Wolf here: I have pointed at the sharp decline rates of shale wells for a long time. The play a huge role. Fracking is an expensive method of extracting oil and gas. It might cost $10 million to drill a particular well. If it’s a good well, phenomenally high production is measured during the first day. Drillers play games to further maximize that initial production number which is shown to investors to impress them, extract more cheap money from them, and drive up the stock price.

But production begins to taper off quickly – or rather falls off a cliff. Within two years, depending on the well, it might drop 80% or even 90% from initial production. These decline rates combined with low prices for oil and gas may make it impossible to recover the investment. And investors are now paying the price.

In the article below, Brent shares his personal experience with this decline rate (combined with the plunging price of oil) in dollars and cents. He remembers what the last oil bust was like. We both lived in Oklahoma at the time; oil busts are terrible creatures that fan out into the broader economy, which is in part why I’ve been covering oil and gas so much recently. But they also offer great opportunities, as Brent points out – if you’re patient and liquid enough to survive. 

By Brent:

I have a little mineral royalty on 10 acres in North Texas. A company drilled a well there a couple of years ago, and I’ve been getting royalty checks ever since. In November 2013, my monthly check was about $2,800. In December 2014, $130.

Oil prices went down, but not by 95%. These shale wells really deplete fast, like, don’t make any plans for the money because it won’t last long. From 600 barrels a day to a stripper in under 30 months.

I lived in Oklahoma City when oil prices collapsed in 1985. We started to see a lot of foreclosed houses by 1987, and very low prices by 1987 as well. I bought some houses in 1987-1992 (the bottom of the price trough) for less than 10% of their previous mortgage balances. Part of this was due to the S&L Crisis, which happened around then. But much of it was due to the fact that a lot of jobs evaporated in 1985-1988 or so, and it took a few years for people to lose their homes.

From 1993 on, the economy in Oklahoma City remained sluggish – no longer terrible, but just mediocre until oil prices picked up again in 2005.

In the oil bust of the 1980s, the FDIC stepped in and liquidated a lot of banks. A lot of assets were thrown on the market at depressed prices. HUD and the S&Ls also liquidated houses for whatever they would bring. A lot of these houses were not worth owning. I saw many, many properties that I couldn’t believe anybody ever lent on, but that’s how it goes in a bubble: anything with an address can be borrowed on and gambled with.

HUD was so buried with foreclosures that they sought bids for packages from 2 to 10 houses. I bought one package that included three duplexes and four houses for around $17,000. They were in crummy areas and needed work, but still….

There have been so many bubbles in recent years (houses, commercial R/E, precious metals, stocks, junk bonds, oil, art, classic cars, commodities, etc.) that it’s hard to say how it will play out. Will they all conk out at once, or one by one?

Some bubbles are leaking already (commodities, junk bonds, oil, etc.) but stocks are holding up. The greater-fool theory is the basis of these bubbles, since there aren’t any fundamentals involved in any of them. The basic idea is that asset prices will just increase forever, so no work or invention or savings or actual investment in real productive assets (like machine tools or factories) will be necessary.

It’s too bad the Fed has convinced people they don’t have to do any of these things since it is mathematically impossible for a bubble of any kind to inflate forever. Maybe 85-95% of so-called “investors” will get burned when the whole thing crashes. By Brent.

At these oil and gas prices, time is running out for many of the companies. Read…  Oil-and-Gas Default Wave, “Outright Liquidations” Next

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.