Wednesday, December 10, 2014

First comes the reassurance, then the penny drops


GS says that the extraction costs for Bakken fields (fracking oil) are in the low $40s.... at most.  Well that sounds not right.  First off, this stuff is deep, so deep that at times radioactive waters are extracted at the same time -- the oil has to be heated out of the rock, and then cleaned from all the chemicals used to extract and make it more viscous.  All together this is not a simple process, or inexpensive.

GS is the same gang that says that oil extraction in Libya (where the stuff is almost lying on the ground) is very expensive, but the "North American deep and expensive wells costs are around $40" is their new song -- why?

The reason is that GS is well aware that lots of investors (in the junk bonds they issued over the past few years) are starting to either (a) read the prospectus they were given, and (b) are just starting to panic -- and are thinking the worse case scenario.  Now, I am certain that GS is not lying (hey they know how to be "economical with the truth", but that's not lying) so investors will think (or hope) that its not "their junk bond that's in trouble" maybe its even time to buy some more as "other investors" panic and sell at a discount.

Now, I'm not an E&P guy -- my interest is marginal but there are a number of truism that you must follow for valuations:

  1. Fracking is an expensive process
  2. The wells are deep and require lots of horizontal drilling
  3. Chemicals have to be used to "loosen" the oil from the rock
  4. The oil is considered "synthetic" and sells for less than "light and sweet" from the Gulf
  5. Frackers (not the best term) have used massive amounts of debt (leverage) so as to improve their returns
Dont' forget that GS are the guys who were confident that gold was on its way to sub $1,000 from $1,200 -- of course gold is still around $1,227, so that was not the best call in the world, but within the standard of investment banks absolutely within the standard of protecting their market.  They are probably right there are ways of calculating the extraction cost of Bakken fields at around $40 -- my guess is that you have to make some aggressive assumptions on production yields...

Anyway, this morning WTI went as low as $62.00 -- the ride continues!


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