Fracking has been described as a ponzi scheme. And that’s pretty much what it is. In a recent report I published for Frackwatch that focused on the relationship with fracked gas and the plastics industry, I highlighted the incredible corruption within the shale gas industry that encapsulates the sheer insanity of neoliberalism on steroids.
Fracking in the US is a high output industry that’s loosing billions. Yet Wall St continues to pump billions back into the industry. Its a crazy merry-go-round that allows a small number of well positioned individuals to make a wholelotta money. How do they do it? Following is an excerpt from the report that tells the story of an industry that is creating a massive debt bubble.
It seems that fracking and ‘cracking’ is part of a global mega casino. The explosion of shale gas production in the US has been described as a ponzi scheme. An investigation by DeSmog reveals a culture of gambling and betting, documented in a series of articles.
In 2008, Aubrey McClendon was the highest paid Fortune 500 CEO in America, a title he earned taking home $112 million for running Chesapeake Energy. Later dubbed “The Shale King,” he was at the forefront of the oil and gas industry’s next boom, made possible by advances in fracking, which broke open fossil fuels from shale formations around the U.S. In 2016, the boom caught up with Aubrey McClendon and he hit a wall – literally:
In 2016, the shale king was indicted for rigging bids at drilling lease auctions. He died the very next day in a single car crash, leading to speculation McClendon committed suicide, a rumor impossible to confirm. However, the police chief on the scene noted: “There was plenty of opportunity for him to correct and get back on the roadway and that didn’t occur.” And that – as reflected in the first article, The Secret of the Great American Fracking Bubble – sums up the shale oil/gas industry in the US.
In short, the oil and gas boom has been a financial disaster:
As a whole, the American fracking experiment has been a financial disaster for many of its investors, who have been plagued by the industry’s heavy borrowing, low returns, and bankruptcies, and the path to becoming profitable is lined with significant potential hurdles. Up to this point, the industry has been drilling the “sweet spots” in the country’s major shale formations, reaching the easiest and most valuable oil first.
After more than 10 years of drilling, fracking is now in the same place as the rest of the fossil fuel industry, with most of the easy to get at stuff gone. When you’ve hit peak, there’s only one direction you can possibly go. Production goes down and the cost goes up.
But that doesn’t stop the PR charade of an economic and technical ‘revolution’. Production may be high but:
…it is true that the volumes of oil produced by fracking shale are increasing and currently at record levels. But here is the catch — when you lose money on each barrel of oil you pump and sell — the more you pump, the more money you lose. While it is true that the industry has been successful at getting oil out of the ground, its companies have mostly lost money doing it.
The Economist quote puts it succinctly:
In March 2017, The Economist wrote about the finances of the fracking industry, pointing out just how much money these businesses are burning through:
‘With the exception of airlines, Chinese state enterprises, and Silicon Valley unicorns — private firms valued at more than $1 billion — shale firms are on an unparalleled money-losing streak. About $11 billion was torched in the latest quarter, as capital expenditures exceeded cash-flows. The cash-burn rate may well rise again this year.’
The second article in the series (Despite Disappointing Returns, Oil Driller Pushes Ahead with Fracking Near Rare Texas Wildlands) follows the fortunes of Apache Corp as it attempts to drill for shale oil in a unique West Texas environment at the edge of the Permian Basin, an area that has been a boon for the oil and gas industry since the early days and is now a productive region for shale oil and gas.
Apache went looking for oil, but found gas instead, which isn’t quite as profitable as oil. This has left investors a bit disillusioned. But perhaps they should have realised that its par for the course for the industry to find a nougat of gold and assume a bonanza.
