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Letters from a Hedge Fund Manager – Part II

Following right along from “Letters from a Hedge Fund Manager – Part I”, today we have “part deux” as a follow up for you…


Date: 10 December 2014
Subject: There Will Be Blood – Part II

Let me be clear: I am no expert on shale wells. I'm not even an “almost” expert in the shale sector. If you called me an idiot when it comes to shale drilling, I wouldn't argue with you. With that caveat out of the way, I'm going to generalize about the shale sector (anyway).

In oil and gas, most of the money is spent up front in acquiring the drilling rights and putting the well into production. You then have revenue and hopefully some profit in the period afterwards, as the well produces for you. Unfortunately, shale wells are very different from conventional wells. Shale wells see the vast majority of their total production in the first two years after they are drilled. This means that you have to keep drilling more wells just to stay at a constant level of production. In many ways this is akin to a hamster wheel – except you can never get off – or your production collapses. If you want to grow production, you need to drill even more wells – all of which see significant declines after two years.

Let me show this by using some data from WPX Energy (WPX: USA):

Basically, in order to keep production roughly constant, they borrowed a bunch of money, spent a bunch of money and lost globs of money in the process – yet production remained constant. Amazingly, this is a $2.5 billion dollar company. Don't feel bad for WPX. Their numbers aren't all that different from plenty of...