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The Secret of the Great American Fracking Bubble

Production

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.

What was McClendon’s secret? Instead of running a company that aimed to sell oil and gas, he was essentially flipping real estate: acquiring leases to drill on land and then reselling them for five to 10 times more, something McClendon explained was a lot more profitable than “trying to produce gas.” But his story may serve as a cautionary tale for an industry that keeps making big promises on borrowed dimes — while its investors begin losing patience, a trend DeSmog will be investigating in an in-depth series over the coming weeks.

From 2008 to 2009, Chesapeake Energy’s stock swung from $64 a share under McClendon to around $17. Today, it’s worth just $3 a share — the same price it was in 2000. A visionary when it came to fracking, McClendon perfected the formula of borrowing money to drive the revolution that reshaped American energy markets.

An Industry Built on Debt

Roughly a decade after McClendon’s rise, the Wall Street Journal reported that “energy companies [since 2007] have spent $280 billion more than they generated from operations on shale investments, according to advisory firm Evercore ISI.”

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.

But at the same time energy companies are borrowing more money to drill more wells, the sweet spots are drying up, creating a Catch-22 as more drilling drives more debt.

“You have to keep drilling,” David Hughes, a geoscientist and fellow specializing in shale gas and oil production at the Post Carbon Institute, told DeSmog. But he also noted that with most of the sweet spots already drilled, producers are forced to move to less productive areas.

The result? “Productivity goes down and the costs remain the same,” he explained.

While Hughes understands the industry’s rationale for continuing to drill new wells at a loss, he doubts the sustainability of the practice.

“I don’t think in the long-term they can drill their way out of this,” Hughes told DeSmog.

While politicians and the mainstream media tout an American energy “revolution,” it is becoming clear that — like the housing bubble just a few years earlier — the American oil and gas boom spurred by fracking innovations may be one of the largest money-losing endeavors in the nation’s history. And it caught up with McClendon.

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.”

The same could be said of the current shale industry. There is plenty of opportunity for these energy companies to correct their path — for example, by linking CEO pay to company profits rather than oil production volumes — but instead they are plowing full-speed ahead with a business model that seems poised for a crash.

But Hope Springs Eternal

Of course, business media and conservative think tanks are still selling the story that the fracking industry has produced an economic and technical revolution.

In 2017 Investors Business Daily ran an opinion piece with the title, “The Shale Revolution Is A Made-In-America Success Story.” It was authored by Mark Perry of the American Enterprise Institute — a free market-focused think tank funded in part by the oil and gas industry.

How does the author measure success? Not via profits. The metric Perry uses to argue the success of the fracking industry is production volume. And 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.

However, much like with the U.S. housing boom, this false narrative persists that the fracking industry is a money-making, rather than money-losing, venture.

Wall Street Journal headline published in early 2018 projected this eternal optimism about the fracking industry: “Frackers Could Make More Money Than Ever in 2018, If They Don’t Blow It.”

This headline manages to be, at the same time, both very misleading and true. Misleading because the industry has never made money. True because if oil and gas companies make any money fracking in 2018, it would be more “than ever.”

However, the nuance comes in the sub-headline: “U.S. shale companies are poised to make real money this year for the first time since the start of the fracking boom.”

Poised to make “real money” for “the first time.” Or to put it another way, the industry hopes to stop losing large amounts of real money for the first time this year.

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 cashflows. The cash-burn rate may well rise again this year.

Some historic money-losing has been going on, and is expected to continue, as reported by the Wall Street Journal: “Wood Mackenzie estimates that if oil prices hover around $50, shale companies won’t generate positive cash flow as a group until 2020.” However, Craig McMahon, senior vice president at Wood MacKenzie, notes, “Even then, only the most efficient operators will do well.”

U.S. oil produced via fracking is priced as West Texas Intermediate (WTI), which averaged $41 a barrel in 2016 and $51 in 2017. The consensus is that WTI should average over $50 a barrel in 2018, thus providing the industry another reason to keep pushing forward. However, even in 2017 with the average over $50 a barrel, the industry as a whole was not profitable.

