Is The Shale Oil “Miracle” Becoming A “Debacle”?
Energy is everything.
This is an amazingly important concept. Yet it’s almost universally overlooked.
Sometimes it’s hard to appreciate the magical role energy plays in our daily lives because most of what we experience is a derivative of it. The connection is hidden from direct view. Because of this, most people utterly fail to detect or appreciate the priceless and irreplaceable role of high net-energy fuel sources (such as oil and gas) to our modern lifestyle.
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With high net-energy, society enjoys increasing complexity and technological advances. It’s what enables us to pursue massive goals like desalinating billions of gallons of seawater, or going to Mars. But without high net-energy fuel sources, our capabilities quickly regress to those of decades — or even centuries — past.
Which is why understanding where we truly are in the ‘net-energy story’ is so incredibly important. Is the US on the cusp of being “energy independent” from here on out? Is the “shale miracle” ushering in a glorious new ‘boom’ era that will vault America to unprecedented prosperity?
No. The central point of this report is that the US is deluding itself when it comes to energy abundance (generally) and oil (specifically).
Yet that’s not what we hear from the cheerleaders in the industry or in our media. From them, we hear a silver-tongued narrative of coming riches — a narrative that contains some truth, some myth, and a lot of fantasy.
It’s those last two parts — the myths and fantasies — that are going to seriously hurt many investors, as well cause a lot of extremely poor policy and investment decisions.
The bottom line is this: The US shale industry resembles a fraudulent Ponzi scheme much more so than it does any kind of “miracle”.
How do I know that? Because, collectively, US shale companies have lost cash in every year of their existence. The burned through cash when oil was $100 — and again when it was $90, $80, $70, $60, $50, $40, and $30 a barrel. They burned through cash in 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015 and 2016.
You don’t have to be a finance guru to appreciate or understand that any industry that persistently burns through cash is a bad deal. Especially one whose prime product – shale wells – principally deplete (-85%) in roughly three years. If you’ve been in business for 9 years drilling wells that mostly run out in 3 years, and you haven’t managed to produce positive cash flow at any point along the way, then it’s time to admit that your business model simply doesn’t work.
As even The Economist magazine recently noted:
The [US shale] industry has also lifted productivity. Drilling is faster, more selective and more accurate, and leakage rates are lower. Wells are being designed to penetrate multiple layers of oil that are stacked on top of each other.
But the fact that the industry makes huge accounting losses has not changed. It has burned up cash whether the oil price was at $100, as in 2014, or at about $50, as it was during the past three months.
The biggest 60 firms in aggregate have used up $9bn per quarter on average for the past five years.
As a result the industry has barely improved its finances despite raising $70bn of equity since 2014. Much of the new money got swallowed up by losses, so total debt remains high, at just over $200bn.
Let’s run that math. Five years is 20 quarters. That times $9 billion/quarter is $180 billion dollars in cumulative operating losses. This begins to give us a sense of the magnitude of losses investors will face when the music finally stops.
Or we could note the $200 billion of total debt outstanding for the industry. Hmmmm…with WTIC oil at $47/barrel, a typical wellhead price (that the operators actually receive being less than WTIC, always) might be closer to $40. $200 billion divided by $40 means that 5 billion barrels of future wellhead production is required just to pay back the debt!
If the industry decided to use the next 5 billion barrels coming out of the ground to debt reduction (it never would decide this, but bear with me for the sake of this intellectual exercise), we’d also need to include the time value of money (and actual production rates over time) and observe that the debt carries an interest rate of 5% to 8% (depending on the company). Taking that into consideration, then the next 6 billion barrels would be required to satisfy the debt, plus interest payments!
Oh, right. And then there’s the issue of repaying the $70 billion of equity raised since 2014. With some sort of return, if possible, of course.
I hope you see the same staggering disconnect in these numbers I do. Which is why, without have to go too far out on a limb, I’ll state that massive losses are coming to the (bag)holders of all this debt and equity.
So why care? Because you need to understand these details in order to position yourself properly for the future. The implications are enormous.
The Danger Behind Myths and Fantasies
Once you become aware of the magical thinking involved, you then have a chance of knowing why the future is going to be very difficult for the shale industry, its investors, and then the nation(s) depending on its oil production.
Hey, sometimes myths and fantasies are harmless to hold. Like dreaming that someday you’ll be a major rock star.
But some can be incredibly damaging because they lead to poor life choices and decision-making. Like emptying your bank account to bet on the Powerball lottery, where your chances of winning are 292,201,338 to one. Or committing your nation to a ground war in Asia thinking you can “win”.
The promise of US shale oil is a very dangerous siren song. It was so carefully marketed to gullible investors that even Obama’s speechwriter and fact checkers got swept along. This is from Obama’s State of the Union speech from 2014:
Now, one of the biggest factors in bringing more jobs back is our commitment to American energy. The all-of-the-above energy strategy I announced a few years ago is working, and today, America is closer to energy independence than we’ve been in decades.
What does “energy independence” mean? It turns out, this crowd-pleasing phrase is a fantasy that lacks any useful grounding in reality. What those who claim “energy independence” are doing are lumping all forms and sources of energy into a single bucket, and then asking if the size of that bucket matches our current demand.
This is an inappropriate and dangerously misguided way to look at things is because the various types and sources of energy are not interchangeable. They don’t function the same way. They generally can’t be substituted for each other. And they don’t cost the same.
For example, your automobile might run on gasoline which costs $2.50 a gallon. Suppose instead you could buy coal cheaper than gasoline on a BTU basis; is that any help to you as an auto driver? Would you suddenly put crushed coal into your gas tank instead of gasoline? No, of course not.
What if you had a