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The Fracking Ponzi gathers pace

We cannot know for sure what prompted North Yorkshire Council to approve Third Energy’s application to hydraulically fracture its KM8 well near Kirby Misperton despite considerable local opposition.  The council will no doubt have taken account of change to UK policy that mean that ultimately Third Energy’s application will receive ministerial approval irrespective of local opposition.  The legal costs of opposing an application that is bound to succeed will no doubt weigh heavily on a council that faces hard financial decisions as a result of government austerity cuts.  There will also have been promises and inducements from Third Energy too – a new road here, full restoration of the areas there; and, of course, the £100,000 fund for local community projects which, according to Third Energy, could rise to (a laughably optimistic) £70,000,000 over 20 years.

Whatever the factors that influenced the council’s decision, two questions that have not been asked in the mainstream media are: Why this? and Why now?

To answer these questions, we must first understand what the fracking industry is.  By which I do not mean a technical explanation of a process that has been around since the 1940s that allows tight (i.e. expensive to recover) oil and gas to be released from shale formations.  Rather, the fracking industry is a high yield vehicle for investment banks that have struggled to make money since the 2008 crash because of zero percent interest rates – to put it another way, fracking is the new sub-prime mortgage industry.  As Debora Rogers from Economic Policy Forum explains:

“In 2011, shale mergers and acquisitions (M&A) accounted for $46.5B in deals and became one of the largest profit centers for some Wall Street investment banks. This anomaly bears scrutiny since shale wells were considerably underperforming in dollar terms during this time. Analysts and investment bankers, nevertheless, emerged as some of the most vocal proponents of shale exploitation. By ensuring that production continued at a frenzied pace, in spite of poor well performance (in dollar terms), a glut in the market for natural gas resulted and prices were driven to new lows. In 2011, U.S. demand for natural gas was exceeded by supply by a factor of four.”

When the bankers issued sub-prime mortgages, it was not because they were keen to hang on to borrowers who were pretty much guaranteed to default.  Nor were they overly excited about the prospect of repossessing low grade properties.  When the bankers issued sub-prime mortgages, they did it in order to sell worthless pieces of paper to chumps (by chumps, I mean the kind of people that run the occupational pension schemes and insurance pools that we all pay into).  Sure, they securitised and insured them before they sold them on.  Nevertheless, the mortgage agreements on which the whole pyramid was built were themselves worthless.  What has this to do with fracking?  Well, fracking is the same.  Certainly there are so-called sweet spots within the big US shale deposits that can still (just) turn a profit even at today’s low prices.  But for the most part, the fracking industry needs an oil price of $70-$90 per barrel to turn a profit.  But that is not the point.  The real profits do not come from the stuff that the cowboys get out of the ground.  The real profits come from repackaging and re-selling the loans.  And to do that, you have to make fracking appear a lot more lucrative than it actually is.

Enter a term that we are going to hear a lot more about in the not too distant future – “volumetric production payments” (VPPs).  These were an integral part of the loans made to the fracking industry, requiring companies to maintain a high output.  For investors, used to conventional oil and gas drilling – where returns start slow and build to a peak over decades – this gave the impression that there was an awful lot more oil and gas beneath the ground than was actually the case.  As Bloomberg notes, there were huge discrepancies between the recoverable reserves reported to potential investors and those reported to the Securities and Exchange Commission (that can bring criminal charges for misreporting).

Image: Bloomberg
Image: Bloomberg

Billions of dollars of Federal Reserve quantitative easing funds found their way into the shale patch; creating hundreds of thousands of jobs and making energy company bosses millionaires overnight.  And so the myth of Saudi America was born.  On several occasions President Obama has claimed that the USA has centuries of oil and gas.  The world believed him.  Why wouldn’t we?  We all wanted to join in.  So European countries with their own shale deposits – Denmark, the Baltic States, Poland and the UK – set about fracking their own oil and gas, and telling the public that shale gas was good for the environment.

Obama was wrong, of course.  That’s what happens when you get your information from Wall Street bankers.  The US does not have centuries of oil and gas.  Its own Energy Information Administration data shows that the USA has 3 years of oil and 9 years of gas.  That’s a lot.  The USA consumes 25 percent of the world’s oil and gas; and they are not entirely dependent upon their own supplies.  So there is every likelihood that the USA will be producing some oil and gas for the next decade or so.  But Saudi America it most certainly isn’t.

The US situation was made worse by the VPPs.  These obliged companies to keep drilling even as prices collapsed in mid-2014.  In any sane world, the energy companies would have simply shut up shop and waited for demand to outstrip supply once more, and then start drilling again.  But the fracking industry is not sane – it is about selling worthless paper.  You can only do that by persuading people with more money than sense that the boom is going to go on forever.  As Debora Rogers notes:

“The purported economic benefits of shale gas and oil have been consistently and egregiously overstated by industry in every shale play to date. While there is some initial economic boost, it has proved short-lived and will almost certainly never cover the peripheral costs of production such as long-term environmental degradation, air quality impacts, aquifer depletion and potential contamination, road repairs and health costs just to name a few. The fact that DEC appears unaware of this is troubling and would seem to suggest that DEC has not done proper due diligence.”