Irrational Exuberance

In the introduction to The Big Short, Michael Lewis’ book-turned-movie about how the 2008 financial crash unfolded, he describes the finances of the housing bubble:

All these subprime lending companies were growing so rapidly, and using such goofy accounting, that they could mask the fact that they had no real earnings, just illusory, accounting-driven, ones. They had the essential feature of a Ponzi scheme: To maintain the fiction that they were profitable enterprises, they needed more and more capital to create more and more subprime loans.”

If you substitute “shale oil and gas development companies” for “subprime lending companies,” it becomes an apt description of the current shale industry. These companies are losing more money than they make and can only sustain this scenario if lenders continue to bankroll their efforts, allowing the fracking industry to drill more wells as it points to production increases, rather than profits, as progress. Which — for now — Wall Street continues to do in a big way.

This article is the first in a series investigating the economics of fracking and where the vast sums of money being pumped into this industry are actually going. The series will look at how fracking companies are shifting these epic losses to the American taxpayers. It will review the huge challenges facing the industry even if oil and gas prices rise: the physical production limits of fracked wells, rising interest rates, rising water costs, competition from renewables, OPEC’s plans, and what happens if Wall Street stops loaning it money.

The oil industry has always been a boom or bust industry. And during each boom someone inevitably declares that “this time is different,” assuring everyone there won’t be a bust. The sentiment about the early 2000s housing bubble was much the same, with critics being drowned out by the players claiming that, this time it was different, arguing “Housing doesn’t go down in value.”

And what about for shale production? Is this time really different? Some in the industry apparently think so.

Is this time going to be different? I think yes, a little bit,” energy asset manager Will Riley told the Wall Street Journal. “Companies will look to increase growth a little, but at a more moderate pace.” There is little evidence of restraint or moderation in the industry. Until analysts and investors start talking about profits instead of growth, however, this time is likely to end, at some point, in a completely familiar and predictable way: bust. A fate even Aubrey McClendon, the highest-paid CEO, the shale king, eventually met.

David Hughes summed up his take on the industry’s financial outlook: “Ultimately, you hit the wall. It’s just a question of time.”

DeSmog Blog



27 Comments on "The Secret of the Great American Fracking Bubble"

  1. Kat C on Fri, 20th Apr 2018 11:19 am 

    And https://www.zerohedge.com/news/2018-04-20/crisis-heart-us-shale
    Gonna be quite a show here at the end of the world as we know it.

  2. dave thompson on Fri, 20th Apr 2018 11:20 am 

    Junk oil that the refineries do not want and lots of it what could possibly be wrong in the oil patch?

  3. BobInget on Fri, 20th Apr 2018 11:58 am 

    I’ve posted this already. Hope you don’t care.

    “The next thing the world is going to wake up to is that the 10 mm barrels the U.S. is producing isn’t oil – it is condensate. Even if we could completely debottleneck the infrastructure problem tomorrow – that doesn’t meet domestic refinery demand of 17 mm barrels per day of REAL oil”.

    ‘Condensate rich crude’ is essential for dilution
    of ‘tar’ or oil sands product. Heavy bitumen crude won’t flow through pipelines in fridged Canada, even Tropical Venezuela.

    China, India’s oil consumption is growing at such
    staggering proportions, ONLY Venezuela’s Orinoco and Alberta’s bitumen will come close to filling your gas tank. Think about an electric or
    a compressed gas conversion.

    I’m NOT speaking about sometime in the future.
    We are facing problems rat now.

  4. Anonymous on Fri, 20th Apr 2018 1:25 pm 

    David Hughes has been dramatically wrong over the years. Here is is in 2006 saying the US was at “peak gas”.

    https://www.youtube.com/watch?v=poRAEL7M9Ds

    He totally missed the shale phenomenon and misunderestimated it at every step.

  5. Duncan Idaho on Fri, 20th Apr 2018 3:33 pm 

    “the Wall Street Journal reported that “energy companies [since 2007] have spent $280 billion more than they generated from operations on shale investments, according to advisory firm Evercore ISI.”

  6. Anonymous on Fri, 20th Apr 2018 4:39 pm 

    It’s called capital expense. By definition it is an investment of something that will deliver cash for many years after the current year. So they will make money in the manana.

    If anything shale is faster than normal. Look how long it takes an offshore platform or pipeline or LNG terminal to pay out.

