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There has been a growing emphasis on the need for transparency when it comes to how shale gas companies report their proven and unproven reserves. Calculating the amount of oil and gas beneath the surface has always been more art than science, but it appears as though the companies in this industry are being allowed to take great liberties when ascertaining the quantity of shale gas in their jurisdictions.

In early 2008, the stocks of many companies in the shale gas arena where struggling due to recession fears, the financial meltdown, and falling gas prices. Giving in to mounting consumer pressure to support “home-grown” energy production, as well as pressure from the natural gas industry itself, the SEC has decided to give gas companies more latitude in how they estimated reserves in areas not yet drilled. Previously, gas companies were only allowed to count unproven gas reserves from areas close to their active wells. Under the new ruling, they are now able to include possible shale gas in regions much further from their active wells using new technology and seismic modeling techniques which the SEC said the companies did not have to disclose publicly because they are considered proprietary. This has given shale gas companies a great deal of freedom to “guesstimate” reserves without having to spend money to drill first. Greater unproven reserves means better looking financial statements, which can translate into higher stock prices.

In addition, this ruling permitted shale gas operators to divide their finding and development costs over a much larger reserve base, which brings those costs down on a per-acre basis.

Some of the larger companies in this space, such as Chesapeake Energy (CHK), have vehemently denied that they have been counting highly questionable reserves on their books. Still, with a legal right to pump up the numbers, it can be difficult to avoid the temptation not to do so. And given the fact that the price of natural gas is currently low, and the ongoing controversy over “fracking” is constantly in the news, these companies need all the help they can get. Furthermore, drilling and environmental regulations in certain states (specifically, Pennsylvania and Oklahoma) is very lax, which encourages greater accounting and operational leeway.

Recently, the U.S. Geological Survey (USGS) released a report stating that the undiscovered technically recoverable natural gas in the Marcellus Shale (which stretches from New York through Pennsylvania, Ohio, Maryland, and West Virginia), is estimated at around 84 trillion cubic feet. This estimate came as a bit of a shock to industry watchers since it was a whopping 80% smaller than an estimate made by the Energy Information Administration, an agency of the Department of Energy. This USGS number is just the latest in a series of wildly varying estimates of the amount of shale gas that could eventually be drawn from the Marcellus, commonly agreed upon as the largest U.S. shale gas formation.

Conclusion

Shale gas is very important, since it is cleaner burning than coal, relatively cheap to extract and, whichever way you look at it, is present in considerable quantities in the United States. On a conservative basis, we calculate that at peak production, it could contribute 10%-15% of domestic energy requirements. As such, we have culled five shale gas companies from the natural gas sector which we think will perform well over the next few years, as U.S. energy demand firms, thanks to a gradually improving global economy. All five companies are well managed, have very cost-efficient operations, are of moderate size, and are in good proven locations. They are Devon Energy (DVN), EOG Resources (EOG), Chesapeake Energy, Newfield Exploration (NFX), and Range Resources (RRC). And given what we think will be an increasing attention to shale gas, the aforementioned entities could also become the focus of M&A activity from larger operators like Exxon (XOM - Free Exxon Stock Report), and Royal Dutch Shell PLC (RDS/A).

 

At the time of this Article’s writing, the author didn’t have any positions in any of the companies mentioned