For better or worse, the European fracking industry never took off.  Shale deposits in Poland turned out to be mixed with clay, preventing the fracturing of shale rocks.  Poor geology also prevented gas recovery in Denmark and the Baltic States.  It is not that the gas isn’t there; it is just that it costs more to produce it than it can be sold for.  As Brian Davey from FEASTA cautions:

“What will happen in the USA will no doubt have a big impact for the future credibility of the fracking industry in the UK and elsewhere in the world. That story is not yet in its final chapter but what has happened in the USA is already a cautionary tale and we would be stupid to ignore it. Local authorities in the UK should be careful that they are not caught out picking up the environmental costs of a collapsing industry. It has already happened in the USA and Canada – the advantage of limited liability to an industry without ethics is that it enables it to pass the cost of clearing up to communities after bankruptcies.”

Which brings us to those two key questions.  Why this?  And why now?

Why this?  Simply because hydraulically fracturing the KM8 well is about the cheapest operation any company could carry out with the best prospect of a return on investment.  The well has already been drilled.  According to David Wethe at Bloomberg, fracking an existing well costs around $20 million, whereas drilling a well from scratch costs $80 million.  Other costs are minimised too.  Because KM8 is in an already producing conventional gas field, the infrastructure  to bring water to the site and take waste away; and the pipeline to take gas from the well to the nearby gas fired power station at Knapton already exists.  Importantly, KM8 sits in an apparent sweet spot at the heart of the Bowland shale formation – the most promising source rock in the British Isles.  There is more chance of extracting profitable shale gas from KM8 than anywhere else on the UK mainland.  And if Third Energy can’t pull this off, then the rest of the industry is toast.

So why now?  The short answer is it is getting late in the day and there is worthless paper to sell to greedy investors.  The mainstream media has yet to pick up on the catastrophe that is spreading through the US shale patch.  Companies are going bust.  Former boomtowns have been turned into ghost towns.  And there is every chance that a collapsing energy industry will spread into the banking and finance sector.  In a 2016 briefing paper for investors, Company Watch warned that:

“Of the approximately one hundred oil and gas companies listed on the London Stock Exchange’s AIM, two out of five (42%) are in its Warning Area, with H-Scores of 25 or lower and where they are approximately 50 times more likely to suffer financial distress than a typical company outside of it. This is an increase on 2014, where around a third of AIM oil and gas companies were in the Warning Area.”

Ewan Mitchell, Head of Analytics at Company Watch, said:

“Sadly for investors the low oil price has taken its toll on the AIM quoted oil and gas companies with around 10 per cent leaving the market and nearly a 40% drop in combined market capitalisations.”

When this news gets into the mainstream media, investors are going to be bailing out of fracking in droves.  So the fracking industry desperately needs to engineer some good news to keep the bubble going.  Simply winning the planning decision is a victory of sorts for the frackers because it removes one of the potential costs to the industry as a whole.  Other councils are likely to follow North Yorkshire’s lead; accepting that the costs of fighting an application that the minister in Westminster will ultimately approve anyway is just not worth it.  If KM8 can deliver some gas, this will further bolster an industry that is currently losing money hand over fist.

But the real story is about how the British government and the British people have been sold the lie of a shale gas energy future.  Because whatever the pros (gas is less polluting than coal) and cons (environmental damage and the need to get off fossil fuels entirely) behind the proposed switch from coal to gas; the truth is that there is nowhere near as much economically recoverable gas beneath the USA, Europe and the UK than the financiers behind the fracking boom have led us to believe.  Capital that we should be investing in a plethora of green energy technologies is being squandered on new gas terminals and new gas fired power stations that will never be brought into operation.  As Debora Rogers warns us:

“It is imperative that shale be examined thoroughly and independently to assess the true value of shale assets, particularly since policy on both the state and national level is being implemented based on production projections that are overtly optimistic (and thereby unrealistic) and wells that are significantly underperforming original projections.”

Of course, we need to keep on protesting.  As Brian Davey explains:

“People might ask, if the future of fracking is so much in doubt then why bother to build a movement of opposition to oppose it? The answer can be expressed by adapting a famous quote by John Maynard Keynes. In the original Keynes says “the market can remain irrational longer than you can remain solvent”. The market can also remain irrational long enough to do a lot of damage.”

But rather than feeling down about the North Yorkshire decision, we should see it for what it is.  Third Energy’s KM8 development is not the start of Britain’s fracking future.  It is the last gasp of a financially bankrupt Ponzi scheme that will end in tears sooner rather than later.

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