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Another big flaw in the economics of fracking

One reason why Third Energy may have suddenly wanted to begin fracking in rural North Yorkshire is that the breakeven price – the point at which shale oil and gas becomes profitable – has been falling in recent months.  Pro-fracking publicists like to pretend that the reason for the fall in costs is due to technical efficiencies.  However, while there have been technical improvements, the real reason for the fall in costs is simple, self-defeating and paradoxical – it is low oil prices!

Writing in the Wall Street Journal, Spencer Jakab explains that:

“In North America, for example, where relatively expensive but abundant shale oil fields transformed the market in recent years, costs are down sharply.  Deutsche Bank oil-field-services analyst Mike Urban estimates that exploration-and-production companies have cut well costs by 30% to 50% in that time—but that half to two-thirds of that is “cyclical.” In other words, part is due to technical advances that may have made shale production permanently cheaper. The cyclical part is because oil-field-services companies have had to slash prices to keep customers—an unsustainable condition.”

The point is that energy companies like Third Energy and Ineos do not have an army of technicians and engineers sitting around drinking tea and playing cards waiting for the day when a local authority gives them the go-ahead to start fracking.  Nor do they have a giant warehouse somewhere full of all of the equipment, fracking chemicals, steel tubing and trucks needed to do the job.  In the event of a local authority in the UK giving them permission to frack, they will need to buy these services from specialist multinational service companies like Haliburton and Schlumberger.

Low oil prices and the resulting crash in the US shale industry since June 2014 have served to temporarily lower the cost of these services.  As UK steel workers know to their cost, one of the knock on effects of low oil prices has been a sharp fall in commodity prices across the board.  But the biggest single cost – labour – has fallen dramatically as the US rig count has fallen from 1,924 in October 2014 to just 343 in April 2016.  For now there are a lot of redundant fracking technicians and engineers prepared to take a large cut in pay to secure employment.

The problem for potential frackers in the UK is that even with low service costs, the price of oil and gas is still too low for anyone to make a profit.  Only a rebound in the global oil price to at least $80 (and possibly as much as $120) per barrel is going to make UK fracking profitable.  But before those high prices resulted in widespread fracking in the UK, a new round of production would be well underway in the easier geological and political climate in the US shale patch.  So, all of those cyclically low service costs will have very quickly become cyclically high again.

Put simply, low oil (and gas) prices make the cost of fracking cheaper… but not quite cheap enough to make it profitable.  But the moment oil (and gas) prices rise toward the point where fracking would begin to look profitable at today’s costs; the service costs rise, rendering it unprofitable once more.

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