Marcellus Shale

Deborah Rogers: Mother of All Natural Gas Spin

Dr. Scott Cline
PhD, Petroleum Engineering

Part IV in a series entitled “Mother of All Spin” about Deborah Rogers’ New York speaking tour.

Parts III and III of our series delved into a myriad of problems with Deborah Rogers’ presentations but there is still more spin, because Rogers, as I’ve said throughout, seems determined to build a reputation as the “Mother of All Spin.” Rogers implies, incorrectly, that accounting impairments with respect to oil and gas companies between 2008 and 2010 (and by-the-way almost every other industry in the U.S. during the economic downturn) were related to overstated reserves.  She also misinterprets a number of other things and, generally, displays a thorough lack of real understanding of the industry.  Let us, in this final piece in the series, address some of these points.

Impaired Reasoning

Rogers, as noted above, suggests accounting impairments with respect to oil and gas companies between 2008 and 2010 were solely related to overstated reserves. This is simply not the case. First of all, one has to be careful not to confuse reserves,  the extractable volumes or oil and gas (either currently economical, originally economical or technologically recoverable depending on reporting requirements to SEC, IRS or other purposes respectively), with reserve value. Reserve volumes only show up on the balance sheet indirectly through valuation and then it is only the “proved” reserves, those known with great certainty.

For SEC purposes, the value of the reserves is computed by the future value of net cash flows from proved reserve properties, discounted at 10% and using the last 12-month first day average product prices. If, at the end of any reporting period, the amount of the unamortized investment exceeds the net present value of the projected future cash flows, such investment may be considered to be “impaired,” and accounting rules require that the investment must be written down to the calculated net present value. Such an instance would require the Company to recognize an immediate expense in that period, and its earnings would be reduced.

And, let’s be clear. The greatest fear for a CEO, and top management in general, is the impairment charge where reserve values are written down and charges against income occur.  Therefore, companies tend to be very conservative with their volume estimates to avoid such an embarrassment. As the natural gas prices plummeted from an average of $7.97 in 2008 to $4.48 in 2010, or almost 44%, wouldn’t it be natural for impairments to have occurred that often had nothing to do with reserve volumes? If gas prices remain at ten-year lows there may be more impairments, but it may not be related to reserves; that is to say the volumes of oil and gas economically extractable.

The resource estimates of “unproved” reserves, those known with less certainty, that Ms. Rogers often points to as also overstated, don’t even have any impact on the balance sheet and income statement. Since the 2010 SEC rule change, companies have been allowed to publish their estimates of such resources, but they are not required to and such decisions have no impact on the financial statements. Such reporting is for informational purposes only, to assist in full disclosure.

Going Horizontal Beats Vertical in Natural Gas

Rogers refers to some unknown “Halliburton advisor” who supposedly said vertical wells may be better than horizontal wells for developing shale. Now this is the coup de grace of vagueness, absurdity and contradiction. Just a few minutes earlier in her presentation she complained shale gas pads were “spaced carpet-like all over the place every ½ mile.”  That is hardly the case (indeed, it’s a bald-faced lie) but, if she wants vertical wells, then try having 32 wells pads per square mile. The truth is that shale gas horizontal well spacing is now about one small 4 acre pad per square mile and, more recently, they are being spaced at every two square miles because of technology that allows longer laterals. Some early Barnett pads may have been spaced more closely, but over time the spacing for shale gas plays has increased.

I do not know of a single professional in the industry that would agree with Ms Rogers that vertical wells are preferable to horizontal wells in shale development and for the life of me I don’t know why she even brought the topic up.

Horizontal vs, Vertical Well Spacing

Horizontal vs. Vertical Well Spacing (Source: Lenape Resources)

Chump Change?

Ms. Rogers makes a big deal of Fort Worth’s royalty revenue by stating that royalties have fluctuated from $50 million in 2008 to $19 million in 2009 to $38 million in 2010, yet the number of wells it took to generate that production she says quadrupled. She indicates “the fact that four times the wells couldn’t keep revenue stable is disturbing.” Hmm, I think what is most disturbing is the spin and lack of explanation. A quick check of natural gas prices over that period will explain a lot. Monthly average gas prices fluctuated from a high of $10.79 in July of 2008 to a low of 2.98 in September of 2009 to $4.37 in January 2011. I suspect that price probably had a lot to do with the royalties. And, without knowledge of  the actual gas price received for the production each month, whether some wells were shut in, restricted or not even hooked up to pipeline we don’t have the data to make the kind of statement Rogers makes, which is obviously tailored to fit her needs.

Regardless, that sums up to $107 million to the city of Fort Worth in three years. Now, don’t you think the cities of Binghamton, Elmira or Corning, New York would like to have that kind of fiscal stimulus?

While we are on that subject, let’s look at some more spin as Rogers takes some out-of context quotes from a Penn State study she says indicates only 18% of municipalities with drilling in Pennsylvania saw a local tax revenue increase with drilling and 26% said that costs had increased. The fact is that impact on local taxes is highly dependent on the state’s particular tax or compensation structure, the amount of drilling and production and its certainly not the only revenue generated for a community.  Moreover, that equivocal study to which she refers is based on subjective interviews and not hard facts and only counts municipalities, not dollars.  The takeaway, if anything from that study, such as it was, should be that municipalities reported no significant increases in costs.

