NEW YORK (TheStreet) -- Recent statements about shale oil from David Einhorn at the Sohn Conference and Jim Chanos on Wall Street Week have added to the pressure on U.S. independent exploration and production companies. Both of these hedge fund managers may be wrong in timing, but they do have general points on the nature of shale drilling right.
I have been talking about the inherent problems with the model of shale oil production, calling it a Ponzi scheme in articles and in my new book, Shale Boom, Shale Bust. Shale oil is the most unique source of energy in its costs and production profile and has become the most sensitive to price, making it the most at risk in the current environment of depressed oil prices.
Shale wells are cheap to drill, often requiring less that $10 million. That allows quite a bit of drilling with relatively little commitment. Small E+Ps have flourished here in the U.S., courtesy of cheap credit and a relative surplus of prime shale acreage.
But shale well drilling also has two very negative factors that put the model at risk. One, the production from shale wells is incredibly front-loaded: Almost 50% of the total oil that will be retrieved from the average shale well will appear in the first 18 months. What happens when so much oil appears so quickly is a conscious and sometime unconscious extrapolation of results to the rest of the lifetime of the well and of future wells to come.