By Sharon Kelly
America is in the midst of the biggest onshore oil and gas rush in recent history, with excitement spreading across the U.S. Oil and gas companies have cashed in on this frenzied excitement by courting huge investments domestically and abroad.
But a growing chorus of independent analysts and law enforcement agencies have their doubts and have questioned whether shale drillers are over-hyping their financial prospects and overestimating how much oil or gas they can profitably pull from the ground. Just this week, one of America's biggest agricultural lenders, the Netherlands-based Rabobank, announced that it would no longer lend money to companies that invest in shale gas extraction (nor to farmers worldwide who lease their land to these drillers).
The way that oil and gas companies describe their prospects in their financial statements matters because investors—and not just the uber-wealthy ones but also pension funds, university endowments, average folks with retirement savings or 401(k)s—can lose catastrophically if the information they rely on is faulty.
This matters to taxpayers too, since lawmakers need accurate information when making long-term decisions about the industry subsidies and tax breaks granted to encourage the drilling boom. The shale fracking rush could prove to be an expensive bust for taxpayers if oil and gas wells do not perform as promised.
Concern that companies have been over-exuberant about shale led Wall Street's two top cops, the Securities and Exchange Commission (SEC) and the New York Attorney General to investigate whether oil and gas companies have been "overbooking" their reserves (translation: inflating their appeal by promising investors more fossil fuels than their wells can actually deliver).
In the drilling industry, Chesapeake is known for being more aggressive than many of its competitors in its "land grab" strategies, its use of book-keeping methods to obscure costs, even in its legal and public relations posture toward local communities that try to block drilling.
Last year, Chesapeake came under renewed heavy scrutiny after then-CEO Aubrey McClendon’s $1.1 billion in personal loans, an undisclosed private hedge fund and extensive perks were revealed by an award-winning Reuters investigation.
Little has leaked out about the SEC and New York Attorney General probes. One company, Goodrich Energy, announced in September 2012 that the SEC probe into their reserves was over, but no other companies made similar announcements.
Recently, with little fanfare, Chesapeake announced a move that underscores the importance of these concerns and also offers another example of the revolving door that has characterized relations between the oil and gas industry and the regulatory agencies that are supposed to police them.
The SEC's Revolving Door Problem
On June 17, Chesapeake Energy announced it had appointed a new chief Compliance Officer, Patrick K. Craine. Craine is an accomplished attorney—he was a partner at a major law firm, Bracewell & Guiliani, where he specialized in white collar criminal defense, regulatory enforcement and internal investigations.
But hands down his greatest value to Chesapeake will be the role Craine played at the SEC. A former prosecutor, Craine handled many oil and gas cases at the SEC and, according to his law firm bio page, "prosecuted the largest oil and gas reserves restatement case in history."
Companies that hire former regulators often dismiss concerns about revolving doors, arguing that no one knows the rules better than the people who used to administer them. Their specialized knowledge and experience in interpreting rules is invaluable to companies who want to follow the rules in good faith and navigate complicated regulations, they say.
But since the financial collapse in 2008, watchdogs have honed in on the problems that can result when former prosecutor go to work for the industries they once investigated – especially at the SEC.
"Former employees of the Securities and Exchange Commission routinely help corporations try to influence S.E.C. rule-making, counter the agency’s investigations of suspected wrongdoing, soften the blow of S.E.C. enforcement actions, block shareholder proposals and win exemptions from federal law," the Project on Government Oversight (POGO) wrote in a report released earlier this year.
When the people who are supposed to police an industry are too cozy with the people representing that industry, they can pick up their world view. They can come to identify strongly with the people they are supposed to be overseeing, undermining their ability to take tough measures. And current regulators can unconsciously give former colleagues who now work for the industry greater deference or leeway because of their shared past.
That's why many federal agencies have ethics rules that attempt to guard against regulatory capture. But last year, the SEC's own Inspector General investigated how the SEC guards against conflicts of interest caused by revolving doors and concluded that the agency's ethics rules on these matters were riddled with loopholes.
And when it comes to policing the colossally wealthy and politically powerful oil and gas industry, the SEC is especially outgunned as its staff of enforcement specialists consists of little more than a handful of experts.
A Little-Noticed SEC Rule Change
In some ways, the SEC has helped create some of the very problems it is now investigating at Chesapeake and other drilling companies.
At the end of 2008, the SEC loosened rules that govern how oil and gas companies can calculate their reserves. The new rules from the SEC allowed more leeway in predicting how much oil and gas their wells, particularly unconventional oil and gas wells like shale or coal bed methane, could produce. This was a boon for drilling companies like Chesapeake in their effort to attract investment.
This little-noticed SEC rule change—one of the Bush Administration’s last moves before leaving office—allowed companies license to more optimistically book unconventional oil and gas, including shale gas and shale oil.
The impact of this rule change on the shale gas industry was enormous and immediate.
"The final SEC rules have demonstrably created a situation where there is room for interpretations" that allow unconventional oil and gas companies to book larger reserves, a July 2012 Society of Petroleum Engineers paper by Ruud Weijemars concluded, adding that "a difference in reserves reporting ‘culture’ has emerged between U.S. independents—engaged in unconventional-gas developments—and the oil majors."
After the SEC changed its rules, a huge gulf emerged between the ways that these independents booked their reserves and how conventional oil and gas companies applied the rules.
