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Economist: Don't Get Too Comfy, Shale Fans

"The more people think things are going to stay the same, the more surprising it will be when they change," might be an apt revision of an old proverb for today's shale gas industry.

"...[F]rom time to time we're in a period of plenty, like we are now, and then from time to time we're not. We have to just have a little more humility about that going forward," economist Michelle Michot Foss, head of the Center for Energy Economics at the University of Texas, told a Houston audience last week.

There is evidence to suggest that the United States will have plenty of cheap natural gas for a long time. But then again, the factors supportive of a long-gas case -- with low prices and low volatility -- all could change, Foss warned attendees at Argus North American Gas Markets 2012.

"Pretty much everything that I see out there is confirming that there's a pretty good probability that at some point we could have a price surprise, and it could actually happen sooner rather than later..." Foss said.

Producing natural gas from shales has turned into a low-price, high-volume enterprise, and that has attracted the major energy companies to acreage across the country that not long ago was the stomping ground of just independent producers. The majors have deep pockets, strong cash positions and balance sheets, giving them the ability to take big acreage positions and absorb the ups and downs in the business. "They're in it for the long haul," Foss said.

Or maybe not.

"...[W]ill the major companies get tired of trying to get that business model proved up? It has happened before, and those of you who have been around a lot know that it has happened before, and there's nothing to suggest that anything has to be permanent in this world," Foss said. "Acreage positions can get dropped, businesses can get spun off. All sorts of things can happen as we work through the price environment and supply that we're in."

Foss is currently engaged in an analysis of producer and supply basin economics. She said producer costs are increasing "in some interesting ways."

For instance, larger companies moving into shale plays have had an effect similar to what happens when a neighborhood is gentrified, prices go up. "Everybody loves to work for large companies because they have master agreements and cost reimbursements are higher," Foss said. "All of that is coming into the picture and pushing up cost structures overall on a full-cost/Mcf basis for all sources of supply.

"We do see some cost reductions on a company-by-company basis in places where people are really working hard. But we see lots of cost pressure. We see spending well above cash flow; we see depleting credit revolvers, all the stuff that is causing people to kind of take another look at the producer segment and sort of wonder what's really going on."

Of particular interest of late, Foss said, has been the category of suspended exploration costs, which are costs that are in limbo because associated reserves have yet to be booked. "...[F]or the North American-based shale specialist companies, the really interesting thing is to see the size of the suspended exploration costs for those outfits because that suggests there's something going on in the low-gas price environment," Foss said. "They are having trouble dealing with those costs and it's something to watch."

Meanwhile out in the patch, the industry has seen the death of the conventional gas project. "People haven't been able to sell deals like that, get them funded, get them drilled for years now, and it's starting to show up" in production figures, Foss said. "All of these natural decline curves that everyone has been fighting are still out there. That's fundamentally the message. There are folks that really, truly believe that shales can make up the difference, but all the business conditions have to support that."

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