When the price of oil and gas dropped, drillers exploited the ‘sweet’ spots – the more productive areas – first. With oil prices recovering, there has been more focus on shale oil. But whatever way you look at it, production maybe high, but there still isn’t any money being made. And now that most of the sweet spots have been drilled, what’s left is the Law of Diminishing Returns, or in the case of the shale industry, the law of zero returns. The article sums up the problem:
The issue of sweet spots raises broad concerns for the shale industry. A Massachusetts Institute of Technology (MIT) study last year found that government energy analysts made a crucial mistake in their yearly forecast, the Annual Energy Outlook. The government analysts assumed that shale wells were getting more productive because drilling industry technological innovations have allowed fracking to free up more of the oil and gas trapped in shale. But in fact, the MIT study found, the plunge in oil prices forced companies to find and drill their very best acreage first. If accurate, their warning bodes poorly for the shale industry, because it means that in coming years, per-well productivity will drop as sweet spots run out, instead of continuing to rise as technology gets better. Or, …“technology improvements can’t cure bad rock.”
The third article (Low Octane: The Surprising Reason Shale Oil Makes a Poor Fuel for High-Tech Cars and Trucks) reveals a problem with shale oil – its not especially oily. In other words its a particularity light crude with relatively higher proportions of natural gas liquids. This gives the stuff a poor octane rating.
That’s bad news for drivers. Because lower octane rated fuels can affect engine performance. That’s why some petrols need to be enhanced by additives. In the past, lead was the ideal solution, but that was banned because of its health impacts.
It appears then that shale oil could become an Achilles heal for the industry, although at the moment this is a problem that is mainly US based. But if the UK was under the impression that shale oil could replace the stuff coming from the North Sea, the industry could be in for a big disappointment. It also means that a lot of money could be spent tapping into a poor quality resource. As the article notes:
“Our thesis is that the U.S. refining system is close to being maxed-out on the amount of shale oil it can process,” a Morgan Stanley research note concluded this month, citing shale oil’s light hue, which makes it ill-suited to make high octane gas, as well as jet fuel and diesel.
“The more shale oil we run, so to speak, the more difficult it is to get that high percentage octane,” Tom Kloza, Global Head of Energy Analysis at IHS’s Oil Price Information Service, told the Energy Information Administration’s (EIA) annual conference last year. “Ironically, we’re not going to be using more fuel in the U.S. in the next 5 years, but we’ll need more octane, at least until more cars run on electricity.”
Article four (GOP Tax Law Bails Out Fracking Companies Buried in Debt) exposes a tax scam introduced by the Trump Administration. The Tax Cuts and Jobs Act of 2017 was a major bailout for the beleaguered fracking industry (amongst others).
The initiative props up an industry that is effectively failing allowing companies to claim back huge tax allowances. As the article points out:
These companies also will benefit from lowered tax rates in future years. However, this onetime handout simply masks the reality that the shale revolution looks a lot like a Ponzi scheme enriching CEOs and Wall Street financiers by producing oil and gas with borrowed money that is unlikely to be paid back in the future.
…and the Wall Street financiers have no incentive to do anything differently. Sure bankrupt energy companies destroy worker pensions, wipe out investors equity, layoff thousands of workers — but if we use the coal industry as an example — CEOs will still get bonuses after driving their companies into bankruptcy.
Its not just the Trump Administration that’s keeping fracking companies on life support. Wall St is pumping billions into the industry. Article five states (How Wall Street Enabled the Fracking ‘Revolution’ That’s Losing Billions):
The U.S. shale oil industry hailed as a “revolution” has burned through a quarter trillion dollars more than it has brought in over the last decade. It has been a money-losing endeavor of epic proportions.
In September 2016, the financial ratings service Moody’s released a report on U.S. oil companies, many of which were hurting from the massive drop in oil prices. Moody’s found that “the financial toll from the oil bust can only be described as catastrophic,” particularly for small companies that took on huge debt to finance fracking shale formations when oil prices were high.
And even though shale companies still aren’t turning a profit, Wall Street continues to lend the industry more money while touting these companies as good investments.
The article makes no bones about comparing the industry to Las Vegas:
Wall Street makes money by facilitating deals much like a Vegas bookie makes money by taking bets. As the saying about Las Vegas goes: “The house always wins.” What’s true about casinos and gambling also holds true for Wall Street.
