Thursday, June 13, 2019

Why Are The Frackers Losing Money And Resorting To Junk Bonds To Stay Viable?

A drilling rig operates in Erie in 2015.

The news in The Wall Street Journal's Business and Finance Section (' Frackers Scrounge For Cash As Wall Street Shuts Spigot'', p. B1, June 7) didn't really amaze me in the least. Especially as we read:

"The companies behind the U.S. fracking boom are turning to asset sales, drilling partnerships and other alternative financing to supplement their cash flow. These forms of funding often come with higher interest rates or other downsides  - such as giving outside investors a hefty share of future oil and gas profits."

And further (p. B2):

"Producers have been forced to get creative about financing because Wall Street began shutting off the cash spigot  last year after frackers routinely failed to turn a profit over the last decade."

Worse, only a tenth -  10 percent - of large shale companies saw a positive cash flow in the first quarter of 2019.   This according to a Rystad Energy analysis of 40  drillers.  And to sustain  or increase their production these companies are having to drill new wells, as opposed to seeing greater production from each existing well .  The piece also noted some companies have become so desperate for cash to jump start new wells that they are starting to turn to junk bonds.  Well, talk about batting on a losing wicket.  But the central question here is why have the frackers - who seem to be all over the place -- failed to turn a profit over a decade?   I've explained this in earlier posts in terms of the lower energy returned on energy invested (EROEI) say compared with the light  crude oil of the past, non-shale based.

I also pointed out the difference in EROEI translated into some bad economics given the lower energy content of shale oil (kerogen) meant the frackers would always be in an energy (and hence economic)  hole.  A less efficient energy source means you have to extract more of it, and at ever higher costs given the innate diminishing returns.  It means, basically, endless reinvestment to support the losing operations.  This isn't relativity or rocket science.

The issue first surfaced some six years ago in Richard Heinberg's book, Snake Oil: How Fracking's False Promise Imperils Our Future', ( p.115).   Therein we learned from a report by a London -based brokerage firm,  Tullett Prebon:

 "Our calculated EROEIs both for 1990 (40:1) and for 2010 (17:1) are reasonably close to the numbers cited for those years by Andrew Lees. For 2020, our projected EROEI of 11.5 to 1 is not as catastrophic as 5: 1 but would nevertheless mean that the share of GDP absorbed by energy costs would have escalated to 9.6% from about 6.7% today. Our projections further suggest energy costs would absorb as much as 15% of GDP (at an EROEI of 7.7 to 1)  by 2030."

The report goes on to conclude that the dismal diminishing energy returns means that the economy we "have known for more than two centuries" will "cease to become viable at some point". Cease to become viable?  Uh, yeah!  To use a human analogy, think of a gluttonous guy of 300 lbs, suddenly dropped on to 'Survivor Island' and forced to eat rice, a few crabs and coconuts for the rest of his life as opposed to just 39 days. Think he'd have the energy to do anything?  Think he'd survive? Guess again. His body - starving of protein  (the equivalent of high EROEI energy)-  would begin to consume itself.    That is effectively what our energy-gluttonous society is now doing but in the process headed toward distinct 'malnutrition"'  given the energy content of what it ingests gets lower and lower.  Think of that 300 lb. human gobbling more and more empty calories.

As Heinberg observes, while it may cost less to extract a cubic foot of natural gas or a gallon of oil shale today, it will cost much more in just five years and even more in ten - such that one would have to spend as much or more to get the energy as the benefit it delivers. Heinberg summons a point that most of the snake oil salesman humping fracking won't tell you, that it costs energy to get energy. And if you are a nation that resorts to employing 15 to 1 EROEI energy to extract  5 to 1 EROEI  oil shale energy.....well, can we say 'stupid'?

As Heinberg puts it (p. 116):

"No evidence suggests that the technology of fracking has actually raised the EROEI for natural gas production. It temporarily lowered prices but only by glutting the market."

