The Fracks of Life

For decades, the United States staggered under the mantle of her ferocious appetite for gasoline. We were at the mercy of OPEC. In 1973, OPEC nations slammed the U.S. for its support of Israel with a boycott, severely curtailing petroleum exports to lots of nations but mostly to the United States. Gasoline rationing hit us hard. Long lines at gas stations ending with consumers forced into only being able to buy gasoline (40% more expensive) on alternating days depending on their license plates. The stock market crashed. Political savants have never forgotten those days. Most Americans were not even aware of how dependent we were on imported oil.

You’d never know that today, as the United States is today one of the world’s greatest producers of oil, very much rivaling Russia and Saudi Arabia. We had thought in the 1960s that we had pretty much exhausted our local reserves. Yet today, we are no longer reliant on “foreign oil.” Even with a depressed oil market, we continue as a major exploiter of oil, and even more dramatically, natural gas. The oil market has improved, although it has yet to reach its earlier peak pricing.

What made this possible is fracking, a process of injecting chemically-treated water under high-pressure into what were believed to be exhausted oil fields or low-grade shale fields. Oil flowed once again in amazing volumes. In about 20 years, fracking resurrected the American oil industry completely. The environmental side effects, however, were and are nasty, from triggering earthquakes to severely polluting groundwater. Those are the obvious costs that most of us know about. What few Americans understand is how very thinly capitalized this world of expensive fracking really is, how close to supporting a much bigger financial collapse we really are based on the harsh economic realities behind this fracking craze.

Author and Oscar-winning documentarian, Bethany McLean, examined the details in an amazing op ed piece in the September 1^st New York Times: “Some of fracking’s biggest skeptics are on Wall Street. They argue that the industry’s financial foundation is unstable: Frackers haven’t proven that they can make money. “The industry has a very bad history of money going into it and never coming out,” says the hedge fund manager Jim Chanos, who founded one of the world’s largest short-selling hedge funds. The 60 biggest exploration and production firms are not generating enough cash from their operations to cover their operating and capital expenses. In aggregate, from mid-2012 to mid-2017, they had negative free cash flow of $9 billion per quarter.

These companies have survived because, despite the skeptics, plenty of people on Wall Street are willing to keep feeding them capital and taking their fees. From 2001 to 2012, Chesapeake Energy, a pioneering fracking firm, sold $16.4 billion of stock and $15.5 billion of debt, and paid Wall Street more than $1.1 billion in fees, according to Thomson Reuters Deals Intelligence. That’s what was public. In less obvious ways, Chesapeake raised at least another $30 billion by selling assets and doing Enron-esque deals in which the company got what were, in effect, loans repaid with future sales of natural gas.

But Chesapeake bled cash. From 2002 to the end of 2012, Chesapeake never managed to report positive free cash flow, before asset sales.

In early 2015, another famous hedge fund manager, David Einhorn, went public with his skepticism at an investment conference. He had looked at the financial statements of 16 publicly traded exploration and production companies and found that from 2006 to 2014, they had spent $80 billion more than they received from selling oil.

A key reason for the terrible financial results is that fracked oil wells show a steep decline rate: The amount of oil they produce in the second year is drastically smaller than the amount produced in the first year. According to an economist at the Kansas City Federal Reserve, production in the average well in the Bakken — a key area for fracking shale in North Dakota — declines 69 percent in its first year and more than 85 percent in its first three years. A conventional well might decline by 10 percent a year. For fracking operations to keep growing, they need huge investments each year to offset the decline from the previous years’ wells.

Because the industry has such a voracious need for capital, and capital costs money, fracking could not have taken off so dramatically were it not for record low interest rates after the 2008 financial crisis. In other words, the Federal Reserve is responsible for the fracking boom.

Amir Azar, a fellow at the Columbia University Center on Global Energy Policy, calculated that the industry’s net debt in 2015 was $200 billion, a 300 percent increase from 2005. But interest expense increased at half the rate debt did because interest rates kept falling. Dr. Azar recently called the post-2008 era of super-low interest rates the “real catalyst of the shale revolution.

Fracking is such a fragile industry that it is not hard to make it go bust. Saudi Arabia almost succeeded in doing so in 2014, when oil ministers from OPEC decided that they would not cut production in order to prop up falling oil prices. This was seen as an attempt by the Saudis to kill off shale, by cutting prices below the point where American frackers could afford to produce a barrel. By mid-2016, American oil production had declined by nearly a million barrels a day and some 150 oil and gas companies filed for bankruptcy.”

Feel comfortable that Donald Trump is at the helm? Trying to cut back EPA mileage requirements, taking away the ability of states to set their own fuel consumption and air pollution standards? We’re watching Trump’s trade wars pushing at our economic throats. Trump’s accelerating income inequality measures are taking their toll on the middle and lower earning rungs on the earnings ladder. But who is watching the shuddering economics underpinning our oil industry? Donald Trump? What exactly would Americans do if oil prices surge and our dependence on foreign oil hits their lives like the tsunami it really can be?

I’m Peter Dekom, and it’s pretty amazing how stunningly important the fragility of the fracking-driven petroleum industry really is… and how little most of us know about that.