Shale Gas Companies: Big Writedowns Coming

For any investors in the energy sector who have not paid attention for the past few years, Hurricane Isaac should have taught them a lesson...the economics of the U.S. energy industry has changed drastically thanks to the shale revolution brought about by hydraulic fracturing (fracking).

Hurricanes in the Gulf of Mexico used to send natural gas prices soaring due to the supply disruptions from the region. But no longer. Now the Gulf of Mexico produces only 7 percent of total U.S. natural gas as opposed to the 20 percent it produced as recently as 2005. Fracking has led to such a boom in gas production in the continental United States that there is now a huge glut of gas on the market. This glut has pushed down the market price of natural gas so low that it is leading to problems for the gas production companies.

This gas glut will lead to, when full-year results are revealed in 2013, a great number of natural gas firms taking large writedowns in their reported reserves. In other words, these companies will be revising downward (some more than others) the commercial prospects for their natural gas assets. This is important in many cases because many oil and gas agreements with banks link borrowings to reserves. The hit may be exceptionally hard, and catch investors off guard, at gas companies which were too aggressive in booking reserves.

The weakness in natural gas prices has even affected the big energy companies like ExxonMobil (NYSE: XOM), which after its purchase of XTO Energy is the biggest U.S. producer of natural gas. Poor results from its gas division led Exxon CEO Rex Tillerson in June to say that energy companies were “all losing our shirts” thanks to the very low gas prices.

But the poster child for these upcoming writedowns has to be the most aggressive of the natural gas companies, Chesapeake Energy (NYSE: CHK). In its second quarter results, the company already wrote off 4.6 trillion cubic feet of natural gas reserves. That was 24 percent of its reserves and equivalent to more than two months of U.S. consumption of gas! However, that was offset somewhat by reserve additions to make the net decline only 7 percent. Its full-year 2012 results, which should have some massive writedowns, will certainly have its suffering shareholders on edge.

Chesapeake has hardly alone in announcing reserve writedowns in its latest earnings reports. One of Canada's major natural gas producers, Encana (NYSE: ECA), took a second quarter loss of $1.48 billion after it took a $1.7 billion charge on some of its gas assets thanks to the low prices. And it warned that further writedowns were to come in the months ahead.

Natural resources giant BHP Billiton ADR (NYSE: BHP) also announced a major writedown. In August, it took an impairment charge of $2.84 billion against its Fayetteville gas assets that it acquired from Chesapeake Energy in February 2011 for $4.75 billion. The company ended up entering the U.S. gas market in a big way just before the major downturn in gas prices. BHP also wrote down the assets thanks to lower than expected production from the gas fields.

Smaller gas producers have also been hit, such as Ultra Petroleum (NYSE: UPL) which announced a $1.1 billion writedown on its natural gas assets, resulting in a $1.2 billion loss in the second quarter. Its average selling price for gas fell plunged 22 percent from $5.17 a year earlier to $4.04 in the second quarter of 2012. The company owns gas fields in Pennsylvania and Wyoming.

The only way for this situation to turn around in the long term for the natural gas producers is to see a substantial cutback in drilling activity. Some cutbacks have already occurred...the number of working gas rigs in the U.S. has fallen by almost half in the past year. However, figures from energy consultancy Bentek Energy show that gas production still rose by about 5 percent in the first half of 2012 due to increased rig efficiency.
Translation? A lot more drilling activity has to be cut back before natural gas prices can enjoy a sustainable rise, ending the writedowns and the troubles for gas companies' shareholders.

This article originally appeared on the Motley Fool Blog Network. make sure to read all my articles for the Motley Fool at http://blogs.fool.com/tdalmoe/,