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Book Review: Saudi America

Posted on 16 January 2019 by gws

book cover  

Before I read the book, I had already read a few articles about it, saw a youtube video, and listened to two podcasts. It was the last podcast, on NPR's new Stateimpact Pennsylvania Energy Explained, that triggered me to actually get the book ...

Well, its not a full length book ... Columbia Global Reports, the publisher, calls these "novella-length books" that "offer new ways to understand the world" and "that can be read in a few hours". I am not a fast reader, but putting in a few hours a day, I was through after five days.

As a scientist researching environmental effects of the fracking boom, McLean's book was of interest to me as a different perspective on the US shale boom. Aside from the peer-reviewed literature I had read Vikram Rao's insightful book Shale (Oil and) Gas - The Promise and the Peril, which focuses on environmental and technological aspects of the shale boom, as well as on policy and economics. But Rao (a materials science engineer) was overly optimistic, more in the 1st Edition, 2011, but still in the 2nd Edition, 2015. He summarily dismissed the notion that shale oil and gas production is a "Giant Ponzi Scheme", a notion that is at the center of McLean's "Saudi America".

While, as a journalist, the author neither endorses the notion of a Ponzi Scheme, nor uses that terminology in the book, a central theme of Saudi America (aside from "fascination" with Aubrey McClendon) is the fact that the fracking industry as a whole is, after 10+ years of operation in the US, still deeply financially indebted to Wall Street. That is because, despite repeated statements to the contrary, overall cash-flow in the industry is negative, aka no profits are produced for stakeholders, losses are. And that may not change any time soon.

Fracking is expensive, ... and does not pay off (yet)

Drilling deep wells with increasingly longer laterals, hydraulic fracturing of the laterals, and subsequent production of oil and gas is not cheap. It requires a substantial, and continuous influx of capital to pay for hardware, labor, infrastructure, and related services. Such costs are weighed against the revenue from selling the produced oil and gas on the global market. As many costs are reasonably fixed, oil prices largely dictate whether a well makes a profit or not. Thus, there are several estimates of the level of raw oil prices at which companies "break even" (when costs of production per barrel of oil are equal to the market price of said barrel); and such numbers typically float around $50 a barrel. McLean usefully explains that this is a simplistic point of view ...

Neither is the break-even price fixed, as production costs vary by well, region, service costs, land and water costs, etc., nor do consumers usually get to see all the math behind these company calculations. As McLean highlights, and a recent WSJ investigation confirmed, many companies have not revealed all the costs they incur, and some have inflated their production projections in an effort to woo investors to keep financing continued exploration and new production. They do this, e.g. by showing only the highest well production curves, or the wells with the most modest annual decline curves, to investors, journalists, and the public. In turn, while investors are mostly interested in returns, and, in aggregate, continue to supply the industry with loans to keep production at high levels, the fees they earn from continued loans to the industry provide for recurring inflows of cash to Wall Street.

Because the capital business model requires making a profit, and profits are ultimately tied to production, the industry is basically forced into a "drilling treadmill", constantly aiming to replace rapid annual decline in production with newly drilled wells, financed by outside capital instead of investment of own capital from profits. As McLean reluctantly admits, that is akin to a (involuntary) Ponzi Scheme.

McLean does not conclude on this arguably very important aspect of the shale boom, and this bothered me until the last chapter of the mini-book ... in her Epilogue she highlights and appears to embrace the thoughts of Charlie Munger ("the [...] Warren buffet sidekick"), who, among others, argues that hydrocarbon resources are too important to be burned and rather ought to be used "as slowly as possible" for much more important purposes such as fertilizer and advanced materials production. This was, interestingly, also V. Rao's main argument of why the shale boom would ultimately be profitable: namely because of products such as natural gas liquids (NGL), including ethane, that serve as vital raw materials for the chemical industry, and sell at much higher prices on the world market.

Other considerations

While much of the book focuses on historical events that brought us the shale boom, using former Chesapeake Energy CEO Aubrey McClendon as recurring anchor, McLlean also explores the geopolitical dimensions of the US as an increasingly important gas and oil exporter. Not surprisingly, the overturning of the 1970s export ban in 2015, and OPEC's decision not to drop production levels amidst a glut in oil supply, driving down oil prices and causing the 2015/16 shale bust, make for interesting reading in the 2nd part of the mini-book. Since this history is still unfolding, with some twists such as the Kashoggi assassination occurring after the book's publication, McLean (rightfully) does not even try to make any predictions as to future developments. However, she poses a very important question in her 2nd-to-last chapter: Should we really pursue a continued, and arguably bolstered fossil fuel energy strategy, for geopolitical or other reasons, when the transition to renewable energy production is both necessary and inevitable?