Unlike Pennsylvania, which has now enacted a local impact fee law to address those local issues (that Ms. Rogers fails to mention), New York taxes oil and gas as real property based on production. So, tax revenue stays with the local towns and counties and will be enormous if production is similar to Pennsylvania. Using current New York unit of production rates, tax revenue would typically be over $300,000 per BCF of production. This of course varies somewhat by local tax rate.  IOGA-NY has an online calculator that can be used to compute tax effect to specific counties in New York.

Significantly, in the first six months of 2011, the three Pennsylvania counties immediately adjacent to New York (Bradford, Susquehanna and Tioga) produced 260 BCF which would translate into roughly $78 million ($156 million annualized) in local taxes for just the three adjoining New York counties. That’s staggering single year stimulus and tax relief.  If towns and counties also own and lease their land, the revenue could jump orders of magnitude through also receiving royalties and, together with our local taxes, would make the $107 million in Fort Worth royalties look like chump change.

Overstatement by the Under Qualified

Ms. Rogers claims job creation is overstated and air pollution effects are understated.

This is neither my specialty nor that of Rogers but, unlike her, I don’t shamelessly paste out of context clips to support a theme of air pollution and lack of job creation, I won’t even go there other than to say there are plenty of studies to show significant job and wage growth and minimal air quality impacts.  Moreover, industry is always committed to making the process safer and cleaner.

Nevertheless, what I can say from my own personal experience of living and working in areas with oil and gas development for decades is that I have witnessed nothing but positives from oil and gas development in every single community and region that I have lived.  I witnessed immense economic benefits in terms of state and local revenue, direct and indirect job creation, community involvement and community spirit. Oil and gas activity was not only universally accepted, but welcomed as a healthy and needed part of the economy and community. Neither I, nor anyone I ever knew suffered any known negative health impacts related to drilling and production operations and were universally thankful for the many positive contributions.

Finally, in a feeble effort to demonstrate shale gas wells are overhyped and overstated, Rogers gleefully mentions a Barnett well called the SW Arlington (TX) well. She says it was written up in the Fort Worth newspaper as the “Mother of All Wells” because of its enormous initial flow volume. She, of course, downplays this by saying she had “friends” pull the production records later and they told her the well had a “huge” drop-off. Well, again, is that vague enough for you? Actually, the well behaved just like all shale gas wells should, as I have already described: They typically have very high initial flow rates as the high permeability large fracture networks produce, drop off relatively quickly and then usually stabilize at lower rates that decline very slowly over times as the smaller, less well connected fracture branches and low permeability matrix flow begins to dominate. This is no secret and should be expected by any mineral owner. People making choices about how to spend their money based on the first royalty checks should know better.

Mother of All Spin

Well, I think it should now be clear to all readers that Deborah Rogers has indeed earned the title Mother of All Spin!  I found her conclusions and spin outrageous, factually bankrupt, offensive and downright unethical. Her personal story of feuding with an oil and gas company would be one thing but masquerading as someone qualified to speak on oil and gas reserves and economics is disingenuous to say the least. In the end, her presentations consisted of a rambling series of out-of-context quotes from “friends,” a parroting of the now thoroughly discredited June, 2011 New York Times article and a series of inconsistent and conflicting arguments. All she accomplished was really embarrassing herself and exposing her biased vendetta as simply the Mother of All (Natural Gas) Spin.

This the final post in the “Mother of All Spin” series …

If you missed Part I, entitled “Natural Gas Critic Refuses to See What’s Before Her Eyes,” check it out here.

If you missed Part II, entitled “Where Is That Natural Gas Treadmill?” you can find it here.

If you missed Part III, entitle “Rogers Natural Gas Spin Cycle,” here is the link.

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Dr. Cline holds s a BS in geological science from Penn State, and both MS and PhD in petroleum engineering from University of Oklahoma and an MBA. He began his career in 1976 for Gulf Oil Corporation (now Chevron) and later worked as geophysicist, geologist, petroleum engineer, and senior manager for several other oil and gas companies based in Houston and Oklahoma City. He currently lives in the Finger Lakes region of NY and consults to the oil and gas industry. He also teaches corporate finance and is an accredited business valuation specialist. He was involved in the early study and implementation of horizontal drilling , published on a wide range of oil and gas topics and his research interests include horizontal drilling in fractured reservoirs, well construction and design, reservoir simulation, fluid flow in porous media, oil and gas valuation, reserve and resource estimation, and unitization matters. His PhD dissertation was on decline curve analysis of horizontal and vertical wells in fractured reservoirs. He has recently served as subject matter expert at the US EPA technical sessions on well construction and hydraulic fracturing in Arlington, VA, the Quebec’s Office of Public Hearings on the Environment (BAPE) in regard to formulating oil and gas regulation in Quebec and testified before the NY State Assembly Energy and Environmental Committees on hydraulic fracturing.

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