The Frack Farce
Published on Huffington Post UK
While Prime Minister David Cameron this week lauded the economic potential of the "shale gas revolution", critics insist that fracking will escalate fossil fuel emissions and create intractable environmental problems.
So the shale gas revolution will not usher in a new heyday of cheap oil - but it will accelerate debt instabilities in the oil industry that might blow up in our faces.
Unfortunately,
in the wake of an overwhelmingly successful industry PR offensive, such questions have been largely overlooked.
The upshot is simple: Rather than ushering in a new wave of lasting prosperity, the eventual consequence of the gas glut could well be an unsustainable shale bubble, fuelling a temporary economic recovery that masks deeper structural instabilities. When the bubble bursts under the weight of its own debt obligations, it could generate a supply collapse and price spike with serious economic consequences.
The UK
government's decision to resume
fracking has been welcomed by the oil industry, and widely lambasted by
environmental campaigners. But to a large extent the debate about the potential
of shale gas in this country has completely missed the point.
While Prime Minister David Cameron this week lauded the economic potential of the "shale gas revolution", critics insist that fracking will escalate fossil fuel emissions and create intractable environmental problems.
Yet neither
have acknowledged a far deeper, and arguably more fundamental question: do the
economics of shale gas really add up?
A New
York Times investigation
last year found that state geologists, industry lawyers and market analysts
"privately" questioned "whether
companies are intentionally, and even illegally, overstating the productivity
of their wells and the size of their reserves." According to the Times, "the gas may not be as easy
and cheap to extract from shale formations deep underground as the companies
are saying, according to hundreds of industry e-mails and internal documents
and an analysis of data from thousands of wells."
Early this
year, US energy consultants Ruud Weijermars and Crispian McCredie, writing in the flagship British energy industry
journal Petroleum
Review, noted a strong "basis for reasonable
doubts about the reliability and durability of US shale gas reserves"
which have been "inflated" under new Security and Exchange Commission
(SEC) rules introduced in 2009. The new rules allow gas companies to claim
reserve sizes without any independent third party audit.
The overestimation of reserve sizes is being used to obscure the dodgy
economics of fracking. The first problem is production rates, which start high,
but fall fast. In Nature, former UK chief government scientist
Sir David King, co-writing with scientists from his Oxford Smith School of
Enterprise & the Environment, noted that production at wells drops off by
as much as 60 to 90 percent within the first year.
The rapid
decline rates have made shale gas distinctly unprofitable. As production
declines, operators are forced to increasingly drill new wells to sustain
production levels and service debt. Rocketing production at inception, combined
with the economic slowdown, has driven US natural gas prices from about $7-$8 per million
cubic feet in 2008 down to less than $3 per million cubic feet today.
"The economics of fracking are horrid",
reports US financial journalist Wolf Richter in Business
Insider. "Drilling is destroying capital at an astonishing
rate, and drillers are left with a mountain of debt just when decline rates are
starting to wreak their havoc."
This year has seen some of the biggest energy companies suffer due to
the bubble economics of the shale gas boom.
Just four months ago, Exxon's CEO, Rex Tillerson, complained that the
lower prices due to the US natural gas glut, while reducing energy costs for
consumers, were depressing prices and, hence, often insufficient to cover
production costs resulting in dramatically decreased profits. Although in shareholder
and annual meetings Exxon had officially insisted it was not losing money on
gas, Tillerson privately told a meeting at the Council on Foreign Relations:
"We are all losing our shirts today. We're
making no money. It's all in the red."
Around the same time, the BG Group was forced
"to take a $1.3bn writedown in its US natural gas assets" due to the
gas supply glut, "leading to a sharp fall in quarterly and interim profits."
By November, Dow Jones reported
ongoing "negative effects in their earnings", underscoring "how
disruptive the shale boom of the past few years has been to the sector."
Similarly, another company, Royal Dutch Shell, saw its earnings fall for the
third consecutive quarter by "24% on the year", while the average
price Shell received for its North American gas fell 38 per cent.
Even Chesapeake
Energy - billed as the country's shale pioneer - in September found itself in a
crisis, forcing it to sell assets to meet its obligations. "Staggering
under high debt," reported the Washington
Post, Chesapeake said
"it would sell $6.9 billion of gas fields and pipelines - another
step in shrinking the company whose brash chief executive had made it a leader
in the country’s shale gas revolution." The sale was forced by a "combination
of low natural gas prices and excessive borrowing."
How has this
been allowed to happen? The Financial
Times' John Dizard points out that shale gas producers
have spent "two, three, four, and even five times their operating cash
flow to fund their land, drilling, and completion programmes." To sustain
this "deficit financing", too much money "was borrowed, on
complex and demanding terms. Wall Street should have provided reality checks to
the shale gas people; instead, they just provided cashier's cheques with lots
of zeroes at the end." But the bubble will continue growing due to
increasing US dependency on gas-fired power. "Given the steep decline
rates of shale gas wells, compared to conventional wells, drilling will have to
continue. Prices will have to adjust upwards, a lot, to cover not only past
debts but realistic costs of production."
So the shale gas revolution will not usher in a new heyday of cheap oil - but it will accelerate debt instabilities in the oil industry that might blow up in our faces.
The
worst-case scenario is that several large oil companies find themselves facing
financial distress simultaneously. If that happens, according to Arthur
Berman - a 32-year petroleum geologist who worked with Amoco (prior to its
merger with BP) - "you may have a couple of big bankruptcies or takeovers
and everybody pulls back, all the money evaporates, all the capital goes away."
The upshot is simple: Rather than ushering in a new wave of lasting prosperity, the eventual consequence of the gas glut could well be an unsustainable shale bubble, fuelling a temporary economic recovery that masks deeper structural instabilities. When the bubble bursts under the weight of its own debt obligations, it could generate a supply collapse and price spike with serious economic consequences.