Sunday, August 18, 2013

The hype cycle: How the oil and gas industry manipulates investors and the public

What would you expect them to say?

That's the question you should ask whenever spokespersons for the oil and gas industry (or fake think tanks funded by the industry or analysts whose bread is buttered by the industry) announce a new find that is going to be a "game-changer" (or bigger than another well-known world-class field or enough to make America energy independent again).

Prepare yourself for another hype cycle in the U.S. oil and gas industry. The industry says it has found a deposit of oil that may turn out to be the largest in the world. The deep tight oil deposit goes by the name Spraberry/Wolfcamp and is located in West Texas. It's no surprise then that the industry is trotting out the America-as-the-new-Saudi-Arabia theme once again, a theme that many including me have shown to be pure bunkum.

[Clarification: If you click on the Spraberry/Wolfcamp link above, you'll read that it is not a new discovery, but rather discovered in 1943 and has been producing some oil since then. But the CEO quoted in the story cited just before that link stated that "Spraberry Wolfcamp could possibly become the largest oil and gas discovery in the world," thus leaving the impression that it was recently discovered. I can only surmise that this was part of the attempt to exaggerate what is actually happening. What's new is the application of high-volume slickwater hydraulic fracturing to the deposit, a specific and admittedly new variant on a 60-year-old technique. What I'm questioning in this story is whether that technique will, in fact, deliver what the executive promises. He says one thing; the data say another.]

And, the chief executive officer of Pioneer Natural Resources Company, which is currently touting its dominant position in the Spraberry/Wolfcamp deposits, added some bunkum of his own when he told The Dallas Morning News, "We’re more like a manufacturing operation than a traditional oil drilling operation.” This is the discredited notion that in tight oil and shale gas deposits, a company can drill anywhere and extract economical volumes of oil and/or natural gas. The idea has been discredited by the record of every tight oil and shale gas deposit drilled to date, deposits which settle down into a pattern of tightly focused "sweet spots" where drillers can make money and vast areas that are not profitable to drill--mainly because the oil and natural gas are too difficult to get out.

Though there are plenty of other reasons to doubt the claims about Spraberry/Wolfcamp, no one will know for certain what's true until the area is drilled and produced [much more broadly using high-volume slickwater hydraulic fracturing]. But, in order to drill it, oil and gas companies must raise billions in capital to pay for drilling and production costs. And, in order to do that, they have to get investors interested in plowing money into the drilling of actual individual wells through what are called private placements.

These placements are riskier than shares of oil and gas companies because they relate to specific drilling projects which may or may not succeed. On the other hand, such projects can be quite lucrative when they do succeed. Hence, the continuing attraction for the speculative investor.

Now, investors are not going to make such risky investments unless they believe the potential return is very high. Here's where the industry hype machine comes in. To raise the necessary capital, it is essential to get investors excited about particular oil and gas plays. The best way to do that is to create buzz in the media about the estimated size of the resources in the play. And, an easy way to do that is to invoke comparisons with Saudi Arabia and its giant oil fields as is being done in the case of Spraberry/Wolfcamp.

Many investors in such deals are not particularly sophisticated about oil and gas investments and so the hype works. The money flows in, the wells get drilled, and then the oil and/or natural gas flows or it doesn't. Or it flows, but not enough to justify producing it. Or it flows and is produced at a loss in order to get back at least some money.

Let's see what's already happening at Spraberry/Wolfcamp. First, we have the claim that Spraberry/Wolfcamp has 50 billion boe. For the uninitiated, boe is short for "barrels of oil equivalent." So, it's a mixture of oil and natural gas, but we are not made privy to how much of each is supposedly there. (About 6,000 cubic feet of natural gas contain the same amount of energy as a barrel of oil.) It's an important distinction since North American natural gas prices are so low that few operators are making any money from gas. Any emphasis on natural gas production in Spraberry/Wolfcamp should make investors skeptical about the profitability of selling more natural gas into an already glutted market.

Second, this number is labeled as "recoverable reserves" when it ought to be labelled "technically recoverable resources" which are based on very sketchy data that are continuously revised as drilling proceeds. And, just because something is technically recoverable doesn't mean it is economically recoverable.

