16th December 2014: 'Will Wall Street kill-off the fracking industry before the protesters do?' » 2014 » Mobbsey's Musings » Paul Mobbs/MEI » FRAW

Deepwater Horizon
The truth has been blown!

Will Wall Street kill-off the fracking industry before the protesters do? – as the shale gas Ponzi scheme teeters, will it cause a wider crash?

Paul Mobbs, "Mobbsey's Musings", 16th December 2014


Published in 'The Ecologist', 17th December 2014, under the title, "With sub-$60 oil, fracking and tar sands losses threaten the whole financial system"


Brought about by the recent fall in oil prices, investors are beginning to review the economics of unconventional oil and gas. For the last few years there have been a number of damning reports[1] about the economics of[2] unconventional fossil fuels. Now it seems those long-ignored observations are being taken seriously by the money-lenders of Wall Street.


John Maynard Keynes was one of the most significant economists of the Twentieth Century, whose observations still draw the ire of pundits and politicians today. One of his lesser-known economic statements was, "If you owe your bank a hundred pounds, you have a problem. But if you owe a million, the bank has". Sound advice, but what if you owe hundreds of billions? Then it becomes a problem for the whole economic system, not just the bank.

During the early 2000s a lot of Wall Street's 'funny money', based around complex investment schemes, flowed into unconventional oil and gas developments. It was seen as the new 'revolution'[3] in America's energy system, and a new, politically approved[4] path to energy independence[5]. When that funding stream collapsed, after the 2007/8 financial crisis[6], the number of drilling rigs operating in America collapsed too.

In the wake of the crisis the US and other governments instituted quantitative easing[7] (QE) – in effect conjuring 'free money' from governments, given at near zero rates of interest to the major banks and finance institutions. Problem was, in the wake of the crisis, there was little to invest[8] all that 'new funny money' in. Throwing free money after bad, the US fracking industry mopped up a large wad of QE cash[9], and shortly after the number of drilling rigs in the US took off again.

Looking for a fast return, sections of the finance industry specialise in 'high risk' or 'junk' investments – which in America is reckoned to be worth $1,300 billion. Over the last ten to fifteen years the global finance system has loaned the American unconventional oil and gas industry hundreds of billions of dollars. Today somewhere between $150 and $550 billion of those loans are considered to be 'junk'. Now, as oil prices fall, the precarious, Ponzi scheme[10] nature of these investments is being exposed – although the basic facts were made public[11] by the New York Times over three years ago.

There's a whole lot of reasons why many have seen 'fracking' as an economic train wreck[1] waiting to happen. What's triggered today's reality-check is the large and fast fall in oil prices[12], and recent studies which have exposed the flaws in the investment models which underpin the industry[13]. Now the 'shale boom' appears to be over[14], and the spin and hype[15] which drove that revolution are finally being exposed. And, as Keynes suggests, if this triggers a wider crisis in the bond market[16] it has the potential to cause problems way beyond the parochial issue of "fracking".

The problem with unconventional oil and gas is that it takes a lot of engineering to produce a small return of product. Some studies, such as one carried out by the Oxford Institute of Energy Studies[17] in early 2014, reckoned that half of all unconventional wells were losing money – and the industry as a whole had written-off assets worth up to $35 billion. To put that into perspective that's more than J.P Morgan's post-crash bank bailout[18], and a bit less than Citigroup's – but unlike the bailouts that $35 billion would never be paid back!

Across America there are a large number of small oil producers[19] – ranging from a few thousand to just four or five barrels of oil per day. These are the people at the bottom of the industry who exist largely on historic land rights and loaned capital. As oil prices fall, lacking the economic power of the major companies, these are the people who see the biggest impact on their earnings. As a consequence they are more likely to shut down and default on their loans.

There are obvious parallels here with the US sub-prime mortgage crisis[20]. As these many small loans go bad the effects compound up the 'food chain' of finance. One measures of this is the bond yield, the earnings from energy investments – which have been sliding all year[21]. Fearful that the 'shale revolution' might implode, some vocal free market pundits are calling for assistance to be given[22] to the US shale industry.