My take-home message

While, as a scientist, some of McLean's writing appeared "imprecise" and at times repetitive to me, I appreciated the historical and economical viewpoints of the mini-book. It arguably achieved its offering of "new ways to understand the world". While we, often incessantly, argue the environmental impacts of the shale boom, what may ultimately cause the shale bubble to collapse is not its environmental footprint. Who could care less about that in the times of Trump ...? No. What Saudi America highlights is that what enabled the shale boom in the first place, namely the 2008 financial collapse and the subsequent ultra-low interest rate period, could also ring in its demise as we enter a new period of increasing interest rates, and increasingly skeptical investors demanding accountability on top of profits.

I recommend you get the book, get a new perspective, and start arguing the financial aspects of the shale boom to your decision makers ... they care much more about money than the environment, and they need to know that billions of $$ sink into shale every year, creating few winners and many losers. Make them think about how much more "winning" could be achieved for all by investing in renewable energy instead.

(Note: Author name mispellings fixed on 17 Jan 2019)

 

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Comments 1 to 13:

  1. Desmog blog have an article here arguing fracking is a ponzi scheme. Here is another article here arguing fracking isnt a ponzi scheme.

    I find it hard to know, and have only skimmed the articles out of curiosity, might read them fully later, but one thing is for sure, it looks pretty highly leveraged.

    Perhaps the more important consideration is the destructive effects of fracking on the environment. This is not just climate change, but local water table pollution, and it causes mini earthquakes. Although the fracking of gas did at least help displace coal.

    There is also the question of how long the oil it will last. The EIA is saying production won't peak until 2040, other researches here believe this is over optimistic. Either way 2040 is not that far into the future. So everything is being pinned on a resource with only a few decades of supply left before it starts to get run down.

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  2. Fracking probably does not exactly fit the way a Ponzie Scheme operates (the top players profit from luring lower players into the game and so on and so on - collapsing when not enough new suckers can be found).

    What is happening with fracking can be understood from a business management reality called 'Sunk Costs'.

    Sunk Costs are payments made that cannot be reversed. With fracking, the costs to get a well producing cannot be reversed. The requirement becomes maximizing the revenue from the well, even if it will be a net-loss, it will be 'less of a loss'.

    Rather than calling it a Ponzie Scheme, I would compare it to a Gambling Addict who keeps placing bets they are likely to lose in the hopes of 'The Big Win'. That Sinking Costs chasing a Big Win is sort of like a Ponzie Scheme. It cannot go on indefinitely. And like a Ponzie Scheme, someone is likely to profit handsomely in ways that cannot be fully reverserd or corrected (any penalty seldom removes all of the enjoyment or wealth collection by the undeserving winners before they lost the ability to continue to Win that Way).

    A serious question has to be how is the full proper clean-up going to be paid for. In Alberta there is a massive problem of Orphan Wells, wells no longer owned by anyone who will be sure to pay to properly clean them up.

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  3. OPOF @ 2, yes and the defining characteristic of a ponzi scheme is it is fraudulent, and I dont think the fracking fits that definition, or they would have been prosecuted. Instead I think they have taken on some "ponzi like characteristics", and were also getting like a speculative bubble. Risky business I would say.

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  4. I read both articles.  Fracking is a complicated industry and it is difficult for outsiders (like me) to get a grip on what is happening.

    The Desmog blog post claimed that frackers have never made money.  They suggested that executives should be paid for profits and not for production.

    The other post talked entirely about production.  They did not mention profit.  They did a long calculation about how much oil might be produced.  They did not calculate what price per barrel of oil was required to make a profit, although they had the data to make that calculation.

    It will be interesting to see how this scheme pans out.  Hopefully it will result in lower oil production in the end.  It is becoming common to see progressives comment that fracking is a Ponzi scheme.

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  5. I've had a better read of the articles. I agree with MS. It doesnt look to me like fracking is terribly profitable as of yet, and this can't be sustained indefinitely, even suckers of investors will have their limits, so the whole thing looks unstable. However the government might decide to subsidise major problems to try to ensure energy independence, but who knows.

    Fracking has certainly had some substantial subsidies form the tax payer already.

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  6. Thanks for the comments guys. I like the "Gambing Addict" analogy.

    McLean does speak to the "instability" of it often, and the collapse between 2015 and 2017 is the obvious example for that. In her interviews she stresses the uncertainty, and possibility of rapid change should financing dry up for whatever reason. She may have even used the word "gamble".

    Alas, good point about long-term issues with orphan wells ... while questions about current, and future, legacy wells have come up in academia, I do not think anybody in the industry cares about what happens when they are "done". Current law only requires a (cement) plug of the well, and surface site restoration, not any type of monitoring.

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  7. nigelj @5,

    Your point about potential government subsidies is as good one. And it relates to the Gambling Addict version of what motivates the Fracking.