  7. Duncan Idaho on Fri, 20th Apr 2018 4:54 pm 

    “If anything shale is faster than normal.”
    You can say that again!
    Depletion rates on shale are startling:
    https://oilprice.com/Energy/Crude-Oil/Nothing-To-See-Here-Frackers-Ignore-Rising-Well-Decline-Rates.html
    You are on to something, but it is not what you expect—–

  8. Rick on Fri, 20th Apr 2018 7:11 pm 

    Chesapeake didn’t buy cheap leases and flip them for more money. Typically they were late arrivers to a play and paid too much for leases. They were too oriented to gas plays as well.

  9. twocats on Fri, 20th Apr 2018 7:55 pm 

    http://www.haynesboone.com/~/media/files/energy_bankruptcy_reports/2018/oil_patch_bankruptcy_monitor_03312018.ashx

    CHA! CHING! ALING! ADING! DONG! MAKING THAT MONEY MANANA HOY!

    I love how bankruptcies are actually picking back up dollar wise. 2018 will crush 2017. Should have left the table when you were only $82 billion down. Ouchie!

  10. The last drop on Fri, 20th Apr 2018 9:19 pm 

    Shortonoil was right! Well, kinda right…
    We’ll see how all this plays out.
    I’m practicing banging rocks together.
    Speaking of Rockman will twist and spin to make it look peachy keen.

  11. Theedrich on Sat, 21st Apr 2018 12:17 am 

    Tverberg is right:  America is in a tailspin.  We can no longer make money from oil.  The solution?  Sell weapons to the rich Saudis so they can genocide the Yemenis.  Now, that is serious money.  And it’s from oil — not ours, of course, but why quibble over such trivialities?  Ignorance is such a profitable process.

  12. Anonymous on Sat, 21st Apr 2018 9:32 am 

    Look at the productivity per rig (top two graphs on pages 3-9.)

    https://www.eia.gov/petroleum/drilling/pdf/dpr-full.pdf

    Most areas either have record productivity or close to it. (And if they are off record levels, its usually because the records were set during a price downturn with very few rigs and extreme high grading).

    Productivity is much better than in 2008 for sure. Hughes has been pushing sweet spot exhaustion as a meme for several years but so far technology improvement has trumped it or we have learned better where the sweet spots are with time.

    Yes nothing lasts forever. But Hughes has been a joke with his predictions. It’s not just 2006 but 2011, 2013, 2015, 2016, etc. He just keeps getting spanked by shale.

    At some point, you have to realize the guy is not a serious analyst but a paid leftist greenie political advocate. Intellectually dishonest.

  13. Boat on Sat, 21st Apr 2018 9:53 am 

    The last dropping,

    Short claimed that demand would be effectively dead by now. Short claimed most rigs would have cobwebs on them and be rusting by now, short claimed the world’s economies would be collaspeing by now.
    Lol the idiot and his buddy last drop couldn’t have been more wrong.

  14. Shortend on Sat, 21st Apr 2018 10:11 am 

    Don’t know about that one Boat…
    Seems if the CBs and and all the financial tricks, piles of cash, debt, bottom interest rates, ect., the wheels would have fallen off by now. Even Shortonoil pointed that out to everyone here many times. Suppose you missed it.

  15. Boat on Sat, 21st Apr 2018 10:27 am 

    Shortend

    I didn’t do the study or make the claims. Maybe the next study will have better inputs. Claiming doom and crash inevitably needs doom and crash to be credible. Short is and was not credible on his own timeline.

  16. twocats on Sat, 21st Apr 2018 11:24 am 

    https://shaleprofile.com/index.php/2018/04/03/permian-update-through-december-2017/

    well productivity has slowed since the 2nd quarter of 2016. Increased use of frac sand and longer laterals are the trick – its not that incredible of an innovation since it costs more to produce faster. The Ponzi death spiral is accelerating. And this is after the massive clearing out of the weak hands in 2016 & 2017. Meaning – they’re all weak hands. Ponzi.

  17. Shortend on Sat, 21st Apr 2018 12:32 pm 

    Boat,
    It’s hard to make predictions, especially about the future.

    It was impossible to get a conversation going, everybody was talking too much.
    he future ain’t what it used to be.

