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No Fracking Way: Debt-Laden Shale Producers May Unleash The Next Financial Crisis

No Fracking Way: Debt-Laden Shale Producers May Unleash The Next Financial Crisis thumbnail

After nearly two decades of horizontal drilling, fracking – as it is commonly known, has “turned the energy world upside down,” according to Journalist Bethany McLean, a former Goldman Sachs analyst-turned-journalist.

And according to a new op-ed in the New York Times, McLean has a warning for anyone betting the farm on the shale industry; beware.

In a nutshell, the fracking industry – which “could not have taken off so dramatically were it not for record low interest rates after the 2008 financial crisis,” is setting up for a spectacular fall without rising oil prices and global demand. Fracking companies have largely survived, according to McLean, because “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. –NYT

Columbia University Center on Global Energy Policy fellow, Amir Azar, calculates that the fracking industry’s net debt in 2015 was $200 billion, a 300% increase from a decade earlier, however interest expense increased at half the rate debt did due to falling interest rates.

Dr. Azar recently called the post-2008 era of super-low interest rates the “real catalyst of the shale revolution.” –NYT

Another major concern is that fracking wells have a ridiculously steep decline rate: “The amount of oil they produce in the second year is drastically smaller than the amount produced in the first year,” writes McLean, citing an economist at the Kansas City Federal Reserve, who noted that production at the average well in the North Dakota Bakken region, declines 69% in its first year and over 85% in its first three years. Conventional wells, meanwhile, may decline around 10% a year. For Frackers, this means constantly poking expensive holes in the ground to try and offset declines from previous years’ wells.

Between the debt, decline rates and the exorbitant cost of maintaining a fracking operation, many on Wall Street have become skeptical that that the industry will ever be able to frack its way into the green amid relatively low oil prices compared to when much of the industry expansion took place.

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.


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. –NYT

“It came back because Wall Street was there,” Chanos told McLean, who notes that in 2017, American frackers raised $60 billion in debt, a jump of nearly 30 percent since 2016, according to Dealogic.

Also eating into profits are hedges that many operators have taken out in search of stability after years of wild fluctuations in crude prices. Many frackers entered into derivatives contracts in late 2017 that ensured they could sell a portion of their 2018 output for $50 to $55 a barrel. At today’s $70 oil, however, companies are failing to capture the rally. WPX Energy, for example, reported an adjusted net loss of $30 million in Q1 of this year because of $69 million in losses they say they took on hedges due to higher oil prices.

Technology to the rescue? 

Fans of fracking maintain that technological innovations will continue to reduce the costs of fracking, “reshaping the financial firmament so that companies can make money, even with low oil prices.”

According to a 2016 paper by the board of governors of the Federal Reserve, not only are rigs in the Bakken region drilling more wells, but each well is producing more. Extraction from new wells in the area in their first month of production has roughly tripled since 2008. The break-even cost, the estimate of what it costs to get a barrel of oil out of the ground, has plunged.

The best-run companies, which often focus on the Permian, are now making some money. “Their rates of return are still below levels that will sustain the industry in the long run,” says Brian Horey, who runs Aurelian Management, but “they are trending in the right direction.” –NYT

Still, McLean notes, just five of the top 20 fracking companies managed to generate more cash than they spent in the first quarter of 2018. “If companies were forced to live within the cash flow they produce, American oil would not be a factor in the rest of the world, an investor told me.”

Catstrophic potential

While interest rates have remained low, pension funds have turned to hedge funds to invest in high-yield debt – including that of fracking companies. Private equity firms have also poured money into shale companies, then played shell games with M&A or taking them public.

Private equity funds dedicated to natural resources raised nearly $70 billion of capital in 2015, according to SailingStone Capital Partners, an energy-focused investment firm, and over $100 billion in 2016. Today, 35 percent of all horizontal drilling (the industry’s preferred terminology) is done by privately backed companies.

Private equity titans have made fortunes, but not necessarily because the companies they fund have produced profits. Private equity firms have generated some of their returns by selling one company to another, or taking a company they’ve funded public. –NYT

Meanwhile, frackers are valued “not based on a multiple of profits,” but according to the acreage a company owns. As long as companies can sell stock or get eaten up by an already public company, “everyone in the chain, from the private equity funders to the executives, can continue making money.

This, says McLean (who wrote a book on Enron and Fracking), is all a bit reminiscent of the dot-com bubble of the late 1990s, “when internet companies were valued on the number of eyeballs they attracted, not on the profits they were likely to make.”

And with higher interest rates on the horizon, it’s going to be harder than ever to generate fracking profits unless the cost of oil – and demand – remains high.


19 Comments on "No Fracking Way: Debt-Laden Shale Producers May Unleash The Next Financial Crisis"

  1. twocats on Tue, 4th Sep 2018 7:11 pm 

    It’s been a decade and fed fund interest rates are just now hitting 2%. but does this even effect high-yield debt rates? i couldn’t really see an impact:

    the fed rate has only just begun to filter through to bank CD / Savings interest rates:

    QE4 the solution?

  2. Anonymouse1 on Tue, 4th Sep 2018 8:59 pm 

    The uS is a bubble-based economy. Inflating bubbles, fleecing the suckers (many of whom got a lot of their money fleecing other suckers), deflating them, getting bailed out by the gubmint with paper-from-nowhere dollars, and then finding new bubbles to inflate, is as amerikan as Apple iphone10, I mean pie. (made in China)

    Not to worry, after this bubble pops, the system will get to work, finding new speculative bubbles to try and inflate so the cycle can begin anew.

