Fracking’s financial bubble

Posted by Christine, June 28, 2013
On May 24th, J. David Hughes and Deborah Rogers gave a briefing to summarize the findings of two new reports dismantling the myth of a “shale revolution”. We’ve heard about it in the media, on both sides of the political aisle: shale gas and oil are the future of US energy. Indeed, natural gas prices dropped thanks to hydraulic fracturing (or fracking) and horizontal drilling, which helped lower the country’s carbon emissions by reducing coal consumption. In January, Barack Obama said that: “We have a supply of natural gas that can last America nearly 100 years, and my administration will take every possible action to safely develop this energy.”  This myth led to a gas drilling frenzy that have benefitted Wall Street investment banks, one that evidence suggests can’t be sustained for very long.
Type decline curve for Bakken tight oil wells / Photo courtesy of J. David Hughes / Post Carbon Institute

J. David Hughes, geoscientist and author of “Drill, Baby, Drill: Can Unconventional Fuels Usher in a New Era of Energy Abundance?” explained why shale production is not sustainable. Depending on the area, the quality of shale plays—geographic areas targeted for exploration—can be totally different, which leads to a concentration of wells in “sweet spots.” He said quality plays are “relatively rare.” 80 percent of shale gas production comes from only five plays with several declining. The biggest issue is the high depletion rate of wells.  For instance, wells in the largest tight oil play of the country have an average depletion rate of 69 percent in the first year and 94 percent in 5 years. Companies need to build more and more of them to maintain production levels, and it is often not enough. For instance, in 2008, the benefits of the shale industry in Fort Worth, Texas, were $50 million for 44 wells. In 2012, it was $23 million for 397 wells. According to Hughes, shale gas is over-hyped in terms of long-term supply. Production has grown explosively to reach 40 percent of US natural gas production but this increase stopped in December 2011. The shale gas industry needs to drill 7,200 new wells every year to maintain production, which cost over $42 billion. Of course, the industry started with the best plays. According to Deborah Rogers, financial consultant, founder of the EnergyPolicyForum and author of “Shale and Wall Street: Was the Decline in Natural Gas Prices Orchestrated”, US shale gas and oil reserves have been overestimated by a minimum of 100 percent and a maximum of 500 percent.

Gas flaring at Bakken / Image courtesy of NASA

In her report, Rogers explains that Wall Street is in part responsible for the huge decline in natural gas prices. Investment banks put pressure on companies to produce a lot to keep shares high by meeting financial analysts’ production targets. It creates a surplus in gas production leading to prices lower than the cost of production. Investment banks profit from this trend through various transactional fees. For instance, in 2011, shale mergers & acquisitions (M&A) accounted for $46.5 billion, one of the most important profit centers for some investment banks. In August 2011, Neal Anderson of Wood Mackenzie said: “It seems the equity analyst community has played a key role in helping to fuel the shale gas M&A market, acting as chief cheerleaders for shale gas plays.”

Gas is not sustainable also because of its low EROEI (energy returned on energy invested), which is basically how much energy it takes to produce energy. For instance, the average EROEI of oil fell from 100:1 in the 1920s to 20:1 today. Natural gas is 10:1, tar sands oil 5:1 and shale gas 3-5:1—and companies know it. In her report, Rogers notes that some can’t sell their plays and sometimes have to declare bankruptcy, such as Norse Energy. In the Bakken (North Dakota), the shale industry recently abandoned a plan to build a pipeline to carry shale oil. It is interesting because a pipeline is an expensive investment and must carry a consistent stream of oil or gas to recoup initial capital outlays. Then, as Rogers says, it becomes a “real cash cow.” The abandonment of its plans suggests the industry isn’t all that confident in the long-term viability of the play.Why haven’t environmentalists done the same? We need to create and then communicate ecophilosophies that offer humanity an ethical code to live by. We need to provide an explanation of suffering (theodicy in religious terms). And we must be able to tell a story that offers individuals a clear and unequivocal purpose – one as simple as “it is humanity’s role to care for and now heal the Earth of which we are part and on which we so utterly depend.”

Gas flaring at Bakken / Image courtesy of NASA

In her report, Rogers also studied what were the costs and benefits of shale industry in different states. She discovered that companies privatize profits and socialize costs, and it looks like the economic benefits of shale are also over-hyped. For instance, in 2012, the Texas Department of Transportation explained that “repairing roads damaged by drilling activity would ‘conservatively’ cost $1 billion for farm-to-market roads and another $1 billion for local roads” (the analysis doesn’t include interstates and highways). In December 2012, the Associated Press stated that the first operating loss in about five years at a north-central Pennsylvania hospital was due to the influx of gas field workers. Indeed, many subcontractors attracted by the shale drilling boom do not provide health benefits to employees.

Shale must be examined independently and rigorously to define its true value. As Rogers says, “policy at both the state and national level is being implemented based on production projections that are overly optimistic.” In addition to the important environmental and health impacts of shale oil and gas, policy makers need to consider the reality of this industry’s economics. Betting on shale gas and oil for the future of energy production not only makes no sense in a changing climate, but might not even be a good short-term investment.