More significantly, in terms of the potential losses, it's the biggest players in the US shale industry who are practising the most egregious tactics to keep on the "drilling treadmill"[23] – continuously keeping new wells coming on stream in order to make up for the low returns and short productive life of the ones drilled previously.

At the national level some of the larger unconventional oil and gas companies have been playing the market[24] to massage their credit ratings – to keep the investment dollars flowing in. Locally some are receiving back-door subsidies as US states overlook unpaid taxes, or pick up the bill for plugging old abandoned wells[25]. In Florida, they proposed to front-load the high exploration costs for shale onto consumer's utility bills[26]. Meanwhile some companies under-pay royalties to landowners[27], or under-pay their workers[28], in order to save money and make their balance sheets look better.

That was before December 2014...

The real fracking financial earthquake began in the first week of December, when oil prices fell below $70/barrel – the point at which most unconventional production becomes barely economic. Lower prices were already hitting the Canadian tar-sands industry too[29], where the break-even price for new projects is estimated at $115/barrel[30].

The week before OPEC had unexpectedly decided to keep oil production unchanged[31] – guaranteeing a further fall in prices as traders off-loaded[32] their increasingly loss-making futures contracts. Then sections of the financial media began to express concern about the viability of the unconventional oil and gas sector[33].

By the second week of December, when prices dropped to $65/barrel, there were reports that the 'bubble' in shale investments[34] might be a serious problem for bond investors – potentially risking another market crash[35]. As a result the value of many US, UK and Australian unconventional oil and gas companies fell further – to the point where Australian analysts suggested they would make ideal speculative take-over targets[36], and Canadian dealers start to short-sell tar sands debt[37] in anticipation of a further fall in value.

At the beginning of this week, the third week of December, as oil prices hit $60/barrel, the off-loading of bonds began as investors tried to limit their exposure to the risk of a crash[38]. As in 2008, companies started to decommission drilling rigs[39] once again. The shale industry may have written off $35 billion in the last 10 to 15 years – but right now bond holders are staring down up to almost $12 billion of losses[40] in the last few weeks.

OK – shale is going bust, isn't that a good thing? Looked at narrowly it is, but there are two problems this gives rise to.

Most importantly, where the industry has taken hold (the USA, Canada and Australia) widespread bankruptcy would allow the industry to walk away from the liabilities for the pollution they have created. This potentially dumps billions in clean-up costs on to state and national governments.

The second problem is the collapse of 'political capital', as politicians seek to distract attention from one failure by jumping on another bandwagon. In the short-term we might see the nuclear industry strutting around saying "I told you so"; and the green energy lobby has also been panicked by recent price falls[41].

In fact the long-term fundamentals of energy supply have not changed – the current trends have everything to do with the geopolitics of oil and little to do with what will happen to oil prices in five or ten years time. Those realities are likely to be drowned out as industry and lobby groups noisily queue at the government's door to sell yet more 'production' technologies to gullible politicians, and an incredulous public.

What we need instead is long-term thinking. The difficulty is, in the fall-out from the failure of shale, the more fundamental arguments about the relationship between energy and the economy will be missed.

The greater argument we should be having is about growth and ecological limits[42], and whether growth has reached its limit in the most developed nations. This isn't just an issue of climate change, or the depletion of national resources. The founders of modern economics – Adam Smith, John Stuart Mill, Thomas Malthus – all believed that the economy would grow to a certain point and then stop[43]. That's not just an issue of material consumption; it's about the finite nature of the world. For example, how many hours of TV can you watch a week, or how many ready meals can you consume, before all your available free time/space is saturated?

What the 'fracking bubble'[44] demonstrates in not simply the bankruptcy of extreme fossil fuels[45] – it's the economic model itself which is bankrupt. Even students studying economics at universities around the world understand that point, and are lobbying for change[46].

Politicians are not necessarily stupid; they're goaded into it by well-connected economists who tell them that they have a fool-proof model for how the world works. The problem is that model is broke – and fracking, or futile carbon trading, or never-ending austerity are simply manifestations of a failure to accept that it's time to change our model of the political-economy.