The biggest lenders by far are JP Morgan and Barclays. The article explains how it all works:
To understand why JP Morgan and the rest of these banks would loan money to shale companies that continue to lose it, it’s important to understand the gambling concept of “the vigorish,” or the vig. Merriam-Webster defines vigorish as “a charge taken (as by a bookie or a gambling house) on bets.”
Wall Street makes money by taking a cut of other people’s money. To a gambling house, it doesn’t matter if everyone else is making money or losing it, as long as the house gets its cut (the vig) — or as it’s known in the financial world — fees.
Understanding this concept gives insight into why investors have lent a quarter trillion dollars to the shale industry, which has burned through it. If you take the vig on a quarter trillion dollars, you have a big pile of cash. And while those oil companies may all go bankrupt, Wall Street never gives back the vig.
Its a bit like going to your bank and asking for loan. Even if can’t pay your interest on the loan, the bank insists in paying out more money to you, even if you tell it to stop! Suffice to say, a small number of people are getting very wealthy from this scam.
As well as benefiting from particular arrangements that are not available to renewables, the shale industry has been a major beneficiary from the financial crash. Since 2008, The Federal Reserve (Fed) has introduced the zero interest rate policy (ZIRP). The net result is that there is no interest on savings, as explained in Article seven (This Federal Policy Enabled the Fracking Industry’s $280 Billion Loss):
One of the results of the Fed’s zero interest rate policy is that the average American saver ends up with close to zero interest on their money in the bank. This is one of the reasons that ZIRP is often described as a wealth transfer from American savers to debtors. Because the shale industry is deeply in debt, these companies directly benefit from this arrangement. Below is a chart of rates for certificates of deposit (CD) since 1980 — historically a safe investment that gave people a decent return on their savings.
The result of this policy has been a reinflation of the housing bubble – a major component in the initial crash. But its not just the housing market that gets reinflated, it has an effect on wider markets as well. And this has included fracking in a big way:
There are two main ways that ZIRP has fueled the shale industry. One is that — unlike the rest of us not making money on our savings — big companies and investors have been able to borrow large amounts of money at very low rates. This is commonly referred to as “free money” during the ZIRP era because if you are paying little-to-no interest on a loan it is effectively free.
The second main way that ZIRP has funded the shale “revolution” is via the junk bond market. Junk bonds are bonds issued by companies — with help from investment banks that get their cut — that have credit ratings below “investment grade.” To be an investment grade bond requires a certain level of confidence the company will pay back both the interest and principal on the bond “through good times and bad.”
Because there is a lower chance of a junk bond issuer being able to pay back interest and principal, those bonds reward investors with the promise of higher returns. If the company does well, the investors are paid well for their gamble. If not … they lose out because they invested in “junk.”
In other words, the shale industry is being built on the back of ‘toxic’ assets – the term used to describe the worthless ‘junk’ that was left stranded following the crash. With interest rates set to rise, the bubble holding the fracking industry is set to inflate to enormous proportions.
What’s effectively happening here is a carbon copy of the events that led to the 2008 crash. The industry can’t even pay off its debts at zero rates. And with most of the good stuff drilled out the house of cards will almost certainly come tumbling down. The article asks the obvious question ‘who will pay to bail out Wall Street and the shale industry if the bubble pops?’ If history is anything to go by, it won’t be Wall St.
Meanwhile top CEO’s are walking away with billions as their companies crash. But the investors keep on flocking. All a company has to do is wax lyrical about the next shale play. Any nonsense will do. Tell the market about a bonanza and the frenzy begins, whether the claim can be backed up or not.
The US fracking industry makes Las Vegas look like a small time operation. If you get the formula right you can make billions. But the oil and gas is running out. What happens when there’s nothing left to gamble on? As Bill Ordemann, Executive Vice President of Enterprise Products noted, ‘We don’t know what we’re doing.’