Monday , September 28 2020
Home / Energy / The shale oil paradox
Fracking paradox
Image: SkyTruth

The shale oil paradox

West Texan shale oil is booming once more, according to Ambrose Evans-Pritchard in the Telegraph:

“The Opec oil cartel is waking up to an unpleasant surprise. Shale output from the Permian Basin in Texas is expanding faster than the world thought humanly possible.

“The scale threatens to neutralise output cuts agreed by Saudi Arabia and a Russian-led bloc last November, and ultimately threatens break their strategic lockhold on the global crude market for a generation.”

Like many so many mainstream journalists, Evans-Pritchard is mixing fact and hype to draw a far rosier picture of the state of the energy industry than is actually the case.  It is certainly true that the Permian Basin is the most advantageous shale play in the USA (and quite probably the world).  Favourable geology, geography, climate and socio-economic factors all allow profitable hydraulic fracturing in parts of West Texas at a far lower oil price than anywhere else on the planet.  With global prices now above $50 per barrel, some of the Permian Basin sweet spots are indeed profitable once again.

The problem for the energy industry, however, has less to do with the quantity of oil beneath the ground than with the financialisation which occurred in the wake of the 2008 crash.  With billions of dollars of stimulus money sloshing around the US economy, but with interest rates at record lows, the banking and finance industry desperately needed to find investments that offered a decent return.  Fracking was one such investment opportunity, because risky investments offer better potential returns. And as with all financialisation, the issue is not whether a company or industry can make a profit (in the traditional understanding of that word) but only whether it can service the interest on its debts – providing the banks with a steady income stream that can be securitised and sold on as a derivative.  At $50 per barrel, enough fracking companies in West Texas can do this to make drilling worthwhile – at least so long as the US Federal Reserve continues to hold interest rates down.

The key advantage enjoyed by a financialised fracking industry is that it is quick.  It takes a lot less time to drill into a known shale deposit in a region already awash with oil-drilling infrastructure and equipment.  However, in oil industry terms, the volume of oil that can be recovered from a fracked well is piffling.  Even if the Permian Basin could produce the 8 million barrels per day reported by Evans-Pritchard, this has to be set against current global production of more than 98 million barrels a day – important, but not game changing.

Unlike conventional crude oil fields which supply oil for decades, fracking is incredibly short-term.  Most fracking wells are 90 percent depleted within three years, and the industry is obliged to keep drilling new spots to service its debts; even though without ultra-high oil prices, the industry can never hope to break even.

What we are actually witnessing in the Permian Basin is not a new gold-rush, but the means by which the global oil industry comes to an end.  This is because even though there are legacy conventional oil fields that are profitable at $20 per barrel, the overall cost of developing new fields is too high for the global banking and finance industry to bear.  The paradox is that although fracking is more expensive in the long-term, it has effectively usurped Saudi Arabia’s traditional role as the world’s short-term swing producer.  Put simply, any attempt by the Saudis to curb production to the point that prices rise will be met with the redeployment of mothballed Permian Basin fracking capacity.  This, in turn, forces prices back down toward the sub-$50 per barrel point where everybody hurts in the long-term.

In the meantime, conventional oil companies are struggling to attract investment to develop new crude oil production.  The case of Premier Oil reported in the Financial Times is just the most recent example of this.  According to Nathalie Thomas:

“Premier Oil is approaching oilfield services companies about helping to fund its next major projects, including a $1.5bn development off the Falkland Islands, as the heavily indebted UK oil and gas producer seeks alternatives to bank finance.”

The company is in trouble with the banks, and has recently had to reschedule its debts.  In these circumstances, nobody is about to stump up $1.5bn to allow the company to go off on what might prove to be a wild goose chase in the South Atlantic where, even if the oil can be recovered, there is little infrastructure in place to bring it to market.

The unspoken problem facing both frackers and conventional drillers is the inability of the global economy to withstand high prices.  According to prevailing neoclassical economic orthodoxy oil shortages will cause prices to continue rising until new, more costly recovery methods (like fracking and deep water drilling) become profitable.  As with so much else, the economists are simply wrong.  Between 2011 and 2014 the world tested the held economic beliefs and found them wanting.  Oil at $100 per barrel crushed consumer demand and brought about a slowdown in the global economy.  Today, at $50 per barrel, the world is limping along, but unable to break out of the lethargy that has plagued it since 2008.

This spells long-term (and not so long-term) problems for the oil industry, as it signals the end of large scale financial speculation on recovering what remains of the world’s oil.  Big oil has had its day.  And the irony is that at least the profitable spots of the costly but nimble US fracking industry may yet prove to be the last men standing.

Check Also

A brown new deal

Those lucky enough to die of old age often fall into a very peaceful state …