Storm clouds for US shale

Who’s daring enough to short several U.S. shale oil and gas drillers? Why it’s short-selling expert Jim Chanos, president and founder of Kynikos Associates, of course.

Mr. Chanos spoke at the Delivering Alpha Conference last week and gave insight on why he believes the Wall Street opinion on US shale and gas stocks is faulty. 

His reasons:

  • Certain valuation metrics in which Wall Street relies on facade issues with the business model in the US shale industry, leaves drillers with smaller returns than investor expectations.
  • Accounting methods that some Wall Street investors use don’t show the true picture of the company. Earnings before interest, taxes, depreciation and amortization (EBITDA) is a metric that, in Chanos’ words, “is going to lead to problems for returns on capital in this industry,” as drillers are forced to reinvest in new wells to replace cash flow from depleted ones.
  • Debt is also a major issue for US shale oil and gas drillers as the methods used are expensive. This forces frackers to rely on more debt. Chanos stated that he, “looked at about three dozen drillers and found that their capital spending would eat up almost all of their earnings, minus certain expenses, this year. That leaves them with little cash to service their debt.”

    (It’s important to note, these frackers were not located in the Permian Basin in Texas and New Mexico, where costs are lower.)

Chanos isn’t the first, and most likely won’t be the last, person to warn about issues within the US shale sector, such as their lack of positive cash flow.  If Chanos is correct with his short sales, it won’t be his first big win, either, as he also forecasted the breakdown of Enron.

To read the full article from CNBC click here.