Are U.S. Shale Oil and Gas Estimates Overblown?

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Jan Arps, a British petroleum engineer, is the person responsible for publishing the formula for predicting how much crude oil a well could produce and how long it will take to extract it all. Historically, the complex formula has been relied on by companies in order to determine the profitability of drilling as well as reporting current reserves to government regulators.

Recently, the method has been challenged by John Lee, an engineering professor at the University of Houston, who has called for a conference on the issue to address inconsistent use of the formula. Lee argues that shale oil reserves are being estimated by companies that are relying on limited drilling data for changed versions of Arps’s formula. Unfortunately, like most estimates based on too little data, overvaluation can become a real risk.

Evidence of such overvaluation can be seen in the $2 billion writedown of Shell’s shale assets last year. At the time, a significant amount of Royal Dutch Shell’s (NYSE:RDSA)(NYSE:RDSB) shale assets were in the Eagle Ford Shale. The Eagle Ford Shale area is well known for “sweet spots,” or areas that are more profitable due to the amount or production volume possible. It is likely that these sweet spots are responsible for the incredible optimism regarding shale reserves, leading estimates much higher.

BP (NYSE:BP) has also been questioned recently on its outlook for future participation in the U.S. shale boom after stating that it was separating onshore operations from the main company. However, it will be tough to tell whether its true intention is to eventually sell it off or if the company is simply looking for a competitive advantage in a market it has been consistently outmaneuvered in.

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