Thursday, September 13, 2012

What You See Is Not What You Get In "Mathematically Impossible" Shale Oil Reserve Data

The Securities and Exchange Commission's (SEC) new rule for oil and gas, companies to book reserves has opened a potential gateway to false valuations of shale assets.

1. The new unrecented SEC rule allows companies to book reserves as proved undeveloped, or PUD's, which must be developed within 5 years: the "5 year rule".

2. Contingent resources that would likely never be developed have been overvalued as PUDs giving an artificially inflated estimation of potential shale reserves, saving some companies from default. A company with underperforming assets in need of cash flow could conceivably book contingent resources as PUDs to access funding and cheat the system.

3. The above may explain the recent massive impairment charge at BHP Billiton (BHP) on its US shale assets. BHP bought assets from Chesapeake Energy and PetroHawk. In the case of the Fayetteville assets bought from Chesapeake, over 50% of the purchase price was written off as an impairment within a matter of mere months by BHP, claiming a drop in natural gas prices.

4. Clearly this is happening for 40% or more of booked reserves at some shale companies, including PetroHawk and Chesapeake, are actually PUD's which was previously never allowed.

5. In late 2011, 80% of the top 10,000 oil and gas companies were issued comment letters by the SEC for anomalies in their public filings. Only 16% could show with that their PUD's would be developed in 5 years. So 84% of the companies were not in compliance with the new SEC rule. Some companies were declaring PUD's that were described as "mathematically impossible".

6. According to company filings, the number of years shale companies would need to develop their PUD's is significantly more than 5 years.

According to the Oil and Gas Financial Journal:

DevonEnergy. 9.1 years
Range Resources. 11.8 years
Chesapeake Energy 13.1 years
Apache Corp. 15.1 years
W&T Offshore. 104.56 years

All of these companies are violating the 5 year rule.

7. PUD's account for nearly half of all reserves at companies like Chesapeake and PetroHawk. These are assets that according to company SEC filings would take almost 3 times longer than allowed to develop. It brings the entire scope of shale oil production estimates and company valuations into serious question.

8. As shale oil reserve data skews our collective vision for an energy secure America, the smart money says, "Don't bank on it."

Why? Because any oil company can lease cheap acreage, advertise it with hyperbole, drill a few wells, and then resell it at an enormous profit without proving the wells are economcally viable since the new SEC rules do not require 3rd party verification of reserves. In other words, smoke and mirrors.

9. What halpened in Q3 2012? A massive flood of asset sales and impairment charges. Who would sell an otherwise proven oil field that was producing cash? They wouldn't, they would continue operations and retain the asset. The only way some of these companies have been able to generate cash is through such pumped up and puffed up asset sales filled more with hot air than with oil.

Buyer beware. The writing is on the wall:

The Financial Times:   "sleight of hand" in shale company financials.

Bloomberg's headline January 2012:
"U.S. shale bubble inflates after near record prices for untested fields".

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