Snake Oil: How Fracking's False Promise of Plenty Imperils Our Future (13 page)

The shale gas industry has touted natural gas exports as a way to improve the US trade balance. Indeed, despite the fact that the United States remains a net natural gas importer, gas export efforts are under way: Dominion Corporation will begin construction on an LNG export project at its Cove Point terminal in Maryland in 2014, with contracts for delivery to Japan and India; Cheniere Energy is converting its Sabine Pass LNG import facility in Louisiana into an export terminal; and United LNG has signed agreements with India for the long-term supply of LNG by way of its offshore Main Pass Energy Hub, also in Louisiana.
19
Meanwhile, Congress is on board with LNG exports—presumably as a way to boost the nation’s foreign revenues.
20

But the industry’s actual motives have nothing to do with improving America’s balance of trade. Potential LNG importers in Japan, India, and China will pay upwards of $15 per million Btus for natural gas, while the American domestic price hovers around $4. The natural gas industry wants to export its product for one reason only: to get a better price. If American users want that same gas, they will have to pay more. LNG exports will drive up the US price of natural gas: it’s simple economics, and no one who has seriously looked into the matter claims otherwise.

The natural gas industry is doing everything it can to substantially increase US natural gas prices, yet the same industry claims low gas prices as a benefit of its practices. The cognitive dissonance inherent in this situation is perhaps lost on most casual observers, but not on the American chemicals industry and electric power utilities—big users of gas. Recall Daniel Yergin’s statement (quoted above) that “gas-consuming industries have invested billions of dollars in factories in the United States, something which they would not have expected to do half a decade ago—creating new jobs in the process.” Are those jobs about to go away as gas prices shoot back up? Will power generators that switched from burning coal to natural gas in order to take advantage of low gas prices now switch back to coal?
21

Industry boosters like Daniel Yergin often cite jobs as one of the principal benefits to America from fracking. Yet, as we have already seen, fracking’s actual jobs record has been oversold. Industry-funded studies often include professions such as strippers and prostitutes in their totals of new jobs created.
22
Jobs for actual oil and gas industry workers have accounted for less than one-twentieth of 1% of the overall US labor market since 2003,
23
according to the US Bureau of Labor Statistics, and where those jobs relate to fracking, they will gradually disappear as plays are drilled out and production declines.

In a research note for
Capital Economics
(April 2013), Paul Dales argued that the oil and gas boom has provided only a modest economic boost to the US economy in recent years:

Since June 2009 the volume of oil and gas extraction has risen by 24%. Over the same period the production of mining machinery has risen by 47% and the output of mining support services, which includes oil and gas drilling, has leapt by 58%. . . .
But that rise explains only a small part of the economic recovery.
Admittedly, it is responsible for a fifth of the 18.3% increase in overall industrial production. Given that the oil- and gas-related sectors account for only 2.5% of GDP,
they have contributed just 0.6 percentage points (ppts) to the 7.6% rise in GDP.
24
[Emphasis in original]

Perhaps the biggest real impact of fracking on the nation is at the macro scale of energy policy. As a result not just of temporarily increased production, but also of exaggerations from the industry (and spokespeople like Daniel Yergin), the United States is failing to plan for a future in which hydrocarbons are more scarce and expensive; failing to invest sufficiently in renewable sources of energy, and in low-energy infrastructure such as electric light rail; and failing generally to do what every nation must in order to survive in a century of rapidly destabilizing climate—which is to
reduce dependency on fossil fuels as quickly as possible
. US politicians of every stripe end up adopting the attitude, “Yes, of course we should be reducing fossil fuel consumption in order to avert the worst climate change impacts—but with the prospect of energy independence, jobs, and economic growth all flowing from shale gas and tight oil, how could we possibly say no?”

Yet, as we have just seen, these promises are largely unrealistic. Meanwhile, the costs of continued oil and gas dependency, which will be borne mostly in the future, already constitute an invisible though mountainous burden, compounding daily.

Throughout, fracking boosters appear to maintain a Marie Antoinette-like attitude toward the American people, saying, in effect,
“Let them eat hype.”

The Oil and Gas Industry

When we inquire who benefits from the fracking frenzy, the intuitively obvious answer is,
“the oil and gas industry, of course.”
Yet this may be a simplistic assumption.

Drilling companies have seen increased revenues as a result of shale gas and tight oil production. This is primarily true for the outfits that managed to lease land in the core areas of shale plays, where wells are more productive and profitable.

The industry as a whole has scored big in terms of public relations: the promise of plenty has largely shifted the conversation in America from worry about high energy prices, supply vulnerability, and climate risks, to ebullience over the illusion of “energy independence.”

However, as we have just seen, many shale gas (and some tight oil) operators in non-core areas have been losing money on production. Only a few companies are profiting handsomely. Clever operators can squeeze profits out of money-losing field operations with “pump and dump” stock schemes, selling stocks to gullible pension fund managers, or selling bundles of drilling leases (of highly variable quality) to foreign investors. A few early birds (such as Aubrey McClendon) have gotten spectacularly rich, while building financial structures packed with risk.

One of these risks consists of price volatility. Shale gas and tight oil production only makes economic sense when fuel prices are high. But (as gas drillers have learned, to their bitter disappointment) there is no guarantee that prices will stay high enough, long enough, for investments to pan out. If the US economy were to fall back into recession, energy demand would drop and so would oil and gas prices. Drillers would have no choice but to idle their rigs and accept losses.

Perhaps that’s what led Aubrey McClendon to say in an investor call in 2008, “I can assure you that buying leases for x and selling them for 5x or 10x is a lot more profitable than trying to produce gas at $5 or $6 mcf.”
25
Gas prices wound up dropping to less than $2 per thousand cubic feet (mcf).