    This is like deja vu all over again.

    You can observe a lot just by watching
    Reporter: Have you made your mind up yet?
    Yogi: Not that I know of.

    Boy, I am sure glad he was just kinda right!

  18. Boat on Sat, 21st Apr 2018 1:33 pm 

    Two cat

    I am not sure you can read the charts from your own link. The amounts of rising production by month keeps going up and utiliment recovery had been going up rapidly as well. The opposite of your claims. Lol
    Your link even stated that an average well took 7 months to reach 1,000 barrels in 2017. In 2014 a well took 2 years to reach 1000 barrels. That my boy is a dramatic rise.

  19. MASTERMIND on Sat, 21st Apr 2018 2:24 pm 

    Anything that grows exponentially, regardless of how small the exponent is, will eventually explode into a hockey stick. Anything that grows at 3% per year will double in size every 25 years (5% doubles in 16 years, 2% doubles in 36 years).

  20. rockman on Sat, 21st Apr 2018 4:55 pm 

    “The next thing the world is going to wake up to is that the 10 mm barrels the U.S. is producing isn’t oil – it is condensate…that doesn’t meet domestic refinery demand of 17 mm barrels per day of REAL oil.”

    That is not the truth. It’s the same foolishness repeated from the same foolish statements of others. And typically made by those too lazy to do the readily available research about the US refining industry. So again, for the umpteenth time: CONDENSATE IS OIL. It is light oil typically graded as an API of 40 or lighter. And condensate/light oil is ABSOLUTELY CRITICAL to the refining industry. Refineries that have for may years processed BLENDED OIL with a gravity very close to 31.5 API.

    https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=MCRAPUS2&f=A

    IOW US refinery run at an optimum level with BLENDED OIL with a gravity around 31.5 API. A blended oil made by mixing light oils, such as condensate, with heavy oils, such as those that make up a significant % of US oil imports. Almost 68% of oil imports range from 30 API to less then 20 API. IOW US oil imports are dominated by HEAVY OILS.

    https://www.eia.gov/dnav/pet/pet_move_ipct_k_a.htm

    In fact, those BILLIONS OF BBLS of dilbit the US has imported from Canada has a gravity of only 23 API. And its gravity was only that light because the bitumen had first been blended with condensate/light oil in Canada. Without blending to make dilbit it could not have been pumped down pipeleines. Thus the term “dil (diluted) + bit (bitumen) = dilbit. Diluted with condensate/light oil. Hundreds of millions of bbls of condensate/light oil imported from the US since Canada produced only about 70% of what was needed.

    https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=MCRAPUS2&f=A

    Heavy oils, such as imports from Canada and Venezuela, have no use for US refinerie4s without being blended with condensate/light oil. Prior to the shale boom the US had to import condensate/light oil to blend with domestic and imported oil. Just as east coast Canadian refineries have been importing Eagle Ford condensate for years to blend with their heavy oil imports.

    If you don’t believe the Rockman’s words here the straight poop directly from Reuters in 2015. From

    https://www.reuters.com/article/usa-refineries-shale-kemp/column-canadian-crude-proves-perfect-partner-to-u-s-shale-kemp-idUSL5N0W14IV20150227

    “While the qualities of crudes vary widely, U.S. refiners have discerning requirements. The average density of crude processed in U.S. refineries has been steady, varying by only 3 degrees over the last three decades, or about 17 kg per cubic metre, according to the U.S. Energy Information Administration (EIA).

    U.S. refiners like to process crudes averaging around 30-32 degrees API, or between 865 and 875 kg per cubic metre (link.reuters.com/vys24w). Refineries achieve this remarkably steady performance by blending crudes to achieve a combined feed as close as possible to the ideal. Bakken, at just 815 kg per cubic metre, is much lighter than the 865-875 kg refineries are trying to achieve. Eagle Ford is lighter still.

    U.S. refiners have responded to the rising output of very light domestic crudes by cutting back purchases of other light oils from abroad while importing more heavy crudes to keep the average density roughly constant. Strict blending requirements explain why U.S. imports of light oils from countries such as Nigeria have dwindled to almost nothing while refiners import record quantities of much heavier oil from Canada.
    In fact, Western Canadian Select (WCS) is the perfect complement for shale oil production from the Bakken and Eagle Ford. WCS is around 55 kg per cubic metre heavier than refiners would like on average, while Bakken is around 55 kg too light, so they blend perfectly with one another (link.reuters.com/jat24w).”