"Digging deeper into company reports reveals some additional cause for concern about the certainty of economic production from shale gas reserves," Weijemars wrote in his peer-reviewed paper.
A company-by-company review led to a damning conclusion for the unconventional gas industry. Weijemars found that "throughout 2009, companies such as Petrohawk, Devon, Chesapeake and EOG could not produce gas with an operational profit. The 51 percent increase of 2009 proved reserves from U.S. shale producers therefore cannot be explained by economic fundamentals."
He said instead, that companies appeared to be making money through financial engineering and the use of creative financing. Forty percent of Chesapeake’s 2009 operational income didn’t come from selling gas, but instead came from derivative trading. (Weijemars is not alone in having doubts about Chesapeake’s prospects—last year a report by ITG Investment Research calculated that Chesapeake could only deliver 70 percent of the oil and gas it was promising.)
"Today’s reality is that nearly all North American shale-gas projects are losing money faster than can be generated from operational income," Weijermar and Joost van der Linden wrote in First Break, a journal that covers applied geophysics, petroleum geoscience and reservoir engineering, "which means losses must be compensated" using various financing techniques and selling off acreage.
The SEC is the federal agency that should be asking hard questions, uncovering information like this and making sure the numbers provided to investors add up. And indeed, Chesapeake has found itself under numerous inquiries that will keep former-SEC prosecutor Patrick Craine’s hands full. But so far it's not clear how aggressively the SEC will police Chesapeake's reserve claims —or similar claims by the rest of the shale oil and gas industry—or whether any results will simply be buried.
Meanwhile, market analysts are increasingly finding red flags in the industry’s publicly-disclosed data. These concerns have even drawn the attention of Congress.
"Shale wells deplete alarmingly," testified energy analyst Deborah Rogers in May before the Senate Committee on Energy and Natural Resources. Rogers, who was recently appointed an adviser to the U.S. Department of the Interior's Extractive Industries Transparency Initiative which is looking into some of these issues, described a pattern where companies like Chesapeake need to drill more wells just to keep gas flowing out and cash flowing in.
She also explained why this pattern is not just financially worrisome.
"The collateral damage in the form of air toxics, ground water depletion, encroachment, road damages and potential aquifer ruination in the United States could be immense," she said, "and will only continue to rise as more and more wells need to be drilled."
Visit EcoWatch’s FRACKING page for more related news on this topic.
By Amy Mall
Used with permission of NRDC - Switchboard
With the void of federal protection from toxic oil and gas waste, states can and should create better rules. As I mentioned in a recent blog post, a new West Virginia law takes one tiny step in that direction. From now on in West Virginia—for horizontal wells only—drill cuttings and other drilling waste can only be buried on someone's property if the surface owner consents.
An article in the Dominion Post illustrates why rules like this are so important. According to the article, the Teel family in Wetzel County, West Virginia, is suing a division of Chesapeake Energy for permanently damaging and polluting their property and groundwater with toxic natural gas waste. Their complaint says that Chesapeake cleared about five acres on their property and "assured them the land would be suitable for home sites when work was complete." Instead, Chesapeake used that spot for drilling and fracking waste. The Teels say that Chesapeake dumped "foamy, foul-smelling material" into unlined trenches 12-15 feet deep and buried it, and that it is now migrating through the soil and groundwater.
The Teels, like many other Americans, are victims of toxic oil and gas waste that is inadequately regulated. We've blogged about how this waste is getting into the environment and being poorly managed with often minimal oversight in spots around the country. We know how toxic this waste can be, and we also know the industry has better methods that can be used for storing and disposing of it. Why should the Teel family have to pay out of their own pocket for a lawyer to represent them in court to protect their land and water from toxic waste? They don't own mineral rights and are getting zero economic benefit from the oil and gas industry.
One of the disposal methods is underground injection of the waste. While this method is almost always going to be a better option than burial in a residential or agricultural zone, it is the lesser of two evils with its own risks to groundwater, and needs to be improved. The U.S. Environmental Protection Agency (EPA) just issued a notice that it has entered into a Consent Agreement and Final Order with EXCO Resources (PA), LLC for violations of the rules governing underground injection of oil and gas waste. It appears that EXCO kept injecting waste into a well that it knew had failed mechanical integrity, didn't inform EPA of the problem in a timely manner in accordance with the permit, and operated the well at a pressure exceeding its permitted maximum injection pressure.
Before this order was issued, the Pennsylvania Alliance for Clean Water and Air was alerted to the dozens of trucks that were unloading waste in this location everyday. Concerned about the activity, they paid to test water from nearby springs and report that they found very alarming contamination data. There is not enough information at this point to know if any contamination is linked to the problematic disposal well, but we certainly hope that EPA will be fully investigating the potential groundwater impacts from this toxic waste site.
While it's good to know that EPA is enforcing the law at the Pennsylvania injection well mentioned above, these problems need to be prevented in the first place. EPA's current standards for underground injection wells are not strong enough for toxic oil and gas waste. Disposal wells used for underground injection of toxic waste from other industries are built to much higher standards than those used for oil and gas waste. It is long past time for national oil and gas waste rules to be strengthened—for pits, underground disposal wells, and other methods currently used by the industry.
Natural Resources Defense Council has asked the EPA to write new rules for toxic oil and gas waste. The current rules have not been updated since the late 1980s. Needless to say, a lot has changed since then, as documented in our petition to EPA. We hope the EPA will take up this issue in 2012.
For more information, click here.