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If shale is a game changer, why do producers seek oil?

Curious, isn't it, how some of the largest shale gas producers seem to be drilling more for oil these days? According to Baker Hughes Inc., a major oil services company, last week the number of natural gas rigs operating in the U.S. fell for a fifth consecutive week to a 10-month low.

Just as the rest of the world seems set to emulate the American engineering breakthrough for harvesting shale gas, it looks like North American producers are scaling back. Do they know something that others don't about this supposed game-changer for world gas supply?

What investors in these companies have already found is the unprofitable wellhead economics of shale gas at today's natural gas prices. Weak cash flows have spurred investor concerns that companies may no longer even be able to meet wellhead break-even costs at those prices.

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While debt rollovers, new equity offering, and asset lease sales have financed the shale gas boom, disappointing cash flows are leading some investors to jump off the bandwagon. And some industry commentators are suggesting that more than a few operators will face Chapter 11 bankruptcy protection over the next year, barring a huge rise in natural gas prices.

In response to deteriorating—if not negative—profit margins, many of the biggest shale gas producers are suddenly redeploying their rigs to drill for something much more lucrative: oil . That includes the likes of industry leader Chesapeake Energy Corp. , whose CEO, Aubrey McClendon, recently noted that "the economics just compel you to go for oil rather than natural gas right now." Other major gas producers, like Petrohawk Energy Corp. , EOG Resources , Forest Oil Corp. , and Quicksilver Resources , are following suit.

The switch in exploration activity from shale gas to oil won't be without consequences for future gas supply. What effect more rigs drilling for oil will have on North American oil production may be debatable. Other than mucking around in the Alberta oil sands or risking another Macondo-style disaster in deep water, there probably isn't a whole lot of oil left to be found.

But there can be no debate about what plunging rig counts mean for future U.S. natural gas production, particularly when you consider the abnormally steep depletion rates that come with shale gas reserves. Lower rig counts mean less production tomorrow and, all things being equal, rising prices for natural gas.

So before the rest of the world jumps on the shale gas bandwagon, it had better take a good long look at what's happening in the North American gas industry right now. Far from being the game-changer it's supposed to be, North American shale gas production isn't even sustainable at today's natural gas prices.

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About the Author
Jeff Rubin

In his follow-up to his award-winning and number one best-selling first book Why Your World  Is About To Get A Whole Lot Smaller, former CIBC World Markets chief economist Jeff Rubin asks a fundamental question: “What will it be like to live in a world without growth?”The end of cheap oil means the end of the easy answers to renewing prosperity. More

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