Oil, Gas, Inflation and Cheap Money

[Occam's Banana]

Oil, Gas, Inflation, and Cheap Money
http://www.lewrockwell.com/lrc-blog/...d-cheap-money/
Ryan McMaken (19 June 2014)

Today’s Mises Daily article covered the impact of government subsidies and infrastructure on the fracking boom. But there is another big player in the oil and gas boom that is routinely ignored by “energy independence” enthusiasts who claim the sky is the limit for fracking: cheap money from the central bank.

Energy companies are employing massive debt schemes to finance exploration and initiation of extraction plans. According to Bloomberg:

Quicksilver acknowledges the company is over-leveraged, said David Erdman, a spokesman for Quicksilver. The company’s interest expense equaled almost 45 percent of revenue in the first quarter. “We have taken concrete measures to reduce debt,” he said.

Drillers are caught in a bind. They must keep borrowing to pay for exploration needed to offset the steep production declines typical of shale wells.

“Interest expenses are rising,” said Virendra Chauhan, an oil analyst with Energy Aspects in London. “The risk for shale producers is that because of the production decline rates, you constantly have elevated capital expenditures.”

Chauhan wrote a report last year titled “The Other Tale of Shale” that showed interest expenses are gobbling up a growing share of revenue at 35 companies he studied. Interest expense for the 61 companies examined by Bloomberg totalled almost $2 billion in the first quarter, 4.1 percent of revenue, up from 2.3 percent four years ago.

Yes, “interest rates are rising,” but they’re still extremely low in the big scheme of things, thanks to the unending new money flowing from central banks. Even with rising rates, however, fracking operations, in order to remain viable, will need to keep borrowing since, as it turns out, fracking is extremely expensive. Bloomberg explains:

The path toward U.S. energy independence, made possible by a boom in shale oil, will be much harder than it seems.

Just a few of the roadblocks: Independent producers will spend $1.50 drilling this year for every dollar they get back. Shale output drops faster than production from conventional methods. It will take 2,500 new wells a year just to sustain output of 1 million barrels a day in North Dakota’s Bakken shale, according to the Paris-based International Energy Agency. Iraq could do the same with 60.

Consider Sanchez Energy Corp. The Houston-based company plans to spend as much as $600 million this year, almost double its estimated 2013 revenue, on the Eagle Ford shale formation in south Texas, which along with North Dakota is one of the hotbeds of a drilling frenzy that’s pushed U.S. crude output to the highest in almost 26 years. Its Sante North 1H oil well pumped five times more water than crude, Sanchez Energy said in a Feb. 17 regulatory filing.Shares sank 7 percent.

The U.S. oil industry must sprint simply to stay in place. U.S. drillers are expected to spend more than $2.8 trillion by 2035 even though production will peak a decade earlier, the IEA said. The Middle East will spend less than a third of that for three times more crude.

So, if we read through the lines just a tiny bit, we can see that the fracking boom towns, like those that dot Noth Dakota, Wyoming, and Colorado, are resting on a shaky foundation of cheap money. If interest rates move into more normal territory, then the funds for fracking will dry up even before the wells do (which is pretty fast).

You can’t blame the fracking frenzy on just some parochial search for profit, though. Energy policy is always of great interest in DC. On the foreign policy front, of course, “energy independence” is always of importance because it allows the American state a free-er hand to meddle in oil-producing countries without wild fluctuations in domestic oil prices. The fact that it’s largely illegal to export American oil means that more domestic production means more control over domestic supplies without having to worry about OPEC turning off the spigot.

There are more mundane domestic concerns as well. Energy prices, including oil and gas for heating homes, and also gasoline, are a big part of the consumer price index. If domestic energy prices can be kept under control by turning up the volume on fracking operations, then it’s easier to push the idea that inflation is low by pointing to the CPI.

Bloomberg again:

Energy prices have become disinflationary in the U.S. as America comes closer to attaining energy independence, which has been bolstered by the proliferation of hydraulic fracturing, or fracking, of the nation’s shale deposits.

While a Labor Department report last week showed that fuel helped lift consumer prices 0.3 percent in December, the most in six months, energy expenses for all of 2013 still decreased.

