A hoodwinking for BHP Billiton

by Michael West | Jun 30, 2012 | Business

I agree with this guy’s assessment. This is one of the four shales I worked at [deleted] and while you had some wells that had already cum’d over 2-3 BCF in their first year or two, they were far apart and usually were overlying structure.

This shale is one of the more difficult shales in the country to work. It is complex structurally and sequence stratigraphically with target zones of only 20-25′. There is a reason we sold all of our Fayetville [sic] assets to BHP (the first shale we have ever sold all of our assets in).

This little gem was buried in a treasure trove of emails discovered under Freedom of Information requests by The New York Times. The guts of it is that BHP Billiton seems to have been hoodwinked out of a cool $4.75 billion.

It bought the Fayetteville asset from the cunning Chesapeake early last year and, if the view of this Chesapeake executive is correct, BHP has been the victim of a very slick dudding.

A company spokesman put a brave face on things yesterday:

”BHP Billiton did not rely on Chesapeake’s or Petrohawk’s company reserves figures in estimating value for its acquisitions. We conducted our own independent analysis to determine not only total proved reserves, but, as important, the total unproved resource base we were purchasing in both transactions, which is the largest part of the value of the properties.”

They were never going to throw their hands in the air and say, shucks, you’ve got us there! But the odd 2-3 BCF well does not make a ”world-class, long-life, low-cost resource”, as BHP put it.

For those not au fait with the glamorous world of shale gas, note that 1 billion cubic feet (BCF) of cumulative production from a well equals roughly one million times the gas price in revenue.

The gas price is now $2.80. A well costs $6 million to $7 million to drill, so $2.8 million in revenue is a dismal failure. And the odd 2-3 BCF well is a marginal proposition at current gas prices.

On the other hand, 5 BCF cumulative production is considered to be a good well, and a darn fine well at a higher gas price.

And Petrohawk, incidentally, is the other US asset swooped upon by BHP last year, for which it is now suffering buyer’s remorse, having splashed $15 billion on something which is now bleeding $4 million a week. In its defence, it could hardly have been expected to predict the rout in gas prices.

Yet there is a more serious matter at stake. The email above is just one of thousands of documents sourced by The New York Times in an investigation into the economics of shale gas. The question the Times is trying to answer is whether Chesapeake and other shale oil plays are part of an elaborate $15 billion ”Ponzi scheme” (its words, not ours).

The question is important because the answer goes to whether the US will remain a low energy cost country or become a high energy cost country again.

And the implications for Australia, let alone BHP, loom large. LNG exports to the US, for instance, are uneconomic at present prices. If the price remains low in North America, then the US will become an energy exporter.

If the shale boom is one big Ponzi scheme, then the price of gas, which has collapsed over the past couple of years – it has bounced off its recent lows of $2 but remains a far cry from its $8-plus peak – will rise again.

If it is not a Ponzi scheme, then the US will remain a low energy cost country. The economic, let alone geopolitical and environmental ramifications, are immense.

Chesapeake, despite its reputation for shoddy corporate governance, accounts for some 10 per cent of US gas production. Its prolific drilling in recent years has helped drive the collapse in prices.

And the suspicion is that Chesapeake and others have been exaggerating their resources. If there are 10 million acres of land which can be drilled, there will be small sweet spots which might boast cumulative gas flows of, say, 5 BCF.

There are wells like this; the question is, how many? How big are these sweet spots? Much of the material turned up by the investigation casts doubt on the industry’s claims.

”The official from IHS Drilling Data, a research company that specialises in energy issues, says that the word among independent oil and gas producers is that shale gas drilling is a Ponzi scheme and that it will be difficult for companies to make money,” the report summary says.

The key issue here is that this letter – which prompted the Chesapeake email – suggests that many of the Fayetteville holes will generate only 0.5 BCF of gas (a disastrously low amount). It specifically canvasses those low cumulative gas flows in areas where BHP has paid for reserves. Moreover, the report notes many holes ”communicate”, which means you cannot just add the reserves – reserves from one hole escape through others.

The Fayetteville mine purchased by BHP comes in for special treatment in the email trove. There is a July 2009 email from a senior official from Ivy Energy, an investment firm specialising in the energy sector, which questions whether a shale bubble burst might be on the way.

Michael West established Michael West Media in 2016 to focus on journalism of high public interest, particularly the rising power of corporations over democracy. West was formerly a journalist and editor with Fairfax newspapers, a columnist for News Corp and even, once, a stockbroker.

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