    Business interests can try to "Protect their interests and reduce their perceptions of risk of loss" by becoming popular and profitable enough to make elected representatives reluctant to correct the unsustainable and harmful activities. Those elected officials may even be motivated to incorrectly compensate the Biggest Gamblers for their loses. And they can be motivated to incorrectly promote the harmful unsustainable activity, including allowing more freedom for environmental impacts or increased risk of 'accidental' harm (less of an accident when less is done to prevent an accident, because doing less about an accident is cheaper - making the investment more appealing to the Gambling Addicts).

    Potentially popular and profitable, but understandably unsustainable and harmful, activity can even encourage people who are trying to win or maintain power to deliberately mislead the regional or national population in support of regional or national actions that are undeniably harmful to the future of humanity (actions that are contrary to achieving and improving on the Sustainable Development Goals). And people who have incorrectly developed small self-interested worldviews can be expected to like to be misled that way.

    The responses to climate science dramatically expose how damaging the developed socioeconomic-political systems are. The systems encourage people to become smaller-minded self-interested gambling addicts.

    A Gambling Addict loses the ability to think about others or the future. They get stuck in a smaller world-view because of their desperation to Win Big playing in a game where they could Lose it all and can do massive damage to others as they are losing it. And they can be expected to angrily fight against being corrected. They have no interest in minimizing the harm they do to others, particularly to the future of humanity.

    The fracking addicts, and other fossil fuel addicts, will fight for the Right to do environmental harm. They will claim that the regional monetary benefits justify doing environmental harm. And they expect that once they get away with doing something they will not get corrected. Even in environmentally leading California, older oil operations continue operating very incorrectly, not required to meet new requirements imposed on new operations, as long as very few influential people are concerned about how the employment or government revenue from such operations is obtained.

    And it is real easy to get regional popular support for incorrect unsustainable harmful activity like fracking when most of the harm is done to Others (the entire global population, especially those irrelevant future generations). It can be even easier if people can incorrectly develop a perception that the supposed harm they are doing will be personally beneficial. People in a place like Alberta may easily believe that warming the planet will reduce how harsh their winter is and improve the growing season in their region during their lifetime. And personal benefit in their lifetime is all that the small worldview they have been encouraged to develop leads them to care about.

    Those poorly governed, harmfully Freer, socioeconomic-political games can be seen to develop powerful resistance to helpful correction of incorrect perceptions of popularity and profitability. The result is undeserved wealth and power being obtained by getting away with unsustainable and harmful activity that is defended by claiming to care about local employment or local government revenue.

    The populist propagandist know what they promote will not continue to be a benefit in the future. But the few hoping to benefit most will fight relentlessly for more freedom to do unsustainable harmful things. And they will fight to keep as much of the undeserved benefit they can get away with (not paying to fully properly clean up the mess they make - leaving as much harmful mess for others have to deal with as they can get away with).

    And those people with incorrectly developed small worldviews will definitely try to claim that climate science is incorrect. And they will be easily impressed by any of the many incorrectly made-up criticisms of climate science and the required corrections of what has developed that climate science has so clearly exposed. They will willingly support fracking if they sense a potential personal benefit.

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  8. OPOF @7, the fracking investors definitely look like they are gambling on something, because nothing else explains their activities, but its unusual to me because gambling on a big new find seems so implausible. The big finds have already been made, and are struggling to be profitable. There are simply not going to be huge new fields and even if there were its hard to see why they would be more profitable than existing fields. Any institutional investor would look at this, and the financial accounts.

    I can only conclude, or rather speculate that the investors have lost their minds and are in a fantasy world driven by the motives you mention. They are clearly very susceptible to marketing hype.

    The profit motive is a powerful force that motivates innovation, but imho it is like a drug, and if its negative consequnces are not corrected and legislated for, it overtakes people completely.

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  9. The fracking industry keeps focusing on its product volume, rather than whether it is profitable or not.  What if its intentionally unprofitable?  If so, what would be the purpose?  What's the purpose of losing money to keep fossil fuel costs intentionally low?  One result is socialist Venezuela has gone under, and is now being snapped up by the Putin mafia on the cheap.  Keep in mind, due to sanctions, the Putin mafia hasn't been able to sell its Siberian assets as easily, so the US 'fracking bubble', and its effect in (apparently) lowering fuel costs, hasn't hurt Putin as badly.  When the bubble pops, and all those Americans who went back to buying pickup trucks and SUV's start having to pay the real cost of driving, guess who makes bank?  Of course, the Putin mafia does.  But, collaterally, anyone the Putin mafia controls...

