- May 5, 2015
- Posted by: Art Berman
- Category: The Petroleum Truth Report
David Einhorn just discovered sex. Too bad that he didn’t ask any adults if they already knew about it.
In a presentation at the Ira Sohn Investment Conference on May 4, Greenlight Capital hedge fund manager David Einhorn revealed that tight oil is not profitable even at oil prices of $100 per barrel.
Mr. Einhorn has apparently just figured out what some of us have been saying publicly for many years.
In a post last month, I wrote almost exactly what Mr. Einhorn said yesterday:
“The financial performance of most companies involved in tight oil plays has been characterized by chronic negative cash flow and ever-increasing debt. The following table summarizes year-end 2014 financial data for representative tight oil-weighted E&P companies.”
Table 1. Summary of 2014-year end financial data for tight oil-weighted U.S. E&P companies. Money values in millions of U.S. dollars. FCF=free cash flow (cash from operations plus capital expenditures); CF=cash flow; CE=capital expenditures. Source: Google Finance and Labyrinth Consulting Services, Inc.
(Click image to enlarge)
In an earlier post, I stated that tight oil companies had terrible financial results in 2014 when oil prices averaged more than $93 per barrel and that:
“this class of company has become the sub-prime derivative of the post-Financial Crisis period.”
Earlier this year, I provided considerable detail on tight oil and shale gas economics and reserves in a video on my website.
David Hughes, Rune Likvern and others have also echoed much of what Einhorn apparently just discovered.
Mr. Einhorn gets shale gas completely wrong. He stated yesterday that “the natural gas frackers… are globally competitive, low‐cost energy producers with attractive economics.”
The financial results for shale gas-weighted E&P companies are, in fact, much worse than for the tight oil companies, as shown in the table below.
Table 2. Summary of 2014-year end financial data for shale gas-weighted U.S. E&P companies. Money values in millions of U.S. dollars. FCF=free cash flow (cash from operations plus capital expenditures); CF=cash flow; CE=capital expenditures. Source: Google Finance and Labyrinth Consulting Services, Inc.
(Click image to enlarge)
Sampled shale gas companies’ negative cash flow for 2014 was -$15.5 billion–$5 billion more negative than their tight oil counterparts and $7 billion more negative than it was in 2013. Shale gas debt for 2014 was more than $93 billion, an increase of almost $10 billion over 2013.
What part of these financial results does Mr. Einhorn see as economically attractive and globally competitive?
I give David Einhorn credit for recognizing what few among Wall Street investment firms have publicly stated namely, that tight oil was not profitable for most companies at high oil prices and is a big loser at current prices. It is difficult to understand why he needs to take credit for an insight that is hardly new.
Besides ” console energy” Greenlight Capital’s” portfolio is far away from energy.
But still close to about a half million $.
Kill oil,promote gas.
Arthur,people who want to find out the truth will not turn to Mr Einhorn,trust me.
William,
You are right. Greenlight Capital is looking for a short, not the truth.
All the best,
Art
Billion
Don’t look a gift horse in the mouth. Hopefully, with more folks like him discovering what you have been saying all along, there would be less money propping up this unprofitable industry. It takes a while, and maybe an event like the current oil price drop, for unconventional views such as yours to become conventional knowledge.
John,
Greenlight Capital is looking for a short, not the truth. I am glad to hear all views on the oil and gas business but confirmation has not been a theme that I am accustomed to or that I anticipate.
Thanks for your comments,
Art
Since Mr Einhorn runs a sizeable hedge fund, you would think he’d allocate one of his staff to read your column. I guess if you are learning about oil and gas company sex on the streets (motherfrackers), you may not get all your facts straight (i.e. ‘natural gas frackers …. are globally competitive’).
As usual, thanks for your column Art Berman. Regards.
Daniel,
I imagine that Einhorn’s staff is astute and well read and, therefore, knows about my work, Dave Hughes’ work and other workers. I imagine that references were not given to make it seem as if all this great insight came from Greenlight for reasons we can only guess.
All the best,
Art
I partially disagree. There are many who have profited from the tight oil plays. They are landowners, CEOs, acreage speculators, and service companies. Unfortunately, investors aren’t on the list.
I remember Sandridge explaining why they paid 5-10x market value for acreage. They said it builds value. They also said they were going to save $7M this year by not painting their tank batteries, and that they reduced the cost of each tank battery by 50% to $270k. I don’t know how Sinopec, Repsol, and others were duped into wasting so much money.
