For years now we've been covering the false promise of the American shale oil "miracle".
Yes, it has extracted a lot more oil out of American soil that most thought possible. But at an economic loss. And at great environmental cost.
If the shale drilling companies can't make any profit, either when oil prices are high or low -- why are we still pursuing shale deposits so aggressively?
To shed further light on this paradox, this week we welcome journalist Bethany McLean to the program. McLean is editor-at-large at Fortune Magazine and a contributing editor for Vanity Fair and Slate magazines. She is also author of the excellent book: Saudi America: The Truth About Fracking And How It's Changing The World.
McLean warns that the hype, the hucksterism, and the geological shortcomings of the deposits themselves, are setting up both investors and American society for tremendous disappointment:
The real catalyst of the shale revolution was the Great Financial Crisis and the era of unprecedentedly-low interest rates that followed.
And that had two effects. One was that it made debt cheap. So these companies that are heavily dependent on being able to raise capital could raise debt at low prices. And without that, I’m not sure there would’ve been a shale revolution because they needed such immense amounts of capital to fund their drilling.
But it had a second impact, which is that when pension funds were no longer able to earn a return in traditional fixed income markets, they’ve increasingly put their money into riskier assets like hedge funds that invest in credit and private equity firms. Those entities, in turn, have increasingly invested in shale.
I got an estimate from one source that said 1/3 of the drilling, a third of the fracking, being done in the country today is being done by private equity-backed companies. So we’ve had this derivative effect of the era of low interest rates.
Now there’s a lot of money that believes believes the story that technological improvements are going to make this industry profitable in the long run. But there are lots of ways that private equity firms and other investors can make money even if the companies themselves don’t. And what I mean by that is that for a long time, a shale company that was publicly traded was valued not on its profits but rather, on a multiple of its production or its reserves.
And so, there's an incentive to take these companies public, where it can trade on its growth and production. It doesn't have to produce profits. You can flip your company to the public markets or sell it to an already-public company. So, it’s kind of a big game of musical chairs in many ways.
And I think there's an unacknowledged problem with the shale revolution that feeds into the lack of profits. And that’s that all wells are not created alike.
And so, that gets to the really core question here. How much really good acreage is there? And it’s a reason to believe that even though the industry did get closer to profitable in this last year, that may not last because a lot of companies were drilling the sweet spots first. They were drilling their best acreage. And the question is, “How much of that is there?” And to be frank, nobody really knows the answer.
Some of that is depending on technological changes. If you can get better technology that enables you to get more oil out of the ground more cheaply; then, something that wasn’t the sweet spot could become a sweet spot. Thus far, though, the evidence seems to be mounting that the picture is the opposite of that. And what I mean by that is Wall Street Journal did a really good piece in late December pointing out that actually, production levels are coming in way short of what companies had estimated.
So, it looks like the sweet spots, overall, aren’t even as sweet as they were forecast to be. It’s not coming in better than expected, it’s coming in shorter projections.
there’s a lot of this idea – the idea has shifted from America being energy-poor to America being resource-abundant. And you hear this idea of American energy independence and even President Trump talks about American energy dominance. And I think I read that the IEA – the International Energy Agency – is forecasting that most of the growth in global production in coming years is going to come from US shale. And as a result of that belief, a lot of the big, long-lived projects that take years of investment before they start to produce have been put on hold. So, that oil isn’t going to be coming online. And so, what happens if shale can’t deliver?
Click the play button below to listen to Chris' interview with Bethany McLean (38m:39s).