LET'S BE HONEST ABOUT SHALE GAS

After 10 years of production, shale gas in the United States is a commercial failure. This is because decline rates are high, per-well reserves are lower than expected and costs are higher. Few of the analysts and journalists who promote the view that gas will be cheap and abundant for decades have worked a day of their lives in the oil and gas industry.

Natural gas prices have been low because of reckless over-production of shale. Chesapeake Energy Corporation has lead the way in shale gas drilling and production and that company’s 2012 financial results calls the shale gas business model into serious question. The mainstream opinion that gas will be cheap and abundant for the foreseeable future is the latest in a series of incorrect supply and price predictions that most analysts agreed upon over the past five decades.

Because of high well decline rates, U.S. production has become a just-in-time phenomenon meaning that the drilling can never stop or production will plummet. In the Haynesville Shale play, 68% of second-half 2012 production was from wells that began producing in 2011 and 2012. Current Haynesville production is down 2.5 billion cubic feet of gas per day from the peak in November 2011 and field production is declining at 40% per year.

When viewed objectively, it is impossible to deny that shale gas has been a commercial failure in the U.S. Accounting tricks and unrealistic modeling assumptions are commonly used to make the case for abundant and cheap shale gas for decades but these are not grounded in fundamentals. Plummeting gas-directed rig counts and shale play production show that the industry has voted with its feet against shale gas. The unraveling of Chesapeake Energy and the poor financial performance of other leading shale gas producers reveals the flaws in the shale gas business model.

Shale gas will not, however, be a commercial failure forever because prices will increase to at least meet the marginal cost of production. More responsible companies will dominate and prosper as the U.S. gas market re-balances and weaker players disappear.