Your insight and analyses have been spot on, but I predict many rigs will be firing back up and making holes once oil reaches $70. The companies might not be profitable, but people will get rich(er) who have the right angle. A good exit strategy (properly timed) could be the key to profit for many companies (i.e. KOG).
Thanks for all the good literature; I thoroughly enjoy your articles.
Sean,
Please don’t forget the investment bankers who have profited from all aspects of shale gas and tight oil during price increases and price decreases as debt, public offerings and asset sales are needed for a risk-free hefty transaction fee.
The analysis presented in my last several posts indicates that only the Eagle Ford Shale play breaks even at $75, and the Permian and Bakken require $85 per barrel to break even. That doesn’t mean, of course, that the tight oil companies won’t be able to get other people’s money at the $70 price at which you say drilling activity will resume.
There is, however, no guarantee that prices will reach $70 per barrel. Prices are rising somewhat based on vapor, on sentiment that rig counts are falling and other inconsequential or indirect indicators. I have worked out the lag time between well spud and first production for the 3 main tight oil plays–it is 3 months for the Eagle Ford and Permian and 5 months for the Bakken. Since the first month of meaningful rig count decline began in mid-December, there will be no decrease in production from rig count until at least April and we won’t know that production data until at least July.
I suspect that, barring some geopolitical crisis that threatens to interrupt oil supply or an OPEC production cut after their June meeting (about which I am increasingly doubtful), it is at least as likely that oil prices will move down to below $50 per barrel as it is that they will rise to $70.
I don’t want to be gloomy, but there is really no reason for oil prices to have risen to present levels. IEA and EIA data indicates that the production surplus increased in March. U.S. demand data is encouraging and U.S. is 20+% of world consumption but we really don’t know about most of the rest of the world. On the other hand, the latest U.S. GDP data is dismal.
At best, there is no tangible reason for oil prices to increase except sentiment. For now, my sense is that it is somewhat more likely that oil prices will fall than rise. At present prices or lower, there will be decreasing well completions regardless of rig count.
Thanks for your comments,
Art
yvest,
Thanks for discovering the incorrect link. AthenaHealth was one of Greenlight’s previous shorts.
The numbers don’t get through because they don’t fit the narrative. The narrative is that we are no longer running out of oil and gas in the United States. We have found a new source from shale that is cheap and abundant. We’ve accomplished this the American way, through ingenuity and technology.
We are now the oil and gas super-power of the world because of it. Everyone wants what we have found. We will change the geo-political structure of the world by exporting our limitless supply of natural gas. We have surpassed Saudi Arabia as a producer of crude oil and will no longer need to depend on the Middle East or any other countries for our energy.
Everyone either has a vested interest in this narrative or just wants to believe it.
That’s why it is difficult to be heard and believed. The problem with believing the narrative is that we–as a nation and collectively as the world–are making terrible decisions based on incorrect information.
All the best,
Art
Hi Art
Indeed you and others have done valuable work by explaining the risk of fast depleting shale reserves in the past years which individual E&P SEC filings subsequently confirmed. The later can be understood by all of us value investors. The field decline rates of 50% however was the all important news some years ago to understanding the risk of the sector – ie that more growth means more value destroyed at $100 bbl and that the sector simply needs higher commodity prices. Instead, access to cheap money for a decade allowed the sector to oversupply the market and gave them lower prices.
But why did Exxon then by XTO? This and other herd behaviour by the industry (not the outsiders) will always remain a mystery to me.
In my view you should be cheerful that David uses his voice to discuss the shale bubble in public. The sooner this discussion starts, the sooner we revert to the mean. But I am afraid central banks, not David Einhorn, will determine the timing!
As for his presentation, should you not correct more of his statements? Or is it true that PDC’s oil assets deplete over 50 years? Not according to David Hughes’ recent Drilling Deeper report. So his DCF seems much to optimistic still. What is your view?
Warm regards
Alexander
Alexander,
ExxonMobil bought XTO for two reasons: reserve replacement and to dance at the party. Majors have had increasing difficulty replacing reserves over the last decade and buying reserves is one solution. The XTO purchase in early 2010 saved XOM from what would have been their worst year ever for reserve replacement.
When FT asked Charles Prince, CitiCorp’s CEO before the Financial Crisis, in 2007 why he decided to put his company into securitized mortgages after resisting this trend he famously said,
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
In other words, if everyone is doing something like buying credit default swaps or entering shale plays, the pressure from Boards of Directors and shareholders becomes overwhelming at some point even if the investment goes against the CEO’s better judgment.
For XOM, XTO and shale was a relatively small part of their overall portfolio unlike the true shale players, so their risk exposure was not great.