What will ultimately be economical to extract will actually be only a tiny fraction of what is technically recoverable. And, in any case, we should remember that previous large estimates of technically recoverable resources in America's shale gas fields were later rather dramatically downgraded. Furthermore, neither technically nor economically recoverable resources represent "reserves" which are, of course, only that very small fraction of resources which can be produced profitably from known--that is, drilled--fields using existing technology at today's prices.

Third, one has to ask why Pioneer Natural Resources, one of the largest holders of drilling rights in the Spraberry/Wolfcamp deposit and the chief cheerleader for its exploitation, would almost immediately sell 40 percent of the company's stake to a foreign investor.

There are many reasons to sell a stake such as raising money for new ventures. But, Pioneer is telling the public that this deposit may be the largest in the world. Does the company really expect to do better than that with the money it received from the sale of a large portion of its interest? Or does the sale tell us that the company doesn't have as much faith in Spraberry/Wolfcamp as its pronouncements seem to indicate? Furthermore, this outside investor will also shoulder 75 percent of the "drilling and facilities costs" as part of the deal. Alas, the problem of finding money to drill the actual wells has in this case simultaneously been solved with other people's money.

The last time foreign investors came rushing into U.S. oil and gas deals was at the tail end of the shale gas boom, and they subsequently got clobbered. It has often been an indication that a boom is ending when foreigners flock to a particular American investment theme since foreigners are usually the last ones in.

This may have to do with the fact that even in the age of instantaneous electronic communication, it is still difficult to get a read on what is happening an ocean away until something has become a fairly big story in the media. (And, so it's no surprise that companies like to talk to reporters in highly optimistic tones as they seek outside investors.)

What ought to worry these late-to-the-party investors is the fate of those who invested not only in shale gas, but also in certain tight oil plays. (Tight oil is often mistakenly called shale oil which actually refers to oil made from oil shale, but that's a different story). Investors believe oil should be a better investment than natural gas since world rather than regional markets dictate the price, and that price continues hover near all-time highs based on the average daily price over the last three years. There is something to this logic unless the amount one is able to extract is small. And, that's what is happening to investors in the Colorado and Ohio tight oil deposits who thought they were in for a bonanza. Both regions were heavily touted, and both turned out to be huge disappointments.

A few reporters are starting to catch on to the pattern and including dissenting voices in their coverage. And, a just recently retired industry CEO has now said publicly that the shale gas and tight oil story is overblown. Mark Papa, former CEO of EOG Resources, which has extensive positions in both shale gas and tight oil, told Forbes recently: “The chances of the U.S. being independent in oil are very slim.” He added, "We’ve studied this from the rocks’ point of view. There’s a whole lot of plays that will have zero significance."

It's possible that Spraberry/Wolfcamp will turn out to be a very profitable venture for oil and gas companies with holdings there. Pioneer Natural Resources has already made a considerable sum by selling a 40 percent share to someone else. And, it's possible that even individual investors in wells may end up glad they invested. No one can know for certain. But all indications are that these investors should not base their decisions solely on the information coming from the industry.

Unfortunately, the public--which mistrusts the oil and gas industry almost universally--for some reason takes the industry's self-interested pronouncements about supply at face value. Perhaps this is because the public does not understand the true purpose behind these pronouncements.

Beyond the industry's desire to raise capital and sell off assets at a profit, the hype cycle aids industry trade groups such as the American Petroleum Institute (API) in propagating doubtful stories implying America is about to become energy independent. (The API has stopped making explicit statements on this subject which it knows are unsupported by the data. Instead, it keeps repeating the word "abundance" to give the impression that the country is or will soon be energy independent.)

The purpose of such stories is not particularly patriotic. Rather, these stories are designed to slow the transition to alternative energy sources by making such a transition seem far less urgent. In the process, the API is able to protect the value of its members' underground inventories of oil and natural gas, some of which might become stranded or at least less valuable in the event of a rapid transition to alternative energy.

As the reality of tight oil and shale gas sets in, even energy analysts--who so often parrot what the industry tells them--are starting to look skeptically at industry claims:

"Oil companies take production data from existing wells and extrapolate it over an entire field that might be millions of acres. And the oil business is rife with cases of fields that were the next big thing but ultimately produced nowhere near early estimates," said Benjamin Shattuck, an analyst with the energy research firm Wood Mackenzie.

