Fracking: costs too deep?

Fracking is costly. Whether it is going to become less so may be just as important a question as whether oil prices rebound. This week investor David Einhorn, famous for his bet against Lehman Brothers, announced his latest bearish wager. At a hedge fund conference on Monday he turned on a set of independent oil producers, notably Texas's Pioneer Natural Resources, that specialise in unconventional drilling techniques such as fracking.

These companies have rarely been profitable, either on a cash or accounting basis. But with oil prices above $100, there was plenty of money willing to subsidise the losses. As oil prices collapsed to below $50, Pioneer shares fell 43 per cent from their peak but have rallied lately as commodity prices have rebounded.

Mr Einhorn's contention is simple: even with oil prices between $60 and $80, the capital requirements of fracking are too high to justify the drilling. His discounted cash flow model that extends 90 years values Pioneer at -$8 per share; the model projects Pioneer generating positive cash flow for the first time in 2038.

Pioneer's market capitalisation of $27bn suggests that plenty of people disagree with Mr Einhorn. But the core debate is on how much more efficient frackers become at drilling wells. Optimists point out that Pioneer rival EOG Resources spent heavily in the early years and its cash returns dramatically accelerated. JPMorgan argues that Pioneer's undrilled reserves are worth $197 per share by themselves. It will not take 90 years for one of these polar opposite positions to be vindicated.

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