The net present value of reserves beyond about 20 years is close to zero but some of the plays have reserve life of many decades that at least pays for operating expenses. We have no experience in producing fracked reservoirs this long so these reserves are quite uncertain. Water handling expense is a factor not included in our cost estimates and may limit reserve life.
All the best,
Art
More copy/paste.
Andrew Hall (astenbeck capital management) was quoted in Bloomberg Business.
“The shale boom has already gone bust”
I was thinking,I’ve read this before somewhere.
Hi Art,
Just watched your video (and saw the einhorn prez also) – very informative indeed. however one point that seems to be missing (or maybe i dont get) is the fact that cash flow are indeed back end loaded. When you develop a play, need to invest up front infrastructure… these guys all have massive inventories and after that costs come down BIG time.
For good plays, IRR on additional wells can be very high and thnn low capex to tie them into existing infrastructure + value in creating expertise to drill shale and knowledge of shale. look at what happened in the wattenberg – wells costs have halved over time!
I dont think its a ponzi scheme – certainly not more than any other business. even though for sure some of these companies are overvalued
boutros,
Your comments about negative cash flow and “expanding the capital base” are commonly raised to me. In a conventional oil and gas play it is true that there are negative cash flows while a field is being developed followed by a period of profit until depletion requires further capital expenditures.
With shale plays, it is different because the development never stops because of high decline rates. If a company stops drilling, production and reserve growth decline ~30% per year, the stock is abandoned, net asset value plunges, loan covenants are triggered and the company is bankrupt.
Looking back 5 years or more for the shale companies, the negative cash flow gets increasingly negative each year and debt increases. If the companies are really expanding their capital bases, we should see this turn around in their cash flows and balance sheets but it never happens.
Thanks for your comment,
Art
Hi Art,
Thank you for sharing your articles and presentations. I have learned much from these.
I was surprised to read your comment that ” it is at least as likely that oil prices will move down to below $50 per barrel as it is that they will rise to $70.”
Do you still believe US production will decline by 500K barrels by June/July. If this is the case, why should prices fall back to $50? If the market knows a supply reduction is looming, does that not support prices? Or is it the rest of the globe over producing now (Saudi, Russia) that makes you feel this way?
Thanks.
Greg
@Greg #17
I have the same question for Art. We know, for instance, that based on current rig count, which is about 40% of the peak, we will see a corresponding decrease in production by Nov. of this year. Since the percent of wells completed is even less than that due to financial constraints, we will see a production reduction that is earlier and bigger than the rig count drop would suggest.
Looking ahead, we will continue to see more good news (for oil prices) from the U.S. production side as well as from demand. The impact of the Iranian deal still seem to be for next year as it seems. Iraq has ramp up production but Libya will continue to be a festering basket case with more instability. Both the Saudis and the Russians have already cranked up production so that is yesterday’s news.
I am sure something will come out of the left field and surprise us, but for now I am just not seeing it.
John
John and Greg,
Oil prices are higher than before based on pure sentiment. Some of this sentiment is founded on things like rig count that should result in reduced production in the U.S. The r2 correlation between rig count and oil price since January 1, 2015 is 38% meaning close to no correlation. Oil price rose in February, fell in March and has been rising again in April & so far in May–all the while rig count has been falling. Rig count is a “soft” factor.
Prices are moving sideways right now. They will probably rise and fall a few more times until something “hard” happens to determine a course. If OPEC doesn’t cut production next month, prices could easily drop to $50 or lower. If OPEC cuts production, prices could rise to $70. That is hard.
There are indications of increased demand. That could become hard but it’s mostly U.S. and, to a lesser extent, OECD where we have data on inventories. It is hopeful but still somewhat soft.
The presumption is that the price collapse is a simple matter of a production surplus of 1-2 mmbpd. But we had surpluses that great or greater in 2004 (almost 2 mmbopd) and 2005 (> 3 mmbopd) without any price decrease (see the graph). In the first half of 2012,we had a surplus of >2 mmbopd and saw a price decrease from $126 to $91 per barrel (Brent) but nothing like what is happening now–within 2 months, prices were back to $116.
Something different is happening now. Production surplus is a big factor but 33 months of oil prices above $90 per barrel is an extraordinary factor and the state of the world economy and world demand are other factors that we must somehow consider.
Also, U.S. production may have been the trigger for the over-supply, but it is not the entire story. Libyan production bounces up and down several hundred thousand barrels each month as the civil war interrupts supply–that’s almost as much as the total U.S. decline that I model out into late 2015. Then there is Iran. If sanctions come off, there could be another 2 mmbopd there (I don’t think it will be that extreme and, in any case, won’t happen all at once). Iraq is another wild card.
