“…why do operators keep drilling while their own over-production has depressed the price of natural gas by half of its value?” Art Berman, 2010

Thirty years ago, at an energy conference at M.I.T., I made a presentation about our research on natural gas supply, and opened with a joke. (That is, intentional humor.) The gas industry, I noted, kept saying that prices were too low to cover their costs, while continuing to drill. What could explain this? Management psychology? Animal spirits? Finance theory (option valuations)? No, the explanation was found in “The Journal of Abnormal Psychology.” The joke was much appreciated, except by the natural gas producers in the audience.

Now, the same question could be raised. After all, for most of a decade, predictions of a production collapse have floated around the punditsphere, while estimates of the breakeven price have tended to be well above those which have prevailed in the market. One typical story in 2009 noted that the “optimists” predicted prices of $5-6/Mcf were needed, while the pessimists thought $7-8/Mcf or more was required for production to be economic. Of course, this was after two brief periods of $10+/Mcf prices, in late 2005 and mid-2008.

Some pessimists, including famed peak oil pundit Art Berman, saw nothing but gloom and doom ahead. He actually commented that the Marcellus but “is likely to move forward more slowly and at greater cost than in other shale plays.” Since then, Marcellus production has grown by a factor of 7, from 2 to 15 bcf/d, and it is now the most prolific shale play in the US.

And there’s Bill Powers, who has spent more than a decade decrying the potential for shale gas production, and assailing the optimistic views of Daniel Yergin, T. Boone Pickens, and British billionaire Michael Lynch (that’s who the link leads to). He argued last year for the popping of the shale gas “bubble” and that “While many economists like to think that higher prices will always bring about more supply, the laws of physics and geology always win and in increasingly mature areas, like much of the US, rising prices will at best only slow down the production decline.” Since then, prices have dropped by 25% and production has continued its increase.

Of course, the conventional analysts haven’t done much better in terms of estimating costs and forecasting prices. A review of academic and other studies that I conducted found that $4/Mcf was the lowest estimate of breakeven prices, and that was from a range of $4-$6.50. Mean forecasts were on the order of $5.50-6 and higher. Estimates for different shales varied widely: for example, Texas’ Barnett shale was estimated to cost between $2.15 and $4.25/Mcf, and the cost estimates for production in the Marcellus also ranged from $2-4/Mcf.

Why have so many been so wrong? (I have been optimistic, but have not produced specific forecasts for shale costs or prices until recently, so can’t claim prescience, although Powers is correct to lump me in with the optimists.) Most cost estimates were static in nature, as production methods and technology were evolving rapidly, so they weren’t wrong so much as limited. This explains much of the difficulties that conventional forecasters have had trying to explain production and prices.

And of course, the pessimists have fallen prey to typical neo-Malthusian biases, focusing on only the bad news, assuming engineering challenges are insurmountable obstacles, and discounting any disagreement.

But there is also a discrepancy between financial and economic analyses, with arguments that most companies and wells are not profitable, that debt levels will crush producers, and so forth, while production continues to soar and some companies claim huge profits. The next post on this subject will address this.