Another risk comes from potential liability for environmental and human health damage. Producers try to contain risk with ongoing improvements to their procedures, but also with nondisclosure agreements. States and counties are increasingly restricting and even banning fracking out of concern for human and environmental health, and the result could be a sharp decline in potential revenues for operators—and therefore a drop in stock value and an increase in borrowing costs. A general lack of transparency in the industry makes it difficult to ascertain the total payments made to date for settlement of damage claims. But worries about declining water and air quality pose a growing public relations hurdle for the companies.

Still another risk comes from the very hype that drives investment toward the industry. When projects go sour, investors flee, and suspicion grows among the investment community that shale production is merely a bubble. This perception is bolstered by companies pulling out of shale plays or deciding against funding, for example, a pipeline to North Dakota—presumably out of recognition that volumes of crude produced will not be high enough, or last long enough, to make such a pipeline pay off.
26
It’s as though drillers are admitting they don’t believe the hype themselves.

Fracking is helping the industry as a whole bring more product to market. But the top international oil companies—ExxonMobil, Shell, BP, Chevron, and Total—have seen their overall production decline by over 25% since 2004.
27
Meanwhile capital spending by the industry has nearly doubled. The only factor forestalling economic bloodshed for the majors is high oil prices: while they must invest more upstream to produce fewer barrels, each barrel sold now brings in more revenue.
28

For a few players, the shale boom is a bonanza. Yet overall, despite protests to the contrary, evidence suggests the oil industry has entered its sunset years.

Wall Street

If, in the final analysis, the nation as a whole and the impacted communities within it lose more from fracking than they gain, and the oil industry is seeing diminishing returns on its burgeoning investments, then who
does
stand to benefit?

In the Introduction and Chapters 2 and 3, we noted how, in many instances, gas prices have been driven down to a level below industry’s production cost. Low prices have in turn been cited as economic benefits of shale development. Yet aside from having gained a PR talking point, the industry itself has actually been hurt by low prices. Chesapeake Energy has not only reduced drilling, but sold off hundreds of millions of dollars’ worth of assets to cover unsustainable debt loads. BP has been forced to write off nearly two billion dollars in assets. Rex Tillerson, the CEO of ExxonMobil, told the Council on Foreign Relations in New York City in June 2012, “We’re losing our shirts [on shale gas production]. We’re making no money. It’s all in the red.”
29

Why
did the industry shoot itself in the foot by overproducing shale gas? In some respects, the glut resulted inevitably from a land rush that occurred in the early years of the shale boom, when companies were leasing as much land as possible, as quickly as possible: the terms of drilling leases required drilling sooner rather than later, even if that meant oversupplying the market. But this is not a sufficient explanation for the price plunge. For a deeper understanding of the industry’s puzzlingly self-destructive behavior, we must follow the money.

In a
New York Times
investigative article (“After the Boom in Natural Gas,” October 20, 2012), Clifford Krauss and Eric Lipton wrote, “Like the recent credit bubble, the boom and bust in gas were driven in large part by tens of billions of dollars in creative financing engineered by investment banks like Goldman Sachs, Barclays and Jefferies & Company.” The article details how this “creative financing” forced drillers to keep drilling even when each new well represented a financial loss.
30

Deborah Rogers, a former Wall Street financial consultant and member of the Advisory Council for the Federal Reserve Bank of Dallas from 2008 to 2011, has further traced the toxic connections between major investment banks and shale gas/tight oil operators in her report, “Shale and Wall Street: Was the Decline in Natural Gas Prices Orchestrated?”
31
She writes:

In order for a publicly traded oil and gas company to grow extensively, it must manage not only its core business but also the relationship it enjoys with its investment bankers. Thus, publicly traded oil and gas companies have essentially two sets of economics. There is what may be called field economics, which addresses the basic day-to-day operations of the company and what is actually occurring out in the field with regard to well costs, production history, etc.; the other set is Wall Street or “Street” economics. This entails keeping a company attractive to financial analysts and investors so that the share price moves up and access to the capital markets is assured. (p. 6)

It was “street economics” rather than “field economics” that drove the gas glut and price rout, according to Rogers, who notes that the price decline “opened the door for significant transactional deals worth billions of dollars and thereby secured further large fees for the investment banks involved. In fact, shales became one of the largest profit centers within these banks in their energy M&A portfolios since 2010.” (p. 1) She concludes that the glut was engineered in large measure “in order to meet financial analysts’ production targets and to provide cash flow to support operators’ imprudent leverage positions.” (p. 1) When natural gas prices tanked,

Wall Street began executing deals to spin assets of troubled shale companies off to larger players in the industry. Such deals deteriorated only months later, resulting in massive write-downs in shale assets. In addition, the banks were instrumental in crafting convoluted financial products such as VPP’s (volumetric production payments); and despite the obvious lack of sophisticated knowledge by many . . . investors about the intricacies and risks of shale production, these products were subsequently sold to investors such as pension funds. Further, leases were bundled and flipped on unproved shale fields in much the same way as mortgage-backed securities had been bundled and sold on questionable underlying mortgage assets prior to the economic downturn of 2007. (p. 1)

Wall Street benefits from manias—at least in the short term. Investment banks make money on sales of shares in companies whose activities spur speculative bubbles. They also profit from mergers and acquisitions when bubbles burst and companies go bust. For the most part, it’s not their money being invested—it’s more likely yours, if you have any kind of retirement account.

There are a lot of people benefiting from the shale gas and tight oil boom, ranging from drillers to landowners to hoteliers, but arguably none have profited more than investment bankers. And when oil and gas production falls and the fortunes of drillers, landowners, and hoteliers plummet along with it, the bankers will most likely continue to do just fine, thanks.