  3. makati1 on Tue, 4th Sep 2018 10:17 pm 

    Anon, you may be correct, but this may also be the bubble that takes the US down the drain for good. We can only hope.

  4. Go Speed Racer on Wed, 5th Sep 2018 2:51 am 

    Geeze Makita, don’t actually hope the USA
    goes down the toilet.
    Think more like, ‘inevitable but regrettable’.

    How can U sit there grinning when all
    the wheels fall off and I can’t get a
    hamburger & fries anymore at the Drive-In.

    I’ll have to sit at home with the lights
    out and eat from cans of grain in the

    And point guns out the windows to keep
    marauders away.

  5. Cloggie on Wed, 5th Sep 2018 3:15 am 

    Cheer up GSR, you always have your older European Brother standing by to bail you out (and give you a geopolitical haircut while we’re at it).

    No worries about your french fries, we’re here to help you (and ourselves). America and it’s 1776 independence was not such a good idea after all.

  6. Cloggie on Wed, 5th Sep 2018 3:50 am 

    Independence is a wonderf thing, yet there is one problematic aspect about independence and that is uou can’t eat it, ad every eomand and every Scot knows all too well…

  7. Cloggie on Wed, 5th Sep 2018 3:53 am 

    Arggh, typing on an iPhone in your sixties in the time of the boss… here we go again:

    Independence is a wonderful thing, yet there is one problematic aspect about independence and that is you can’t eat it, as every woman and every Scot knows all too well…

  8. MASTERMIND on Wed, 5th Sep 2018 4:58 am 

    JP Morgan’s warns next crisis to have flash crashes and social unrest not seen in 50 years

    “If they don’t manage to,” Kolanovic said, “then you’re spiraling into depression, social unrest and a lot more disruptive changes that can negatively affect returns for a very long time.”

  9. deadly on Wed, 5th Sep 2018 5:34 am 

    The earth is dead and humans killed it, that’s the story of that’s the glory of Mother Earth.

    Humans malignified the earth. Cancer Earth is the destiny.


  10. makati1 on Wed, 5th Sep 2018 5:54 am 

    GSR, that might be your future, but not mine. I no longer live in the US Police State. I am cheering on the end of the US as a terrorist bully. Tomorrow is not too soon.

  11. makati1 on Wed, 5th Sep 2018 5:56 am 

    deadly, you are correct. All that remains is the end of this ecosystem and the beginning of the next, without humans. The cancer is beyond cure and we did it to ourselves.

  12. MASTERMIND on Wed, 5th Sep 2018 6:59 am 


    Limits to growth had 12 models. One of those models, the “standard run” or, alternatively, the “business as usual” model was the one that 30 years of historical data tracked/followed. And according to that model the global economy will collapse by 2030.

    You have tunnel vision..Your days in the rocking chair are coming to an end soon..

  13. makati1 on Wed, 5th Sep 2018 7:56 am 

    Mm, and you like to believe all the propaganda bullshit rather than looking out your window. The end is near. I hope you have that pistol and bullet nearby. You will soon need it. Look at what is happening in the US. The collapse is accelerating faster and faster every day. But, you deny it will happen, maybe tomorrow. LMAO.

    The 29′ crash of the stock market happened three days after the news and economists all claimed that it would never happen. WW1 started with two bullets fired by a teen in a small town called Sarajevo. All it takes is a spark …

  14. makati1 on Wed, 5th Sep 2018 7:58 am 

    BTW: It appears that I will out live you by many years, if your suicide plan is activated. I doubt that it will be. You are too much of a coward to pull the trigger. Better to be a bitch to some huge black gang banger. LMAO

  15. fmr-paultard on Wed, 5th Sep 2018 8:30 am 

    hello guys, welcome to the anger agenda where one kicks the anti-american dog in orwell’s fashion of 5 or whatever minute hate. the tard will do it all the time.
    my current tard basic research is NAD+ because biology is somewhat accessible if you skip over the technical stuff. it seems supertard aubey de grey is not really technical so this makes my research a bit more difficult.

  16. twocats on Wed, 5th Sep 2018 8:57 am 

    imagine how blind TPTB had to be to not see the 2008 crises coming. but we were talking Bush, who was the original Trump.

    now, even though we are at stupidest heights and the heights of stupid, yet even the dumbest of the inbred oligarchs and new-money twits can see the system will not survive even a mild downturn.

    any and all measures will be deployed.

    the tax cuts were really just a stealth QE. Can you believe we might hit over 4% growth in the third quarter? Neither can anyone else. But if you buy enough of your own stock you will suddenly have a pop in Earnings per Share.

    besides geological limits (which are being handled with accelerating depletion to avoid a peak) the only real risk is contagion. if even one large leg of the stool collapses it will probably spread (E&P, Pensions, EM Currency – starting to happen, etc).

  17. Anonymous on Wed, 5th Sep 2018 10:58 am 

    Did we get in a time warp to 3 years ago? US E&P is setting records. For instance, Texas (just the state) is up almost 1 million bopd over the last year:

    JUN17: 3.415 MM bpd
    JUN18: 4.410 MM bpd
    growth: 0.995 MM bpd

  18. on Wed, 3rd Oct 2018 7:31 am 

    Valuable information. Fortunate me I found your web site unintentionally, and I’m stunned why this twist of fate did not took place in advance!
    I bookmarked it.

  19. John on Wed, 3rd Oct 2018 6:29 pm 

    The shale epitaph is being carved in alabaster as we speak and reads as follows.

    “We got the VIG” – the street

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