Are Canadian Natural Gas E&P companies having an Enron moment?

Natural gas companies have been placing enormous bets on the wells they are drilling, saying they will deliver big profits and provide a vast new source of energy for Canada and the United States.

But the gas may not be as easy and cheap to extract from shale formations deep underground as the companies are saying, according to hundreds of industry e-mails and internal documents and an analysis of data from thousands of wells.

In the e-mails, energy executives, industry lawyers, state geologists and market analysts voice skepticism about lofty forecasts and question whether companies are intentionally, and even illegally, overstating the productivity of their wells and the size of their reserves. Many of these e-mails also suggest a view that is in stark contrast to more bullish public comments made by the industry, in much the same way that insiders have raised doubts about previous financial bubbles.

“Money is pouring in” from investors even though shale gas is “inherently unprofitable,” an analyst from PNC Wealth Management, an investment company, wrote to a contractor in a February e-mail. “Reminds you of dot-coms.”

“The word in the world of independents is that the shale plays are just giant Ponzi schemes and the economics just do not work,” an analyst from IHS Drilling Data, an energy research company, wrote in an e-mail.
Company data for more than 10,000 wells in three major shale gas formations raise further questions about the industry’s prospects. There is undoubtedly a vast amount of gas in the formations. The question remains how affordably it can be extracted.

The data show that while there are some very active wells, they are often surrounded by vast zones of less-productive wells that in some cases cost more to drill and operate than the gas they produce is worth. Also, the amount of gas produced by many of the successful wells is falling much faster than initially predicted by energy companies, making it more difficult for them to turn a profit over the long run.

There are implications for the environment, too. The technology used to get gas flowing out of the ground — called hydraulic fracturing, or hydrofracking — can require over a million gallons of water per well, and some of that water must be disposed of because it becomes contaminated by the process. If shale gas wells fade faster than expected, energy companies will have to drill more wells or hydrofrack them more often, resulting in more toxic waste.

 “And now these corporate giants are having an Enron moment,” a retired geologist from a major oil and gas company about other companies invested in shale gas. “They want to bend light to hide the truth.”

IFRS IAS 36!!! The big bad COP of the accounting world drives into town on North American Natural Gas Reserves.

North American Natural Gas reserves will be under serious pressure this closing fiscal year.  For those firms with all-in FD&A costs in excess of $18/boe or $3/mmbtu the need to apply IAS 36 strictly is a certainty.

The purpose of the impairment review, which applies to all intangible and tangible oil and gas assets, indefinite life assets and goodwill, is to ascertain that the carrying value of the assets does not exceed their recoverable amount. Under IAS 36, “recoverable amount” is defined as the higher of fair value less costs to sell (FVLCTS) and value in use (VIU). If either recoverable amount exceeds the asset’s carrying value, no impairment exists and no write-down is necessary.

FVLCTS is generally recognized as a valuation based on the potential sale of an asset, i.e., the amount that would be obtained from the sale of the asset in an arm’s length transaction betweenknowledgeable willing parties less disposal costs.
VIU is defined in terms of discounted cash flow, i.e., the present value of the future cash flows to the entity generated through utilization of an asset throughout its life plus proceeds from eventual disposition. Selection of an appropriate discount rate under IAS 36 definitions is an important consideration in completing a VIU impairment test. VIU is an entity-specific value that permits consideration of synergies; however, IAS 36 is restrictive in the cash flows and other inputs that may be used in the valuation.

Principles

There are two standards that address impairment within the upstream oil and gas industry:

• IFRS 6 “Exploration for and Evaluation of Mineral Resources”, which is applicable only in respect of exploration and evaluation (E&E) assets — see Section 1, and

• IAS 36, which is applicable to intangible and tangible oil and gas assets (except E&E assets), intangible assets with an indefinite life and goodwill.