Tudor Pickering Take On Berman...

The following was sent to me by email by Tudor Pickering as part of their analyst opinions.  In my mind, Tudor Pickering is THE Cadillac analyst shop.  Real engineers, Holditch acolytes, etc.

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

 

·         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 actualincremental 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!

Comments

[Scott]

Thanks for the post. I believe you when you say these guys are good. I also understand how their bread is buttered.

When I got my first job in this business, I asked an old crusty engineer, “how do you calculate reserves for a well”? He smiled and said “Son, I’ll tell you how you calculate reserves, you plug the well and add up the production” There is a lot of truth to this.

I want these plays to work, but there are three (3) problems today, NYMX futures, operating expenses, and steep declines. There are a lot of words in the TP post, and some serious bravado, but they skip the numbers necessary to generate a forward looking model. What numbers does one use for a predictive model in terms of product prices and operating expenses? I believe the reserves. The average NYMX gas price through December 2015 is $7.09. I see wellhead prices discounting NYMX between 10% and 40%. This can put the wellhead price near the $4.00 per MCF, the number that TP disparages. What are the operating expenses? I am reading financials that indicate production costs between $1.25 and $3.25 dollars per MCF for shale players. Choke, what number do you use? TP dances around the hard questions.

Aburey McClendon says shale wells will produce for 65 years, but most models have the wells going uneconomic significantly before this projected life expectancy.

If one uses NYMX discounted 20%, and 2.00 per MCF operating expense, it is hard to make a shale model yield positive economics. I don’t want to be negative, but I have some hard nosed pencil pushers to answer to. Bravado does not impress them.

There are four factors depressing gas prices ad follows:

1) The recession which had lowered demand.
2) Increased supply due to shale wells
3) Real and anticipated LNG growth
4) The end of government incentives. Don’t look for any of those juicy tight gas tax credits….our government seems to be fixated on incentives for renewable resources.

Are any of these likely to change anytime soon? My models say that a shale play is a bet on a long NYMX position. Why not skip the hassle of drilling and just go long?

What am I doing wrong? How can I defend a shale play with hard numbers? I’ll let Tudor Pickering do the tough talking. I am waiting to see some input numbers.

[Crash N. Burn]

Rodney King: "You don't own me..."
Rodney King: "Ow, ow, ow, ow."
Rodney King: "Can't we all just get along?"

"What's your point, Crash?" you ask.

First, we make the decision to deploy assets based on a variety of factors, most of them highly speculative, some of them emotional, (i.e. everyone is doing it, let's do it, and some of them are doing it well, and we're smarter than they are). Retrospect will decide if you should have stayed in the car or become a playa'...shale playa'.

Second, reality often bites you on the butt. If you're really, really good, you could be successful in the shale plays. If you're not that talented, like not seeking and understanding all of the data, you could take a beating!

Third, this is a highly speculative business, always has been, always will be. We make smart decisions every day that turn out to be wrong. We make bad decisions and trip over a giant gold nugget. Some very smart people have differing opinions about resource plays, so it boils down to in whom/what do you place your trust and what is your appetite for risk.

Ultimately, every prospect is a bet on a long NYMX position, a bet on a deep talent pool, and the belief that it can be done by us, right here.

Once upon a time, Dean McGee thought you could bolt a drilling rig on a barge and go punch a hole in the bottom of the Gulf of Mexico to find oil...

[Scott]

Crash, I disagree with your statement that "Ultimately, every prospect is a bet on a long NYMX position", not in my world.

I am sure every shale location will be drilled, but it is a question of timing as to who makes money. There are a lot of companies that invested heavily in acreage 18 months ago when futures were promising. They guessed wrong, and they are going to loose huge amounts of money, unless we get a big surprise in gas prices. Today gas prices suck and so do the futures. Many of the plays won’t work with these prices. There is a lot of scrambling going on right now, to include “optimistic” projections of reserves and economics. It is panic time. This is the reality as I see it. There are not enough rigs or capital to drill the vast amount of leased acreage. Leases will expire and assets will evaporate. It’s hard to drill uneconomic wells to hold acreage. Now it is crunch time. Pony up the $ to drill or write off the leases. Choke wrote a piece several years ago about “lease overhang” in the Barnett. He identified the Barnett as a top leasing option. Maybe the true Playas are sitting back, waiting for the right time to strike. You can’t BS a BS’er.

[Scott]

Berman's Blog:

http://petroleumtruthreport.blogspot.com/

[Crash N. Burn]

You don't run project/prospect/well economics using future cash flows based on forward price curves in your world? Yes you do.

