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Posted by on Mar 5, 2014 in Peritus Asset Management

Cracks in the Shale Oil Story

Cracks in the Shale Oil Story

By: Doug Holt, Energy Analyst for Peritus Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (HYLD)

It’s not as easy as sticking a straw in the ground…

Are cracks starting to appear in the illusion that is the shale oil “revolution”? It seems that one such crack may have appeared yesterday as Forest Oil Corporation (FST) reported disappointing Q4 drilling production numbers, missing estimates.

The company recently divested assets in an effort to reduce debt and focus on the Eagle Ford basin. In doing so it has become even more dependent on its Eagle Ford assets for growth, and indications are that this bet is not playing out well for them. Last quarter’s well results from the region were not what they were hoping for and 2014 production guidance and product mix toward oil was less than expected.  As a result of these drilling challenges, they have elected to delay further drilling and head back to the drawing board, and are looking to instead focus their efforts in East Texas, where it costs more to get oil out of the ground and they have a limited track record.  In reaction to yesterday’s news, we saw the company’s stock fall more than 37% and the senior bonds take a 9-10% hit.

We believe that the spin of the shale “revolution” is overblown.  As shale basins like the Eagle Ford are developed, the natural course of events, as would be the case with any oil field, is that the “sweet spots” get snapped up early and drilled out first. However, unlike a conventional oil field, the rapid declines rates of shale oil necessitate continuous drilling just to keep production rates flat. As a result these “sweet spots” are disappearing quickly. Late entrants to the shale game and those in need of new leases are discovering that beyond the sweet spots, the reservoir heterogeneity and well output can vary considerably, making production more difficult and costly.  These issues can and do directly impact well performance, including decline rates and production levels.

While we see definite opportunities in certain areas of the energy market, we believe that is it critical to be very selective in the energy investments one pursues in today’s environment, making active management all the more essential in this space.  Through active management you are able to analyze and put together a recommendation of whether to invest or not.  In passive, index-based products, these types of challenged investment could be in a portfolio just because of the industry and size of the debt tranche, with no thought put into the investment.  When one considers shale’s continuous drilling requirements for reserve replacement, lease expiration drilling pressures and the realization that shale plays are not as homogeneous as once thought, it starts to become clear that stories like this are likely going to become more commonplace not less so.

The AlphaBaskets blog provides frequent market insight and commentary by AdvisorShares Investments, LLC, created by AdvisorShares and other leading active managers.  AdvisorShares Investments is an SEC-registered investment adviser and the investment adviser to the AdvisorShares actively managed ETFs. The views expressed on AlphaBaskets should not be taken as investment advice or a recommendation for any of the actively managed ETFs advised by AdvisorShares.