  21. Boat on Sat, 21st Apr 2018 5:13 pm 

    Mm

    Get your head out of your ass and read Rocks post. Then go read about biofuels that we could mix in much higher percentages if needed. Yeah, a liquid. Henry Ford built the model T to run on biofuels, Standard Oil owned more congressmen. You fool, an entire world of knowledge not peer reviewed. Lol

  22. Davy on Sat, 21st Apr 2018 5:26 pm 

    weasel, did you read Rock’s post? That is an example of a good comment unlike the pricking that you and greggie dish out. Try being intelligent like Rockman please or go somewhere else.

  23. MASTERMIND on Sat, 21st Apr 2018 5:51 pm 

    Boat

    Corn better used as food than biofuel, study finds
    https://news.illinois.edu/view/6367/520569

    So yeah..

  24. MASTERMIND on Sat, 21st Apr 2018 6:03 pm 

    US Real Cost per Crude Oil, Natural Gas, and Dry Well Drilled -EIA
    https://www.eia.gov/dnav/ng/hist/e_ertw0_xwwr_nus_mdwa.htm

    HAYNES AND BOONE, OIL PATCH BANKRUPTCY MONITOR March 31, 2018
    https://www.scribd.com/document/376939191/HAYNES-AND-BOONE-OIL-PATCH-BANKRUPTCY-MONITOR-March-31-2018

  25. GregT on Sat, 21st Apr 2018 8:02 pm 

    Boat,

    “Short claimed that demand would be effectively dead by now. Short claimed most rigs would have cobwebs on them and be rusting by now, short claimed the world’s economies would be collaspeing by now.
    Lol the idiot and his buddy last drop couldn’t have been more wrong.”

    To be fair to Shortonoil in his absence, the following is a direct quote from page 36 of The Hill’s Group ETP study:

    “2030 will be the year that a discontinuity appears on the P140 curve. It is when the
    average barrel of crude will have reached the “dead state”. After that date petroleum will no longer
    act as a primary energy source.”

  26. GregT on Sat, 21st Apr 2018 8:21 pm 

    “That is an example of a good comment unlike the pricking that you and greggie dish out. Try being intelligent like Rockman please or go somewhere else.”

    Give it a rest already Davy.

    Alberta tar sands bitumen, is some of the dirtiest ‘oil’ on the planet. By continuing to produce the stuff, Canada will not meet it’s commitment to the Paris accords, and is contributing greatly to a potential runaway greenhouse event. There is also currently a dispute between BC and Alberta over the proposed Kinder Morgan Trans Mountain pipeline. It looks like it will be going to the federal court level, where the usual suspects will bribe their way to victory, once again.

    Kinder Morgan is yet another US company BTW, based out of Houston Texas.

    https://thetyee.ca/Opinion/2018/03/21/Trudeau-Notley-Trans-Mountain/

  27. Anonymouse1 on Sat, 21st Apr 2018 8:38 pm 

    Right again Greg. One of the biggest scandals-that-is-not-a-scandal over this whole issue, is how quickly the ‘canadian’ political elites, up and down the chain, have lined up to declare such pipelines are in ‘the national interest’. Very few are asking the more pertinent question, ‘Whose national interest’ is being served. How are this ‘national interest’ defined? What is its scope? Someone’s interests are being served, by those whose job it is to serve those interests. Like, true-dough, and Notely for example. They are saying, and promising to do what there masters want and expect, the question is, will they be able to deliver?

    The ‘free press’ here is doing its part, and floating all kinds of stories about how the ‘majority’ of BC residents are behind the pipeline. Because, you know, such things are determined by a sample groups of about 1000 or so ‘random’ people called by telephone where they get asked a series of skillfully crafted questions designed to elicit certain responses, and omit or restrict others.

    Because expediting the transfers of Canada’s resources as quickly and cheaply as possible, for the benefit of their largely foreign owners, is definitely what interests true-dough and Nutely.

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