It may be as simple as a fall in U.S. tight oil production that will balance the market and cause higher oil prices. But higher prices will bring back the same old problem of over-production.
I see an equal probability that oil prices could rise or fall by $10-20 or continue moving sideways. I believe they will move sideways until something hard happens–OPEC cut or no cut, clear production decline, clear demand increase, a geopolitical crisis, combinations of those factors, etc.
I am not trying to be pessimistic. You asked for my opinion and I am being completely objective and honest. I may also be completely wrong!
All the best,
Art
Art,
Thanks for elaborating. I agree with your assessment that something different is going on now. It seems that the decline was overdone, given the facts. God only knows what else is behind it.
I follow the weekly EIA Domestic Production number, which stands at 9,369, down 4 on the week. It’s been flat now for 3-4 weeks. A “hard” event may be a drop into the 8’s on this figure. At that point I can’t imagine ever getting back above 9 with prices below $100. How many rigs were required to put us here? This is the culmination of four years of $100 oil and QE 1-3.
Thanks again for sharing your thoughts.
Best.
Greg
Greg and John,
I see that the U.S. rig count only fell by 11 this week. That should dampen expectations for a production decline and market balancing! Soft factors can cut both ways.
Art
Art,
Thanks for the thoughtful response. Looking at the graph provided through your link, I see the following patterns,
1. When the oil price is above about $100, excess supply causes prices to drop.
2. When the prices of oil is significantly below $100, prices go up regardless of supply and demand excesses until it reach about $100.
I am going out on a limb with the following speculation, so please take it with a large grain of salt.
This pattern is characteristic of peak oil. With our current mode of energy usage, demand naturally will push until prices reach $90-$100 range, at which point demand destruction becomes acute and demand drops until prices of oil drops.
Supply needs $100 to increase as you have pointed out. This is for tight oil, deep sea or arctic.
Looking at both demand and supply, the natural equilibrium state is at $90 or higher, so in the long run, oil will be at this price.
To get there, we will continue to see oscillation between demand destruction/Increased production and demand stimulation/decreased production. This will continue until we are either in a permanent recession or find new way to use oil at the higher prices, or both. If the oscillation becomes more frequent, we will see a faster path to permanent demand destruction as the memory of the last high prices are still with us during the low price period and lower prices will not stimulate enough demand to return to the old habits of energy usage. In the longer run, adjustment will be made in the economy for the higher oil prices. In the short to medium term, there will be more recessions and economic malaise as we try to adjust to the new price of energy and transport.
Like you, I have no illusion that the Saudis will cut production in June. The only question is, how much of this is already baked into the current prices.
Regards
John
John,
You are not out on a limb at all but some people think that I am a crackpot for my views on peak oil.
That is probably because they don’t understand that peak oil is not about running out of oil–it’s about running out of cheap oil.
I don’t see how any rational person can dispute that tight oil, deep-water oil and oil sands are expensive oil. So, we continue to find plenty of oil but it requires $90 long-term prices to make the investment. As you correctly point out, that leads to price cycling as price rises above anyone’s marginal cost and demand destruction sets in. I highly recommend James Galbraith’s The End of Normal for more detail.
The investment banks launder the silly notion that tight oil is cheap with their absurd break-even price “research.” They do this so they can sell deals to investors desperate for a yield above treasuries and CDs, and they get risk-free transaction fees. If the oil companies get in trouble, they make money on asset sales, mergers and acquisitions, or liquidating the zombies. It’s a great business model for the banks especially when the Federal Funds rates are zero so they can even make money buying treasury bonds while they pedal secondary share offerings and corporate debt for the tight oil crowd.
The Saudis are concerned about long-term demand for oil and competition from renewables when oil prices are high, not to mention competition from expensive oil. I don’t know what they will do in June but I don’t see how a production cut works in their favor now. If I were them, I wouldn’t cut production. Why subsidize the competition by making expensive oil and renewables attractive at higher oil prices?
If there is no production cut in June, I can easily see a $10 drop in oil prices but I may be wrong.
Thanks for your thoughtful comments,
Art
I think it is a positive that a high profile hedge fund manager like David Einhorn is finally bringing to light the mathematics that you have been illustrating for years Art. He’s another credible voice.
The one piece that I think he missed is that he seems to accept the production type curves presented by the industry as real. He assumes the 50 year well life is legit which, of course, it is not. My guess is that if he did an audit on actual well production versus company presentation, he would come to the same conclusion regarding nat gas as he did for oil.
