Industry Experts: The Numbers Don’t Add Up
The shale gas revolution was meant to bring lasting prosperity.
But the result of the gas glut may be just a bubble,
producing no more than a temporary recovery and
masking a deeper boom and bust economic problem.
The Great Oil Swindle: What Happens When the Shale Boom Goes Boom
By Nafeez Ahmed
A spate of reports last year, in particular the International Energy Agency’s (IEA) World Energy Outlook in November 2012, forecast that the US will outstrip Saudi Arabia as the world’s largest oil producer by 2017, becoming, as Reuters put it, “all but self-sufficient in net terms” in energy production.
According to the IEA, the projected increase in oil production will come “entirely from natural gas liquids and unconventional sources” — largely shale oil and gas — while conventional oil output will begin to fall in 2013.
These resources can only be mined at the cost of massive environmental pollution: their extraction involves hydraulic fracturing (or “fracking”: a pressurized injection of water, sand and detergents to create new cracks in the rock to force out the gas using the technique of horizontal drilling.
This exploitation in the US has brought the creation of hundreds of thousands of jobs and offers the advantage of cheap and abundant energy. Exxon Mobil’s 2013 Energy Outlook says the shale gas revolution will make the US a net exporter by 2025.
But is the shale revolution all it’s fracked up to be?
A New York Times investigation first unearthed major cracks in the “shale boom” narrative in June 2011, finding 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.”
In early 2012, two US energy consultants, writing in the flagship British energy industry journal Petroleum Review, sounded the alarm. They 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 rules introduced in 2009. The new rules allow gas companies to claim reserve sizes without any independent third party audit.
The Tricky Economics of Fracking
The overestimation of reserve sizes is being used by oil industry majors to obscure the dodgy economics of fracking. Apart from the harmful effects on the environment, the problem is one of production rates which start high, but fall fast. In Nature, former UK chief government scientist Sir David King, co-writing with scientists, noted that production of wells drop off by as much as 60-90% within the first year.
Such a rapid decline has made shale gas distinctly unprofitable. As production declines, operators are forced to drill new wells to sustain production levels and service debt. Rocketing production at inception, combined with the economic slowdown, drove US natural gas prices from about $7-8 per million cubic feet in 2008 down to less than $3 per million cubic feet in 2012.
Finance specialists have not been taken in.
“The economics of fracking are horrid,” writes US financial journalist Wolf Richter in Business Insider. Richter wrote:
“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.
To keep the decline rates from mucking up income statements, companies had to drill more and more, with new wells making up for the declining production of old wells. Alas, the scheme hit a wall; namely, reality.”
Arthur Berman, a petroleum geologist who worked with Amoco says that “the decline rates of shale reservoirs are incredibly high.” Citing Texas’ Eagle Ford shale site (the “mother of all shale oil plays”), he points out that the “annual decline rate is higher than 42%.” Just to keep production flat, they will have to drill “almost 1,000 wells in the Eagle Ford shale, every year. Just for one play, we’re talking about $10 or $12 billion a year just to replace supply. I add all these things up and it starts to approach the amount of money needed to bail out the banking industry. Where is that money going to come from?”
‘It’s All in the Red’
ExxonMobil’s CEO, Rex Tillerson, complained that the lower prices due to the US natural gas glut, although reducing energy costs for consumers, were depressing prices and were often insufficient to cover production costs resulting in dramatically decreased profits. But, in shareholder and annual meetings, the company had officially insisted it was not losing money on gas. Tillerson candidly told a meeting of the
Council on Foreign Relations: “We are all losing our
shirts today. We’re making no money. It’s all in the red.”
The British BG Group was forced to take a $1.3 billion write-down in its US natural gas assets due to the gas supply glut, “leading to a sharp fall in profits.” By November 2012, after Royal Dutch Shell saw its earnings fall for the third consecutive quarter by 24% on the year, Dow Jones reported the “negative effects in their earnings,” underscoring “how disruptive the shale boom of the past few years has been to the sector.”
Even Chesapeake Energy — billed as America’s shale pioneer — 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.”
How has this been allowed to happen? Analyst John Dizard pointed out in the Financial Times that shale gas producers have spent “two, three, four and even five times their operating cash flow to fund their land, drilling and completion programs.” 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 checks with lots of zeroes at the end.”
The premise of “peak oil” — the point at which geological constraints and economics combine to make the black stuff more difficult and expensive to produce — is far from undermined by the shale gas boom. Several independent scientific studies released over the last year– largely ignored by the media– vindicate this conclusion.
In a study in Energy Policy, Sir David King and his Oxford team concluded that the oil industry had overstated world reserves by about a third, and estimates should be downgraded.
“While there are certainly vast amounts of fossil fuel resources left in the ground, the volume of oil that can be commercially exploited at prices that the global economy is accustomed to is limited– and will soon decline,” King said.
And US financial risk analyst Gail Tverberg found that since 2005, “conventional world oil supply has not increased, that this was a primary cause of the 2008-2009 recession, and the expected impact of reduced oil supply will mean the financial crisis may eventually worsen.”
That’s not all: a new report from the New Economics Foundation warned that the arrival of “economic peak oil” — when the cost of supply “exceeds the price economies can pay without significantly disrupting economic activity” — will occur around 2014-15.
But the upshot is simple: Rather than ushering in a new wave of lasting prosperity, the eventual consequence of the gas glut is likely to be an unsustainable shale bubble, fueling a temporary recovery masking deeper structural instabilities. When the bubble bursts under the weight of its own debt obligations, there will be a collapse in supply and a spike in prices with serious economic consequences.
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This article has been abridged and images added. Readers may want to see Mr. Ahmed’s full scholarly article in LeMonde’s English Diplomatique, “The Great Oil Swindle”. Our appreciation to ZeroHedge for the tip.