[Scott]

Crash, yes I do use futures in my forward looking models. Now if the futures don’t make the project work, I can’t get it financed. I can not make the project drillable based on hope gas prices will out perform NYMX. The reserves have no collateral value and hedging is impossible. If I invest resources to promote this type of prospect, I am seeking a greater fool. Sometimes it makes sense to sit still. It is just that simple.

If you will look at Berman’s Blog, you will see why he is drawing so much heat. He has specifically put into question the reserve claims of XTO, Devon, Chesapeake and EOG, and done a good job of it. Berman is claiming their reserves in the Barnett are grossly overstated, and does it sans the T&P macho. My $ is on Berman.

[Scott]

Choke, I have reread the T&P piece, and I have to say I am surprised and disappointed with the language, as well as the content. The article lacks class and certainly lacks professionalism. Here are some excerpts:

“Two can play this game..and we say GAME ON!”… “Enough said. Read the technical papers.” “Look at the data.” “Enough said again.” “Don’t go away mad…just go away” “Chihuahua can only bark at a bull dog for so long before the bull dog snaps back”

What are they so scared of? I think I know.

So T&P is the bulldog and Berman is the Chihuahua? Read Berman’s response to this piece. If nothing else it is a lesson to T&P in class and professionalism. The T&P piece reads like something a schoolyard bully would write.

Now we write stuff like this in Blogs all the time, the difference is we don’t put our company name on it, hell we don’t even put our real name on it!

[Crash N. Burn]

It's the investment banker mentality...the smartest guys in the room! I never believed it, and believe it less so now. Like I told my father, the banker, "Those who can, do. Those who can't, loan money to those who can."

My real name is Marcellus B. Haynesville. My stripper name is Pico D. Gallo.

[Scott]

Crash...I had to laugh at that one!!

[Scott]

That T&P report reminds mne of the Jeff Skilling / Cree conference call from 2003....http://www.fool.com/investing/general/2003/10/24/crees-conference-call-blues.aspx

[Open Choke]

I see your points, but have to disagree overall with the conclusion. The TP article IS substantive, it addresses specific issues, unlike Skilling et al. Also, I think the tone compares in tonality with the "conspiracy" theme running through Berman's work. He isn't exactly non-snarky, either. Of course, no one compares with moi for Snark Factor.

[Crash N. Burn]

You're the Snarkinator!

[Scott]

In the brilliant words of Mark Felt…”follow the money”. The whole Berman thing can be boiled down, in my opinion, to his stinging and accurate criticism of the stated reserves of four companies’ Barnett production as follows:

XTO claims….3.3 BCF per well………………...Berman says XTO < 1BCF per well
Chesapeake claims….2.65 BCF per well………..Berman says CHK < 1BCF per well
EOG claims 2.45 BCF per well………………….Berman says EOG < 1 BCF per well
Devon claims 2.2 BCF per well……….…………Berman says DEV < 1 BCF per well

Does anybody really think XTO’s Barnett wells will average 3.3 BCF per well?

The claimed numbers vs. Berman’s numbers are huge. The difference between G4 Flying and sticking out the thumb. Berman is challenging some big, big boys, and there will be blowback. Can investment banking types and stock analysts “miss” the obvious while raking in big bucks? Just look at Enron, and all the accounting / financial firms that towed the line for big fees.

“In a time of universal deceit - telling the truth is a revolutionary act.”
George Orwell

[Open Choke]

Or, alternatively, Scott, instead of being the lone honest voice, perhaps Berman doesn't know how to run the hyperbolic decline function and can only calculate exponential declines. Isn't that what the Tudor Pickering argument is when it is boiled down?

[Scott]

Choke, I disagree. In an earlier comment to this post I referenced a link to Berman’s response to the T&P piece. He responded with composite decline curves, which are hyperbolic. T&P is dancing around the tough questions. Does anyone support the XTO stated reserves of 3.3 BCF per well?

[Driller]

First, Scott I agree with you - I was very disappointed with the language in the article. Given their claims to technical supremecy, you would think they would learned how to write a professional critique of a peer's work.
XTO (and Range to some extent) both seem to overstate their Barnett reserves. I personally believe it is how they report/calculate their IP's but I don't have many facts along those lines.
In T&P's report: I strongly disagree that following the money (point 10) is much of an indicator - with all the hype there is plenty of stupid money wanting in with no idea what is in store. Following money is a different path than following reserves.
However, I do agree with point 5 - there is no doubt that over time the average reserves will increase for a well in a given area. However, they gloss over the fact that this requires technical innovation which some (not all) companies are capable of and/or willing to do. For me, this means that for a given shale investment, I have evaluate not just reserves, costs, etc - I need to have some knowledge of how good a shale operator really is regarding technical ability.

