Last week's typically provocative presentation by New York hedge fund titan David Einhorn questioning the model of shale gas exploration and production has divided both Wall Street and the broader US oil and gas industry.
Einhorn says the US debt-fuelled addiction to drilling wells for shale oil is fast becoming the next big financial catastrophe waiting to happen. Einhorn, who first shot to fame after exposing illiquid real estate investments at Lehman Brothers months before its 2008 collapse, set his sights on the shale industry at the famed Sohn conference in New York.
His speech can be roughly distilled into a few main themes: he says the cost of acquiring, fracking and developing a barrel of oil has completely outstripped internal cashflows made from selling the actual oil itself.
Using data from his own firm, Greenlight Capital which manages $US11 billion ($13.9 billion) of funds, Einhorn presented slide after slide to show how the large oil frackers have spent $US80 billion more than they have received from selling oil since 2006.
As a result of this spending binge, share prices for some of the fastest-growing US energy companies such as Pioneer, Concho Resources and EOG Resources have grown completely out of whack with their actual return on capital.
A spending binge fuelled on cheap debt? That's hardly novel when it comes to Wall Street.
But Einhorn's point was that many investors have little clue of the dangers of negative operating cashflows the companies generate because of some fancy financial gymnastics. His biggest bugbear? The shale industry's preference to use non-traditional financial metrics such as earnings before interest, taxes, depreciation, depletion, amortisation and exploration expenses or Ebitdax.
Einhorn zeroes in on Pioneer Natural Resources, a $US23 billion giant dubbed the Mother-Fracker, which he says is losing $US12 for every barrel of oil equivalent it develops. He says this type of balance sheet shows a bubble has formed within the company that could speak to a larger industrywide problem.
So is he right? Well, yes and no.
Share prices are undoubtedly inflated as they have been in the tech sector several times in the last 15 years.
On a valuation basis, Pioneer is trading at a price to earnings ratio of 24 times – a pretty, eye-watering multiple given the savage cut to the price of oil in the last 12 months.
But critics of Einhorn say his timing for attacking the shale players is off the pace.
Yes shale companies are in debt but they are barely standing still. The majority has been cutting back rigs and slashing spending at a frenzied rate as a response to the falling oil price.
More than half of all rigs in the US have disappeared since October. Now with oil back near $US60 a barrel, following a 25 per cent gain in April alone, companies like Pioneer and EOG are nearing more comfortable levels.
Many of the exploration and production companies cite $US65 a barrel as a point to start deploying more rigs. Brent crude last traded at $US65.39 a barrel, up 40.5 per cent from lows of $US46 in mid-January, but still well off the $US115 a barrel if was fetching last June.
While that alone won't get them near break-even, it's likely to be enough to keep their banks happy if oil prices again dip under $US50 a barrel.
Others point out the frackers are not exactly throwing their money away.
Many have built up sizeable and lucrative acreage positions where rigs can be deployed in the future if oil prices move back up the cycle.
It's also important to note that in the oil and gas sector, like many other extractive industries, the vast bulk of a company's capital expenditure is front-loaded meaning fresh cash flow is limited until a company hits production.
The biggest risk to the shale sector isn't the prospect of the prospect of the price of oil falling again. Companies have already shown they will pull back and in some cases exit the market if the price is marginal.
Rather it's a question of how long banks will remain comfortable with the level of debt enshrined in the sector.
Deutsche estimates US energy companies raised $US550 billion of new bonds and loans since 2010 thanks to cheap loans.
But with borrowing costs surging as the price of oil slumped, an expected return to tighter monetary policy by the US Federal Reserve later this year may provide the first spark of trouble.
Einhorn, of course, is shorting Pioneer in the hope of repeating the sort of windfall he made with his Lehman bet.
While Pioneer shares fell a relatively modest 7 per cent in the last week, Einhorn is betting the shale revolution still has another twist in its tale.
