How to Lose (or Make) a Fortune in West Texas

How many bubbles have been made in the oil industry just in the last ten years? Have we currently made another one in West Texas?

Last week an article in the Wall Street Journal trumpeted in the sub-title "Wall Street’s rush to Permian Basin is [a] sign that long-awaited recovery in oil and gas prices may be in the offing."  Ironic that the journalist cites as evidence that "[i]n some cases, Permian drilling properties are fetching prices that exceed those paid when oil prices were above $100 a barrel two years ago."  The story goes further when it quotes analyst Charles Robertson II of Cowen Group Inc, "Some are starting to feel like this is a bubble,” he said.

Count me among the "some."

Over the course of my career, I've watched up-close a number of lemming-rushes into hot plays.  The Austin Chalk in the 90s.  The Barnett in the mid-2000s.  The Fayetteville, the Haynesville, the Eagleford.  In fact, I doubt that there has been a single modern shale play that has not been overbought.  

Like most modern shales, the Barnett still serves as a useful model.  In north Texas, fortunes were made and fast.  But the fortunes were made by those who sold, not those who bought. Land prices more than doubled every year for seven straight years, and anyone could make money as long as there was someone else trying to rush in. The tide, of course, eventually turned.  The last buyers were left holding the bag and their names are now legends of cautionary tales, names like Quicksilver and Legend Natural Gas and Chesapeake Energy. 

When Chesapeake leased the Barnett under my suburban home, they paid me $8000. Since then, seven years of royalties have totaled about $953.  When Quicksilver paid over $1.3 billion in 2008 for its largest acquisition ever, it was paying mostly, and heavily, for the undeveloped Proved and even Probable locations. This asset, plus other major assets of the company, liquidated in bankruptcy early this year for $245 million

The Austin Chalk could have served as a lesson before the Barnett.  It caused an adolescent Chesapeake Energy shares to rocket up to $32 /share as one of the very best performing stocks on the NYSE during its excitement and then crash to just over $1 as reality arrested the dreamed-of expansion.  On a shorter time frame and more recently, the Haynesville fever caused land prices in Henderson County, Texas to explode from $300 /acre to $15,000 /acre and then implode again back to $300 /acre all within 12 months. 

In all of these, and many other cases, the new entrants bet heavily on uncertain contingencies and often shallow analyses.   They bet that the geology was the same in the next ares, that they could use conventional methods to predict ultimate recovery based on short and transient production, that they can make a type curve from a dozen wells, that technology will always increase recovery. They bet that commodity prices would stay high or rise, that price differentials wouldn't change, that drilling costs would decrease.  

It is true that lots of money can be made in bubbles, and bubbles can continue for longer-than-expected periods.  Making money depends, though, on the timing of news and thus sentiment that is largely outside individual control. Trying to profit in a bubble is a little like playing a game of "chicken" with a cliff you can't see. 

If we could curb our enthusiasm enough to take a steely-eyed look at the science, at the historical patterns of shale development and at the basic laws of economics, maybe we could avoid the cliff others have fallen off.  And I would be pleased to help you try to navigate the dangers.  

Perhaps the first step, though, is to recognize the bubble.  As the WSJ article of last week closed with the following quote from Permian stalwart Concho Resources, I heard piercing alarm sirens.  

“The Permian has attracted so many new entrants that the competition for these deals is really at a fever pitch,” 

What do you think?  What advice do you wish you had gotten entering a new and hyped play?  Do you think the Permian falls in this category now?  May it in the future?