[Open Choke]

Driller, spot on. Plug to my sponsors here, but Drillinginfo's ESP group categorically quantified Operator Ability in the Barnett in their unconventional research platform. This issue is a real game changer in the industry since land grabs no longer guarantee success. Also, it adds a huge new fact set to O&G attorneys advising clients on leases. No longer is it Bonus and Royalty that are overriding factors, but operational competence. Most of these lawyers are in big danger of giving really negligent advice now, because their business rules of thumbs are out the window, and these guys typically don't discern between legal advice and business advice they give.

Herald in the new age of the stimulation and completions engineer. It could be the best age yet!

[Scott]

Operator ability is certainly a factor, but is substantially overblown in my opinion. The real expertise in stimulation exists within the walls of Halliburton, and is for sale to anyone with the $.

[Scott]

http://www.ft.com/cms/s/0/b4240cf4-c585-11de-9b3b-00144feab49a.html?nclick_check=1

[Scott]

According to Berman, his gig at World Oil was cancelled due to pressure from companies which have vested interests in shale plays, specifically Petrohawk. If this is true, it is pretty clear the oil business can not police itself, and needs additional regulation, preferably at the Federal level. Perhaps the SEC can pick up where Berman left off, and put these shale reserves under the microscope.

[Open Choke]

I wasn't aware that World Oil was an industry self-policing body. The SEC does look at reserves and reserve reporting. Berman is not a reservoir engineer. He may have had more credibility had he been. In any case, he got what he wants. Notoriety. Live by the snark, die by the snark.

Scott, you should look at the methodology the DI ESP folks used for quantifying operations. The range is huge. My personal experience with field operations in unconventional plays is that it CANNOT be merely bought from a service provider. It is doing a dozen things right on many levels, both during completions and in normal day to day field operations. Again, just my experience and luck at being able to compare my own poor operations and having the luck of being a non-op with a company that really knew what they were doing. For us, it was the difference of having a hugely economically successful acreage position and having a non-economic position... not in the Barnett, but in another unconventional play.

[Scott]

Yes, you are correct that World oil is not a police force. It is also true that if Petrohawk did put pressure on WO to silence Berman, then perhaps the “conspiracy” you attribute to Berman is actually a conspiracy to silence a critic that is speaking the truth. Today the oil drum had 49 posts regarding the censoring of Berman, the majority of which support Berman’s position. You don’t have to be a PE to understand the economic limits of a gas well. Again, I ask the question, does anyone believe the XTO stated average reserves of 3.3 BCF per well for their Barnett wells? Yes it is true that the SEC audits reserves, but they also audited Madoff multiple times. So there are audits and AUDITS. Die by the snark (or fraud) is also true.

[Open Choke]

At the end of the day, Berman's work doesn't bother me at all. In fact, it helps me because it causes FUD in my competitors, and allows me to get positions I couldn't probably get. I should buy him dinner! However, we live in times where we aren't likely going to be able to let this play out the way it should... drilling wells and producing better and better wells, but rather having huge existing producing areas permanently excluded from exploration and production because of myopic analysis. Ready, shoot, aim. That is the defining philosophy of the Pelosi/Reid Congress thus far. Like giving children whiskey and handguns.

[Crash N. Burn]

...there's a little gauge on all these gas wells that reports the volume of gas which flows through it over any given time period. If you had all those numbers together, you get total production. Multiply that by the price of gas in the particular market for the given time period and you get the gross revenue, then subtract LOE, taxes, royalties. The day the net operating revenue drops below the cost of producing that revenue is the day the economic limit is reached.

I would suggest that a good operator pushes that day further into the future just as surely as a higher gas price does.

Ultimately, who gives a rat's ass what World Oil "thinks"...the truth lies at the end of a drill bit, always has, and shareholders can make the snarkiness call on their own. Like XOM says, the market values the company, not vice versa. A free market is self correcting. (I know Scott...we've already discussed this)

Meanwhile, Scott's point makes me wonder if the big engineering companies who prepare or audit public company reserve reports are not unlike the ratings services hired by Wall Street to assess risk. If that thought can cross my mind, you may be assured some elected imbecile in Washington DC can think it, too!

[Crash N. Burn]

In the end, Berman is wrong. In the end, Petrohawk is wrong. For today, its a pig (educated guesses) wrapped in a blanket (agenda) to provide us a nourishing and tasy snack for thought.

My final point: In no other field besides geology does one get such a wholesale return of "knowledge" for such a trifling investment of "fact". Wouldn't an E&P play which was not geology driven drive the geologists crazy?