Case Study on Natural Gas/Shale Industry; Buffett Reads

Shale gas is not a revolution. It’s just another play with a somewhat higher cost structure but larger resource base than conventional gas.

The marginal cost of shale gas production is $4/mmBtu despite popular but incorrect narratives that it is lower. The average spot price of  gas has been $3.77 since shale gas became the sustaining factor in U.S. supply (2009-2017). Medium-term prices should logically average about $4/mmBtu.

A crucial consideration going forward, however, will be the availability of capital. Credit markets have been willing to support unprofitable shale gas drilling since the 2008 Financial Collapse.  If that support continues, medium-term prices for gas may be lower, perhaps in the $3.25/mmBtu range. The average spot price for the last 7 months has been $3.13.

Gas supply models over the last 50 years have been consistently wrong. Over that period, experts all agreed that existing conditions of abundance or scarcity would define the foreseeable future. That led to billions of dollars of wasted investment on LNG import facilities.

Today, most experts assume that gas abundance and low price will define the next several decades because of shale gas. This had led to massive investment in LNG export facilities.

(CSInvesting: You should read Mr. Berman’s full report at the link below.  He uses history to debunk long-term prediction models and shows the common sense of looking at markets through the long lens of history.  The assumption of abundant natural gas could be wrong–many “experts” are not even thinking of vastly different outcomes to their models.)

Excellent interview:


Excellent investment letters from Moran Creek

Are these sustainable competitive advantages ?

A great read on investing:

5 responses to “Case Study on Natural Gas/Shale Industry; Buffett Reads

  1. Hi John,

    It’s been two years since I last read your blog. Learnt a lot before that, and I am a VIC contributor now.

    Funny that it’s been so long and I was just researching shale (for the purpose of investing in depressed north sea offshore drilling industry). We think ~the same about shale.

    Check this out

  2. Hi,

    Could you please help me understand exactly how does this work?

    Does the reference to the credit markets mean that the cost of capital should be higher but because it has been so low the cost of production has been lower than what is sustainable?

    And if the cost is close to $4 for shale production, why would that not be a known fact?

    And what about cheniere energy. They have contracts to export at $3 for long in the future. If the price goes to close to $4, they would be losing money, wouldn’t they? Would Icahn and Klarman have missed that low prices are unsustainable or am I missing something?

    • Good questions. You are not taking anything on blind faith. Note the post before this one to look at how the market/experts could be wrong.

      Ok, if the Fed is/has been monetizing debt by creating money on their computer screens to purchase government debt from Wall Street, then interest rates are probably below the “real rate” of interest (the rate in a free market but we can’t know what that rate is unless the market were free of central planning) thus projects are being financed that are NOT supported by “REAL” capital/savings. Note the empty condos in the Las Vegas desert after the housing boom. Fiat credit replaces and partly supplants REAL credit. Real credit is saving that comes from NON-consumption. Think of yourself alone on an island. Your starving for two days to build a net is such an example.

      I am not saying Icahn and Klarman are WRONG, but they could be. the BIG money would be made if the price rose significantly ABOVE $4 or $5.

      Forget about Klarman, Wall Street Analysts……………go through the companies producing in the shale regions and see if they are generating free cash flow while replenishing reserves. If not, then the low prices will not be sustainable. I don’t know since I haven’t done the work yet.

      Where is that thinking in the Morgan report? Find where there is a big gap between belief and reality–therein lie profits. No one makes big money following Wall Street reports that are widely distributed and ACTED upon.

  3. I don’t know how to do this but I had a look at the financial statement of Antero Resources to find out the cost of production. I noticed that they produce some different products (natural gas, C2 ethane, C3+ NGLsm and oil). They then add the production into mcfe.

    They then give a price of production in mcfe and I don’t understand if that is what is supposed to be used to calculate the cost of production for natural gas specifically?
    Anyway, the average cost in 2014 was $3.3, in 2015 it was $3.21 and for 2016 $3.04.

    The sales price for the combined products for 2014, 2015, 2o16 were 4.73, 2.52 and 2.60.
    They only made profits because of their hedges.

    Net cash from operations for 2014, 2015, 2o16 were 998 m, 1,015 m, and 1,241 m. total investment outflow for these years were about 4.1 bn, 2.3 bn and 2.4 bn.

    I don’t know how you calculate the cost of replenishing reserves? Could one use cash flows from investment and compare it to the effect on the reserves to get an idea?
    In that case, the investment of 2.4 bn lead to a increase in reserves of 3251, adjusting for revisions and production. the production of 676 that year would be equivalent to a cost, or cash outflow of about $500 m. With an operational cash flow of $1.24 bn, that would not look too bad?

    I’m not sure if this method makes sense. I would appreciate feedback. I want to find out what the costs really are.

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