If the analysts are finally looking skeptically at industry pronouncements, you should, too. Don't fall victim to the emerging hype cycle over Spraberry/Wolfcamp or the next cycle over something else, or the next one after that.

PLEASE NOTE: Clarifications are in brackets [].

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now, The Oil Drum,, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at


Anonymous said...

The one thing that you do not mention is that America consuming 22% of world oil consumption consumes 7 billion barrels of oil each year. Assuming no increase in consumption this find if it came to fruition would last less than 7 years. It would last the world less than 2 years.

ChemEng said...

Mr. Cobb:

Your blog refers to chief executives and spokespersons on the one hand and increasingly skeptical analysts on the other. There is also another group of people who could influence the way in which we approach peak resource issues. I refer to the middle managers, senior engineers and scientists, consultants and project managers who work in the oil and process industries. They have a good grasp as to how the energy industry works and are comfortable with numbers (including charts and graphs).

Obviously they have a financial interest in the success of their companies, but their income is more on a straight salary or hourly rate basis. If this group of people were to become more aware of the long-term trends discussed in blogs such as this they may well be able to influence the broader discourse. And it is they who will be needed to implement any changes in direction that we need to make.

Anonymous said...

According to AllianceBernstein, the shale oil revolution is already ending and oil prices are going to surge.

Productivity of the newest plays to come on drillers' radars have not come close to what's been coming out of the Bakken in North Dakota and Eagle Ford in Texas.

And even for those two, he says, peak recovery rates of new wells drilled have been declining and flat, respectively.

As a result, drillers are moving on to less productive basins and lower-quality acreage.

In order to maintain current levels of overall production, marginal conventional production must be maintained with high oil prices. We expect marginal cost inflation will continue.

We forecast $96/bbl WTI for 2013, $101/bbl WTI for 2014, and longer term prices above $120/bbl and rising after 2017.

Kurt Cobb said...

Thanks for such insightful comments. The first anonymous commenter is correct to point out that even if the outlandish claims for Spraberry/Wolfcamp were to turn out to be true, the amount of oil wouldn't last the world very long, and, of course, it wouldn't come out all at once on demand, but at a fairly slow rate over many decades.

ChemEng points to something I already know from experience. Many of those who work for the oil industry understand our energy predicament better than they are letting on (for fear of losing their jobs or at least the acceptance of some of their colleagues with whom they must work on a daily basis). The top managers are obliged to pitch investors and lobby legislatures and so habitually put the most optimistic spin on everything.

The second anonymous commenter points to work by Bernstein, an investment management firm which has been unafraid to look out for its investors' interest when it comes to oil and gas investments. Their analysis has been careful and data-driven and points to a relatively short boom in the shale gas and tight oil fields of America.

ChemEng said...

Thanks for your comment on my comment. Actually, I see it slightly differently. Many mid-level managers do understand these issues (I had one colleague who taped a hand-drawn Hubbert Curve to his office door) but most don’t. They go to work day after day and think mostly of short-term issues (such as where the next project is coming from). Like most other people they do not see that the world could change.

It’s a pity because, as I noted, these people are numerate, have access to key data and are (at least by human standards) rational. I see many people in the Peak Oil movement complaining that the mainstream media do not explain these issues to the general public. That may be a step too far; maybe the true leadership could come from these mid-level managers and technical experts.

If you are looking for an example, consider Matt Simmons. His writings and speeches are what introduced me to this topic. When he spoke to engineering/management groups he seemed to be “one of us”. Even the way he dressed seemed to fit in. He was a true leader.

Anonymous said...

What matters most with oil is the price!

In 1973, the U.S. was the World's Biggest Oil Producer.
In 1973, the U.S. imported only 35% of its oil (44.6% in 2011).

Despite this situation, the 1973 oil crisis in the Middle East ended the post-World War II economic boom and the recession in the U.S. lasted from November 1973 to March 1975.
U.S. unemployment rate jumped from 4.9% in 1973 to 8.5% in 1975.

So, the idea that being the world's biggest oil producer will protect the U.S. from a new oil crisis is not realistic.

Dan Beecroft said...

Great article. Thanks for the post.