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  10. Not to belabor this point, but there are some references online from the USGS that estimate mean EUR (estimated ultimate recovery) of shale oil wells from U.S. shale oil basins (2013--a little dated). What's interesting is the amount of oil estimated to be produced on a per well basis: thier mean EURs range from 240,000 to 10,000 barrels of oil (BO). For comparison, a good conventional well typlcally produces about 10,000,000 BO within 15 years or so. At $50/bbl, it would require at least 200,000 BO to just cover the capital cost to drill and complete the well. This doesn't consider all costs associated with drilling but it at least gives you an understanding of why this looks uneconomic (also, these wells have a much steeper decline in production than conventional and are put on pump within a 1 to 3 years tops. If they don't make their money back in the first couple years of production it's probably uneconomic). According to the USGS, only the sweetest spots have EURs greater than 200,000 BO.

    Also, something else to consider is that what makes these unconventionals so appealing for industry to develop is the low geologic risk; typically a rank wildcat worldwide has at most a 10-20% chance of flowing hydrocarbons to the surface. These unconventional wells are probably greater than 90% chance of geologic success.

    What all this obviously means is that oil development is being pushed out to the limits, either technological or enviromental, because the low hanging fruit so to speak has been picked. It's painfully obvious how wasteful this whole industry is, in terms of resources, both human and natural, to keep us addicted to oil. It's completely unsustainable.

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  11. Here is another DeSmog article about this: Fracked Shale Oil Wells Drying Up Faster than Predicted, Wall Street Journal Finds.

    It has a quote from this book's author in the last paragraph.

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  12. David Kirtley @11,

    Thanks for pointing to that DeSmog article.

    The quote of Bethany McLean at the end is right on target.

    To achieve the economic corrections required to minimize the harm done to the future of humanity it is important to get all of the wealthiest and most influential to be more dedicated to leading the required correction.

    Anyone among the wealthy and influential who isn't as helpful as they could be needs to be publicly called-out and corrected (by the other wealthy and influential who expose the unacceptability of their peers as part of their helpful actions). And the ones who can be shown to be acting harmfully should be penalized (the developed 'honour among thieves - mutually excusing understandably harmful actions' will need to be exposed and broken).

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  13. Many unsustainable and 'harmful to future generations' things are happening related to the fracking activity in the USA:

    • The activity was developed after it had been made clear to global leaders (and the entire global population) that rapid curtailing of fossil fuel burning (I add burning after 'fossil fuel' because many people who are difficult to correct incorrectly claim that fossil fuels make plastic), was required to minimize the harm done to future generations. That clear required correction was solidly established by the late 1980s.
    • Massive financial gambles have been sunk in the expansion of fracking in attempts to quickly obtain personal benefits from the unsustainable and harmful activity. Some people are getting very rich every year in spite of the growing financial questions about the 'Business viability of the activity'. Important Note Here: The business justification for fracking is undeniably totally contrary to, devoid of being governed by, what is needed to develop a better future for humanity.
    • The recent global oil price drop made it clear that something needed to be done to bail-out the bad financial gamblers who continue to personally profit handsomely from the unsustainable and harmful activity that is also financially questionable. Sanctions were reimposed on Iran to limit Iranian oil in the market as part of that bail-out of the Bad Betters, and it was probably helpful for getting the Saudi's to lead an OPEC reduction of production.
    • The people who benefited most from the unsustainable harmful activity are also unlikely to suffer the most financially in the future if the massive gambles do not pay off. Some of them may suffer no negative consequences if it all crashes down.

    Fracking for Oil and Gas in the USA is like Canada's Oil Sands. As Trudeau stated, what nation would leave a large opportunity for short-term benefit from an understood to be harmful activity in the ground (a stranded asset)?

    Good Caring People struggle to be influential enough to get proper corrections of the directions of development, or corrections of what has developed, when undeniably harmful pursuits of benefit are big opportunities for undeserving people to get more undeserved benefit at the expense of the future of humanity.

    Anyone wanting to claim they are a Good Caring Person but who is still willing to support anything but the rapid curtailing of the harmful and unsustainable pursuits of benefit from fossil fuel burning will have to be forced to face the reality that they are not Good Caring People, no matter what else they do to try to look like Good Caring People.

    That requires serious correction of the developed socioeconomic-political systems/games that are clearly willing to see anything compromised for business/personal interests (especially compromising the future of humanity because none of those people are able to influence the game). And that compromising for profit and popularity becomes a poor excuse for claiming to be a Good Caring Person even though you support an unsustainable harmful belief and action that is contrary to sustainably improving the future for humanity.

    Regional temporary unsustainable impressions of popularity and profitability are easy to promote. And that easy appeal to greed (or intolerance) develops impressions that are hard to correct. What gets developed are regional/tribal unjustified impressions of success and superiority relative to Others. An obvious result is the Uniting of greedy people with intolerant people, supporting each other's harmful interests to collectively have more influence relative to the Good Caring People who are not so easy to impress and are trying to correct them and the harmful developed beliefs and actions they want to continue get away with.

    Climate science unintentionally exposes how much correction is required of what has developed, including the requirement to correct the developed socioeconomic-political systems.

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