This piece is excerpted from my upcoming book "Shale Oil Boom, Shale Oil Bust - The Myth of Saudi America" coming in May.
NEW YORK (Real Money) -- Shale oil is a Ponzi scheme. I don't mean that there is a vast conspiracy inside the energy world to confuse investors about its potential or fleece Wall Street. What I mean is that the business of drilling for oil from shale creates an endless circular appetite for more drilling for lesser returns.
Think of a classic Ponzi investment scheme -- constant fresh capital is needed to generate false gains and pay off early investors. Shale production is similar in that more and more drilling is constantly needed to continue to generate even equivalent returns, much less growing ones. In a classic Ponzi scheme, when the new money inevitably stops coming in, the pyramid quickly collapses. In shale, that moment when the pyramid becomes too heavy to sustain itself is far from being reached, but the inevitability of it is equally clear. Further, I believe that the tipping point is far closer than most other analysts, and certainly the U.S. Energy Information Agency (EIA), believe it to be.
Read more from Dan Dicker every week with a free trial of Real Money.
The main reason I characterize shale oil production as a Ponzi scheme is because of the fast decay of shale oil wells as compared to virtually all other oil production. One chart is enough to give a good indication of the progress and problems of oil from shale:
Here we have a compilation by the EIA for production of the average well in the Eagle Ford shale, but it serves well as a model for shale oil in general. Two very interesting points should be immediately clear:
1. The rate at which oil comes out of freshly drilled wells has greatly improved in the last five years since 2009.
2. The amount of oil that shale wells deliver is substantially front-loaded. More than 50% of all the oil you will see from a shale well is recovered in the first two years and the greatest proportion of that will appear in the first six months.
The first point above -- regarding the recent fantastic increases in efficiencies and other technological advances in fracking -- has actually distracted from my thesis of shale oil as a Ponzi scheme. But it's only a temporary distraction. In projections by the EIA, the forward progress of technology is interpolated as being practically limitless. Even more stunning, the EIA believes that the potential reserves of shale oil not yet explored are almost equally limitless.
But here's the real truth: There are only perhaps eight to 10 core shale areas worth working here in the U.S., and they're all being relentlessly tapped right now. Mark Papa, the former CEO of EOG Resources (EOG - Get Report), one of the premier shale producers, remarked on his exit that all of the even potentially good shale plays in the U.S. have already been entirely picked over.
What we are seeing in U.S. production today is the outcome of the best technology and best capitalized in the global oil industry drilling in the richest and greatest potential acreage that this country has to offer. And efficiency and technological advances in the drilling for shale oil cannot make up for this bounded limit of prime acreage forever. When the potential of technology is reached, the fundamentals of just how much good acreage there is will really begin to be realized.
Ultimately, and far sooner than most analysts believe, U.S. shale production will consist of ever-less productive wells that cost more to drill, take longer to pay for themselves and generate less oil. The EIA believes that nothing like that will occur for at least the next 25 years. I think that the peak of U.S. shale potential will be reached in the next 10 years, if it hasn't been already -- and that is when the pyramid will begin to fall apart.
Meanwhile, oil companies have to scramble to generate ever more investment to drill ever less productive wells, just to keep up with production targets. That ever ramping chase of capital just to stay even sounds more than a bit familiar. Shale oil does share many of the characteristics of a Ponzi scheme.
Can you beat TheStreet ... at basketball? Jim Cramer and our Wall Street pros are posting their brackets on ESPN. Take them on at www.thestreet.com/espn, password: Thestreet2015