References:

  1. Post-Carbon Institute: 'Drilling Deeper', October 2014http://shalebubble.org/drilling-deeper/
  2. Shale Bubble: 'Shale And Wall Street – Was The Decline In Natural Gas Prices Orchestrated?', Deborah Rogers, February 2013http://shalebubble.org/wp-content/uploads/2013/02/SWS-report-FINAL.pdf
  3. PWC: 'Shale oil – the next energy revolution', February 2013http://www.pwc.com/gx/en/oil-gas-energy/publications/shale-oil-changes-energy-markets.jhtml
  4. Earthworks: 'The Halliburton Loophole'http://www.earthworksaction.org/issues/detail/inadequate_regulation_of_hydraulic_fracturing
  5. BBC News: 'How American energy independence could change the world', 3rd April 2014http://www.bbc.co.uk/news/business-23151813
  6. Wikipedia: 'Financial crisis of 2007-08'http://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%9308
  7. Wikipedia: 'Quantitativer easing'http://en.wikipedia.org/wiki/Quantitative_easing
  8. Guardian On-line: 'Quantitative easing: giving cash to the public would have been more effective', 29th October 2014http://www.theguardian.com/business/economics-blog/2014/oct/29/quantitative-easing-policy-stimulus-janet-yellen-ecb
  9. Global Research: '0% Interest Rates: Federal Reserve Keeps Shale Gas Fracking Bubble Afloat', 4th November 2014http://www.globalresearch.ca/0-interest-rates-federal-reserve-keeps-shale-gas-fracking-bubble-afloat/5411745
  10. Wikipedia: 'Ponzi scheme'http://en.wikipedia.org/wiki/Ponzi_scheme
  11. New York Times: 'Drilling Down – Industry Privately Skeptical of Shale Gas', June 2011http://www.nytimes.com/interactive/us/natural-gas-drilling-down-documents-4-intro.html
  12. Wall Street Daily: 'Junk Bond Carnage', 11th December 2014http://www.wallstreetdaily.com/2014/12/11/energy-sector-junk-bonds/
  13. Nature: 'Natural gas – The fracking fallacy', 3rd December 2014http://www.nature.com/news/natural-gas-the-fracking-fallacy-1.16430
  14. Guardian On-line: 'US shale boom is over, energy revolution needed to avert blackouts', 6th June 2014http://www.theguardian.com/environment/earth-insight/2014/jun/06/shale-oil-boom-over-energy-revolution-blackouts
  15. DeSmog Blog: 'New Report Casts Doubt on Fracking Production Numbers', 26th October 2014http://www.desmogblog.com/2014/10/27/drilling-deeper-post-carbon-institute-fracking-production-numbers
  16. Wikipedia: 'Bond market'http://en.wikipedia.org/wiki/Bond_market
  17. OIES: 'US shale gas and tight oil industry performance: challenges and opportunities', March 2014http://www.oxfordenergy.org/2014/03/us-shale-gas-and-tight-oil-industry-performance-challenges-and-opportunities/
  18. Wikipedia: 'Troubled Asset Relief Program, Participants'http://en.wikipedia.org/wiki/Troubled_Asset_Relief_Program#Participants
  19. Independent Petroleum Association of America (IPAA)http://oilindependents.org/about/
  20. Wikipedia: 'Subprime mortgage crisis'http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
  21. Market Oracle: 'What Blows Up First? Shale Oil Junk Bonds', 19th November 2014http://www.marketoracle.co.uk/Article48267.html
  22. Forbes: 'Time to Protect the US Shale Revolution?', 17th October 2014http://www.forbes.com/sites/chipregister1/2014/10/17/time-to-protect-the-us-shale-revolution/
  23. Bloomberg News: 'Shale Drillers Feast on Junk Debt to Stay on Treadmill', 30th April 2014http://www.businessweek.com/news/2014-04-30/shale-drillers-feast-on-junk-debt-to-stay-on-spending-treadmill
  24. Bloomberg News: 'Junk Bonds Fuel the Shale Boom', 1st May 2014http://www.businessweek.com/articles/2014-05-01/junk-bonds-fuel-the-shale-gas-boom