Heinberg's book is essentially a tour-de-force exposing the false promise of fracking - whether for oil or natural gas-  with hard statistics and basic energy principles. He also shatters the myth  of "100 years of cheap  natural gas" as  effectively as he does the trope of cheaper and cheaper shale oil.   He observes, for example(p. 110), that "a study of the EROEI for electrical heating of methane hydrate deposits between 1000 and 1500 meters deep yielded ratios from 2:1 up to 5:1, depending on the source of the electricity"

The entire issue of sinking oil shale fortunes pivots on the breakeven price: that amount which the recovered oil needs to earn to have made its extraction worthwhile  If that per barrel amount tends to be below what the market offers, a loss occurs and over years the losses pile up. In many cases, as seen in recent years there is the added factor of an oil glut from over production.  In this case one has an excess supply and so oil prices tend to plummet. According to the Federal Reserve Bank of Dallas:

"The average breakeven price of oil has fallen 4 percent (or $2 per barrel) over the past year, to $50 per barrel, according to the latest Dallas Fed Energy Survey."

 This report was dated May 21st  and since then oil prices have climbed owing to the recurring Middle East instability and especially U.S. saber rattling at Iran.  Nonetheless,, given the frackers have repeatedly found themselves in such gluts, their losses have been magnified even over their inability to achieve  breakeven (in normal times).

Unmentioned until now is that whenever one has increased production which expands the existing supply beyond the current demand, a deflationary force is interjected, What this does,i.e.  in tamping down the cost at which oil can be sold, is create more problems for lower efficiency oil sources like fracking - whether in the Permian or Appalachian basins.   (There is also variability among operators;   according to the Dallas Fed survey, with the breakeven prices ranging from $23 to $70 a barrel.  This merely informs us that different operators will have differing methods of extraction, and some may be more efficient, Also, some areas may be more bountiful then others and that needs to be factored in.)

None of this detracts from the point that shale oil is a lower EROEI source and hence much more work must be done to extract it and process it (i.e.g from kerogen) and hence this inefficiency must appear in the lowered GDP over a future track, as reported by Tullet Prebon, e,g,  "Our projections further suggest energy costs would absorb as much as 15% of GDP (at an EROEI of 7.7 to 1)  by 2030."

Energy costs absorbing as much as 15% of GDP by 2030? What does this mean? It means our present energy-intensive civilization with its HDTVs,  Ipads, Smart phones, F35 bombers, Dreamliner and MAX jets,  ICBMS, drones and SUVs will need to go into ever  more debt to function at the same level. That is, to produce the same energy intensive devices, products, gadgets, toys etc.  much greater manufacturing and processing costs will have to be born.  That almost certainly implies much higher levels of debt, namely for the U.S. frackers who will be unable to contend with light crude oil producers (say like the Saudis)- who enjoy far lower breakeven prices (e.g. $23- 24 per barrel).  They mostly enjoy these lower breakeven prices because that oil has a significantly (2x, 3x) higher EROEI.

The much higher processing costs for shale oil also contribute to its producers never having made profits over the past 10 years, and always seeking loans or going through the junk bond route in desperation.   Why? Look no further than the fact (from FactSet) that 40 of the largest oil and gas frackers  since 2009 have collectively spent more than $200b  more than they took in from operations.  This is an ancillary aspect to the lower EROEI and efficiency of the source.   Again, Heinberg succinctly describes the basis of the problem which one never reads about in the mainstream media:

"Kerogen is not oil. It is better thought of as an oil precursor that was insufficiently cooked by geologic processes. If we want to turn it into oil, we have to finish the process nature started: that involves heating the kerogen to a high temperature for a long time. And that in turn takes energy- lots of it, whether supplied by hydroelectricity, nuclear power plants, natural gas, or the kerogen itself. Therefore the EROEI in processing oil shale is bound to be pitifully low. According to the best study to date, by Cutler Cleveland and Peter O'Connor, the EROEI for oil shale production would be about 2:1. That tells us that oil from kerogen will be far more expensive than regular crude oil."

This is something to keep in mind as one reads more and more media accounts of how the frackers are going into debt, and basically getting nowhere fast in extracting their product and selling it beyond the breakeven threshold.  The problem for them now is getting the money to support their continued operations since "investor appetite for buying shale companies' corporate bonds has dwindled"  - leaving the companies "no choice other than to explore the junk bond markets"   There they may find the loans, but with up to 13 percent interest imposed on each one.

This isn't even just a losing wicket, but a veritable sinkhole.

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