only bark at a bull dog for so long before the bull dog snaps back. And the dogs are snapping. Look at the BILLIONS of dollars being invested in shale activity. The industry is responding with its actions every single day. We are responding with this report. NO MAS!
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Shale speculation off base
POINT OF VIEW: MISINFORMATION CLOUDS NATURAL GAS GAINS

BY DAVID A. HAGER
Published: October 19, 2009
NewsOK.com

At a time when we are seeking solutions to our long-term energy questions, it is too bad that progress can be clouded by misinformation.

“Gas shale’s future is uncertain” (Associated Press business story, Oct. 13) cast
inexplicable doubt on a new resource that has changed the landscape of our energy future.

Geological consultant Arthur Berman has been making a name for himself recently by writing columns and giving speeches that question the long-term viability of shale as a source of natural gas.

There is nothing new about shale. It is a type of rock that energy companies have been drilling into and around for decades. We knew how natural gas and oil can emanate from shale, but until recently we did not know how to produce energy from the dense, tight formations themselves.

By unlocking the shale, we have opened vast new natural gas supplies that were beyond our reach a decade ago. This would be exciting news at any time, but at a time in history when we are worried about energy independence and clean energy, this new development is better than a ninth-inning homer to win the Series. Meanwhile, Berman is in the stands speculating on whether the slugger is on steroids.

Questions are an important part of the scientific process. But Berman slings doubt with a broad brush. Speaking last week to the Association for the Study of Peak Oil and Gas, he called shale natural gas the nation’s next speculative bubble likely to burst. He compared optimism surrounding shale to banks buying into mortgage-backed securities.

I guess it is true that every paradigm shift has its doubters. After all, there were people who downplayed Thomas Edison and his incandescent light bulb.
The fact is that shale is a proven success story. The Barnett Shale, which Berman targets with his skepticism, has grown from almost nothing 10 years ago to the largest producing gas field in the United States. Today, the Barnett’s annual production is enough to heat 20 million homes for a year.

The shale story doesn’t stop at the Barnett. Devon and many other energy companies across North America are applying what we have learned in the north Texas field to other shale fields. The industry is investing billions to develop natural gas production other shale fields. The industry is investing billions to develop natural gas production from untapped shale formations in Louisiana, Texas, Oklahoma, Pennsylvania, New
York, British Columbia and elsewhere.

Because of shale, natural gas production in the United States has been on the increase in recent years, reversing a prolonged trend downward. And, these wells are expected to produce for 40 or 50 years. Meanwhile, the country’s natural gas inventory is growing. The Colorado-based Potential Gas Committee estimates reserves are up 35 percent over 2006 estimates,
largely because of new access to shale natural gas. Estimates suggest the United States has nearly 2,000 trillion cubic feet of natural gas reserves, enough to last more than a century.

To borrow from Mr. Berman’s terminology, that is a mighty big bubble.

Hager is executive vice president of exploration and development for Devon Energy.

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BY JAY F. MARKS
Published: October 15, 2009
NewsOK.com

Chesapeake Energy Corp. officials are optimistic about the future, with a stable of
“legacy assets” they expect will provide revenue for years to come.

Officials touted Chesapeake’s strengths Wednesday in New York at a conference for
investors and analysts that was broadcast live via the company’s Web site. They pointed out Chesapeake is the most active driller in the United States, with substantial lease holdings in the most lucrative shale gas plays.

“We do feel like we have the No. 1 resource base in the nation,” said Steve Dixon,
Chesapeake’s chief operating officer.

Dixon said Chesapeake’s shale holdings will continue producing for years to come,
despite “misguided” predictions from an analyst at an industry conference in Denver
earlier this week.

“We’re very confident that these types of rocks will continue to bleed gas for decades
and decades,” he said.

Jeff Fisher, the company’s senior vice president of production, said the unique size of Chesapeake’s assets will allow the company to develop new technology to maximize production.

“We’ve achieved great results to date, and we’re just getting started,” Fisher said.

Chesapeake detailed its holdings in the nation’s two largest shale plays: more than
500,000 acres in the Haynesville shale in Louisiana and Texas and 1.45 million acres in the Marcellus shale in West Virginia, Pennsylvania and New York. The company produces an average of 210 million cubic feet equivalent per day of natural gas in the Haynesville shale, a “world class” asset Chesapeake discovered in 2007.

“We’re just scratching the surface on the production side,” geoscience manager John
Sharp said of the Haynesville operation, which is being supplemented by additional
plays in Louisiana.

Chesapeake is the most active driller in the Marcellus shale, a massive play close to the best gas markets in the northeast. Tom Layman, the company’s vice president of geoscience for the eastern division, said Chesapeake is determined to make its efforts count in that area.

“We are gathering data and learning about the play like no other company,” he said.

Marc Rowland, Chesapeake’s chief financial officer, said Wednesday’s technical
presentations were meant to show analysts the value embedded in the company’s
assets. Officials project Chesapeake will produce 5 trillion cubic feet equivalent a year for the next several years, while finding an additional 3 trillion cubic feet equivalent each year, Rowland said.

CEO Aubrey McClendon said he expects gas production to decline, but he is optimistic prices will continue to rise, which will lead to an increase in drilling and production.

“We think all of the elements are in place for gas prices to be higher in 2010 than they are today,” McClendon said.

He also said gas prices could be affected by increased demand from China, much the same as other commodities. McClendon said he and other natural gas company executives are working to increase demand, focusing on making inroads into transportation and power production, which is reliant on coal and transportation.

He borrowed a line from fellow gas advocate T. Boone Pickens to sum up his thoughts on the issue. “If you’re not for this … you are for foreign oil,” McClendon said. “That’s one of Boone’s best lines, I think.”

He said transportation seems like an easy place to increase natural gas use.
“There is no alternative for trucks because you can’t move an 18-wheeler by battery,” McClendon said.

He also said he expects the market for liquefied natural gas to continue to grow because it is cheaper and more environmentally friendly than other alternatives.