Guest Post: The Shale Oil Boom is More "Mirage" than "Miracle"

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Submitted by Adam Taggart of Peak Prosperity,

Gail Tverberg, is a professional actuary who applies classic risk assessment procedures to global resources: studying issues such as oil & natural gas depletion, water shortages, climate change, etc. She is widely known in the Peak Cheap Oil space for her reports issued across energy websites over the years under the penname "GailTheActuary".

In this week's podcast, Chris asks Gail to assess the merits of the shale oil "revolution". Does it usher in a new Golden Age of American oil independence?

With her actuarial eyeshade firmly in place, Gail quickly begins discounting the underlying economics behind the shale model:

We have to ask: At what price is the oil available? Is this shale oil available because prices are high and in fact, because interest rates are low, as well? Or is it available if it were cheap oil with interest rates at more normal levels?

 

I think what we have is a very peculiar situation where it is available ,but it is available only because of this peculiar financial situation we are in right now with very high oil prices and very low interest rates.

 

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The shale oil plays are going to be probably much less than a 10-year flash in the pan. They are very dependent on a lot of different things, including low interest rates and the ability to keep borrowing - which could turn around very quickly. Lower oil prices would tend to do the same thing. But even if you hypothesize that we can keep the low interest rates and that the oil price will stay up there, under the best of circumstances, the Barnett data says they probably will not go for very long.

 

You know, when you take how long the payout really is on those wells, I think the companies drilling these plays have been very optimistic as to how long those wells are going to be economic. There was a recent study done saying just that: 10 years or 5 years; but certainly not 40 years.

 

And so these companies put together optimistic financial statements that have the benefit of these extremely low interest rates. They keep adding debt onto debt onto debt. How long can they continue to get more debt to finance this whole operation? It's not a model that anybody who is very sensible would follow.

Similar to many energy experts Chris has interviewed prior, Gail looks at the math and concludes that humans (especially those in the West) have been living on an energy subsidy that is beginning to run out. We have been living outside of our natural budget, and will be forced to live within what remains going forward. As a result, she expect great changes in store for the next several decades: socially, politically and lifestyle-wise.

Click the play button below to listen to Chris's interview with Gail Tverberg (38m:07s):

 

 

A further excerpt:

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Chris Martenson: Okay. So which comes first, then – low oil prices or low oil supplies leading to higher prices? Which do you see is driving the future here?

Gail Tverberg: I see government problems that are being brought on by oil as being the next step. And the government problems will bring the oil prices down. So as oil prices come down, then that brings the supply down. But it is the government problems that are the intervening step in there. It is the fact that the governments are put in a position where they need to support all of these people who cannot find work, and this is related to the high price of oil. And also, it is supporting promises that we have made over the years.

There is also the debt part of it. We depend on very low interest rates to keep the cost of that debt low right now. But the debt has been escalating since 2008, the federal debt has. And so the government is in a very tight situation, and it is the government problems that have the potential to spill over into the rest of the world situation. And it is through that mechanism that we will see the decline in oil supply. That is the way I see it going.

Chris Martenson: All right, so make sure I have got this: Because the government has taken on a whole lot of debt, it is trying to support a lot of people who are out of work; the economy is basically moribund because of high oil prices, so there is a little self-feedback loop in there. But ultimately, it is going to be the fiscal condition of the government – let’s say the U.S. government?

Gail Tverberg: It is going to be the fiscal condition of the U.S. government, and it is going to be all of the debt outstanding. It is going to be the fact that we cannot keep those interest rates low permanently. We cannot keep this quantitative easing up. And what is going to happen is the interest rates will rise, and that will cause a big problem. Or at least that is one scenario. There are so many different scenarios that could cause a problem. That is just one of them, anyhow.

Chris Martenson: You are talking about all of this leading to a deflationary outcome at some point. The Federal Reserve obviously is working double-overtime to prevent that outcome exactly. A lot of people have staked complete faith that the Fed has this all in hand and will lead to an inflationary outcome, I believe. World bond market prices, equity pricings, resurgence in real estate values, things like that are all collectively telling me that the bet has been made. The Fed will not lose this battle. Do you think they might?

Gail Tverberg: What happens is all of the extra money from the quantitative easing is going into speculation. And it is pumping up the prices of the stock market, the bond market, housing prices, farm prices, you name it. And so it is off in these places where it is not Main Street, it is not doing things that are getting people jobs. And so we have this temporary bubble on assets that cannot stay there if interest rates go up.

Chris Martenson: That is the big “if” in this story. Well, for me, it is a “when” – when interest rates go back up. We have hundreds of years of history on interest rates. And right now, I believe the U.K. or English gilts are at a 400-year low in terms of interest rates. So you might say there is a small chance of reversion to the mean in that story.

Good chance that might happen, and yet, we have this collective bet on such an outcome not happening. People are really hoping for something other. This is, I think, the heart of what you write about a lot – this idea that capital formation is a very different process from printing money. And I have seen otherwise very well-credentialed economists mixing those two things up, using the words interchangeably, that the Fed is basically creating capital. In my mind, capital is something that happens after you have performed some useful economic activity and there is a surplus left over. And then, that capital can be saved and that savings can go back into investment. That loop seems to be pretty well broken, as far as I can tell.

When we look at capital expenditures by corporations, we look at infrastructure spent by the Federal government. Very much a decade of lows. So we are not plowing any of this money back in. It is being used instead for speculation.

But the common story right now says that hey, high asset prices are a cure; they work. High housing prices, prices going up, that creates a wealth effect.