DDH,
I welcome David Einhorn’s voice in the discussion on the truth about the economics of shale plays.
I am certain that he has some extremely bright people doing his research who undoubtedly could know the reality of shale gas. My guess is that it was outside of his interest for a short so he didn’t ask them to look into it much or that he’s long on gas.
All the best,
Art
Art,
Skimming through the media, I am already seeing indication from the Saudis and Kuwaitis that they are not cutting production given that the prices have already gone up. It seems June 5 is increasingly going to be a none-event.
John
John,
I agree that an OPEC production cut at their June meeting looks increasingly doubtful especially if oil prices remain in their present range. Why cut if the market is taking care of things nicely by itself? At the same time, I doubt that prices can do anything but fall based on the bleak data on persistent over-production. Please see my most recent post “Oil Prices Will Fall: A Lesson in Gravity.”
All the best,
Art
Art: Great insights, as usual! Do you agree with the following Economist article’s conclusion that “American shale firms are now the oil market’s swing producers”? http://www.economist.com/news/business/21651267-american-shale-firms-are-now-oil-markets-swing-producers-after-opec
Sam,
It think the idea that shale producers are the new swing producers is among the truly inane things that I hear regularly.
John Kemp’s recent comments on this typify the lack of meaningful things that analysts find to write about these days. His argument takes an obvious market factor–low prices will force the high-cost producers to produce less–and gives it the name “swing producer” and voila, we have something worth writing about!
Why do analysts continue to babble about swing production?
EIA states that “In late 1985, Saudi Arabia abandoned its swing-producer role, increased production, and aggressively moved to increase market share. Saudi Arabia tried a netback-pricing concept, which tied crude oil prices to the value of refined petroleum products. This reversed traditional economic relationships by guaranteeing specific margins to refiners, thereby transferring risk from the crude oil purchaser to the producer.”
I suspect that if more analysts had any background in geology, geophysics or engineering and had working experience in the oil and gas business, we might hear less nonsense from them. But, then again, they are selling a product for their patrons–usually the investment banks–so perhaps this would only temper the nonsense.
All the best,
Art
Hello Art, I enjoy reading your blog.
Shale companies are still making a lot of noise about how they’ll be able to cut costs. Personally I think they are being far too optimistic and are basically engaged in a PR campaign in order to ensure they can keep selling shares and bonds. How long do you think this PR campaign can continue to be successful in keeping sentiment on fracking so high? Obviously it depends a lot on the oil price (and there are some other jokers in the deck like a Fed rate hike) but it seems to me that even if they can reduce costs at a very optimistic number, say 30-40%, WTI would have to be at $75 or so in order for even the well-run companies to go cash flow neutral, especially considering debt loads (this is back-of-the-envelope, nothing more). Naturally, a lot of the valuations are very high, when the facts on the ground are considered.
I don’t expect investment advice, but just as an example, to hedge some investments in companies that I think are long-run profitable but could be badly punished if/when oil tumbles from here, I’ve thought about going short on some high-debt producers with very high market-cap-to-balance-sheet-equity ratios that haven’t yet been punished by the market (PVA for example has been hammered, CLR and CRZO have not been hammered at all, in fact they’ve ripped a bit even from when WTI was $1.50 above current levels). But I find that the market pricing and sentiment for some of these companies is so high, it’s just a quixotic battle against hopium and not an investment whatsoever. So I’ve been reasonably cautious.
The article I’m talking about is here, perhaps as a blog post idea you could even concentrate on the “CEO PR” that these shale companies are constantly engaged in.
http://www.bloomberg.com/news/articles/2015-06-10/why-this-shale-ceo-isn-t-afraid-of-opec-or-low-oil-prices
Facebear,
Can you think of any business that can take a 35% cut in its only product and still make money? I can’t so I say that claims that companies are “making it up on efficiency” are borderline fraud.
I am confident that the industry is getting more efficient at drilling wells. They are getting discounts on drilling rigs and frack crews right now too. But when a company like EOG (I own stock in EOG) states that they are making more money at $60 oil than they were 3 years ago at $90 oil, I really have to doubt that this can possibly be true. Of course they are using a measure called “ATROR” which excludes everything except drilling and completion costs so even if the statement is true, it is not true in the real world where there is a universe of other costs that are conveniently excluded.
Regarding Apache, the premise of the article that Apache CEO Christmann is “he’s making more cash from operations than he’s spending” is incorrect. Based on Apache’s Q1 2015 10-Q, cash from operations was $650 million and capex was $1,991 million or a negative free cash flow of -$1,341 million.
Thanks for your comments,
Art