  25. State Impact: 'Abandoned wells could be significant source of greenhouse gas', 11th December 2014http://stateimpact.npr.org/pennsylvania/2014/12/11/study-abandoned-wells-could-be-significant-source-of-greenhouse-gas/
  26. Tampa Tribune (Florida): 'Fracking: Florida utilities want you to pay', 14th December 2014http://tbo.com/news/politics/fracking-state-uilities-want-you-to-pay-20141214/
  27. Wall Street Journal: 'Chesapeake Accused of Underpaying Gas Royalties', 11th March 2014http://www.wsj.com/articles/SB10001424052702304071004579407572017346590
  28. Scranton Times-Tribune (Pennsylvania): 'Shale gas industry 'ripe for noncompliance' with wage law', 11th December 2014http://thetimes-tribune.com/news/shale-gas-industry-ripe-for-noncompliance-with-wage-law-1.1801049
  29. Globe and Mail: 'Low oil prices could cut Alberta revenue by $7-billion, Prentice says', 9th December 2014http://www.theglobeandmail.com/news/alberta/low-oil-prices-will-punch-huge-hole-in-alberta-budget-prentice-says/article22015643/
  30. Reuters: 'In Canada's oil sands, a boomtown starts feeling the chill', 16th December 2014http://www.reuters.com/article/2014/12/16/canada-energy-fortmcmurray-idUSL2N0TO20F20141216
  31. The New Yorker: 'OPEC's War on Fracking Is Good News for the Rest of Us', 1st December 2014http://www.newyorker.com/news/john-cassidy/opecs-holiday-present-helps-everyone-except-frackers
  32. Telegraph On-line: 'Oil 'contango' fandango over how low prices will finally go', 12th December 2014http://www.telegraph.co.uk/finance/oilprices/11291080/Oil-contango-fandango-over-how-low-prices-will-finally-go.html
  33. Quartz: 'Is the US energy sector flirting with a mini-bust that could take down the bond market with it?', 1st December 2014http://qz.com/304015/is-the-us-energy-sector-flirting-with-a-mini-bust-that-would-take-down-the-bond-market-with-it/
  34. Bloomberg News: 'Fed Bubble Bursts in $550 Billion of Energy Debt', 11th December 2014http://www.bloomberg.com/news/2014-12-11/fed-bubble-bursts-in-550-billion-of-energy-debt-credit-markets.html
  35. Counterpunch: 'Will Falling Oil Prices Crash the Markets?', 12th December 2014http://www.counterpunch.org/2014/12/12/will-falling-oil-prices-crash-the-markets/
  36. The Age: 'Energy stock bargains beckon for Christmas', 16th December 2014http://www.theage.com.au/business/markets/energy-stock-bargains-beckon-for-christmas-20141216-12844n.html
  37. Financial Post (Canada): 'Savvy traders short oilsands debt as restructurings loom', 8th December 2014http://business.financialpost.com/2014/12/08/savvy-traders-short-oilsands-debt-as-restructurings-loom/
  38. FuelFix: 'U.S. shale junk debt tumbles amid oil crunch', 15th December 2014http://fuelfix.com/blog/2014/12/15/u-s-shale-junk-debt-tumbles-amid-oil-crunch/
  39. Argus Media: 'Drop in US rigs may be start of longer trend', 12th December 2014http://www.argusmedia.com/News/Article?id=963135
  40. Bloomberg News: 'Junk Bonds Backing Shale Boom Facing $11.6 Billion Loss', 2nd December 2014http://www.bloomberg.com/news/2014-12-02/junk-bonds-funding-shale-boom-face-8-5-billion-of-losses.html
  41. Independent On-line: 'New era of cheap oil 'will destroy green revolution', 12th December 2014http://www.independent.co.uk/environment/new-era-of-cheap-oil-will-destroy-green-revolution-9922217.html
  42. Paul Mobbs/MEI: 'Ecological Futures'http://www.fraw.org.uk/mei/ecological_futures.shtml
  43. Centre for the Advancement of the Steady State Economyhttp://steadystate.org/
  44. Newsweek: 'Is the U.S. Fracking Boom a Bubble?', 14th July 2014http://www.newsweek.com/us-fracking-boom-bubble-258623
  45. Extreme Energy Initiativehttp://extremeenergy.org/
  46. Rethinking Economicshttp://www.rethinkeconomics.org/