U.S. Shale Gas Hype

With natural gas prices at record low levels in the US, I have been hearing arguments that the abundance of shale gas has resulted in an abundant supply for that country far into the future. While this is good for consumer, it is bad news for investors in natural gas companies.

The Oil Drum, a well-known peak oil website, has posted an article entitled 'Shale Gas - Abundance or Mirage? Why the Marcellus Shale Will Disappoint Expectations'. It gives a detailed analysis of the likely poor financial performance of Exploration and Production (E&P) companies involved in the shale gas play. Of particular interest to me was the following paragraph:

"Our evaluation suggests that there is limited commercial value from these plays despite public enthusiasm and operator claims. E&P company shareholders have subsidized low natural gas prices and have little hope of recovering their investment in the near term. The underlying problem is a failure to grasp the concept of discounting. Reserves that are produced in small volumes over decades have little future value and are, therefore, not reserves. The shale plays are called resource plays for a reason: they are all about resources but not profit or the shareholder."

The conclusion is that the shareholders and bondholders of these E&P companies are subsidising consumers of natural gas in the US.

Why is this relevant to us? Because one of the companies analysed in the article is Chesapeake Energy, which received a US$500 million investment from Temasek Holdings in the form of a 5.75% cumulative non-voting convertible preferred stock with a liquidation preference of $1,000 per share. Besides Singapore, sovereign wealth funds from Korea and China have also invested money in the company. One hopes that buying the preferred stock is a much smarter move than buying the ordinary stock of Chesapeake, which has had a dismal performance since the financial crisis of 2008.