And on top of all of this is the fact that the states, which can collect huge tax revenues from fracking operations, love it, and it can create booms for local economies.

For example, last week’s state-by-state GDP map shows some interesting growth patterns:


We can see that the highest growth is, for the most part, concentrated in the interior West.

Some conservative web sites rather simplistically tried to make the case that this proves the triumph of Red State Republicanism. While it is likely true that conditions for economic growth are in fact better in places like Texas and Nebraska than they are in New York and Pennsylvania, why are the red states of the east, such as Tennessee and Alabama showing such lackluster growth?

The answer: This map shows that GDP growth is especially strong in oil and gas producing states (Wyoming and Colorado), and in states with close ties to the industry, such as Texas.

Nowhere is this connection to recent economic growth more obvious than in North Dakota which registers a whopping change of 9.7 percent (year over year). The Bakken shale formation up there has created boom conditions for that economy.

Thus, we can see that the politicos will favor cheap and easy fracking as long as possible. If the party needs to kept going by more tax breaks, or subsidies, or more easy money, then the friends of the oil and gas companies in DC will make sure that the favors keep flowing. Of course, when inflation becomes undeniable, and as cheap money becomes not-so-cheap, the party will be over.


Copyright © 2014 by LewRockwell.com. Permission to reprint in whole or in part is gladly granted, provided full credit and a live link are provided.

[Occam's Banana]

Here is the Mises Daily article reference in the OP:

Government Roads, Subsidies, and the Costs of Fracking
http://www.mises.org/daily/6784/Gove...ts-of-Fracking
Sal Ahmed (19 June 2014)

Thanks to the extraction of oil through hydraulic fracturing, also known as fracking, the US is not only on its way to being energy independent, but is predicted to become a net exporter of oil and gas by 2025. Serious drilling operations have yet to be started in the Utica Shale, which underlies much of the northeastern part of the US, which is said to contain the richest deposits of natural gas and crude oil in the country. With the excavations in North Dakota’s Bakken Shale alone, enough gas had been discovered to carry on for generations ahead. And since 2008, natural gas prices have decreased by almost 75 percent.

Some of the original pioneers of fracking are impressive in their entrepreneurial and technical skills. Among fracking’s innovators, including Harold Hamm, Aubrey McClendon, Tom Ward, and George Mitchell, few have a college degree or any experience in geology or oil drilling, and are simply examples of the creative energies that are unleashed by the market. Nonetheless, the fracking industry is most certainly not a free-market industry and can be heavily dependent on government subsidies. Mitchell’s impact on the development of fracking technology, for example, is sometimes regarded as equal to Henry Ford’s impact on the automobile, but Mitchell was well known throughout the ’80s and ’90s for petitioning the federal government for increased support. Due to his successful track record in the Eastern Shales Project, the Department of Energy granted Mitchell a fat check to develop technologies that drill deeper into the earth.

In 1980, the Section 29 tax credit for “unconventional gas” companies was started. It supported large investments into infrastructure to carry out drilling operations, and it later led to tripling in production of nonconventional gas. It was during the late ’90s that fracking technology’s big breakthrough came, with the creation of “slickwater” — the industry-standard controversial blend of chemicals that are used in groundwater injections. The fluid is crucial in creating cracks in the thick sediment rock quickly, and wide enough for the gas to leak upwards and be collected. Before its breakthrough, slickwater had been the recipient of federal aid for over twenty-five years.

The State initiatives taken on fracking issues go back to the 1950s before natural gas became the favored household fuel. Over three decades, from the shale fields of Texas and Wyoming to the Marcellus in the East, the federal government contributed more than $100 million to develop fracking R&D projects, and billions more in tax breaks. As of 2013, the natural gas and petroleum industry account for roughly $3.2 billion in federal energy subsidies. Halliburton, along with two other companies (Apache and Chesapeake), dominate nearly 63 percent of the American pressure-pumping market. In 2005, the Bush administration implemented the Safe Drinking Water Act which exempted natural gas drilling on federal land, and allowed drilling companies a loophole to not have to disclose the chemicals used in excavations.

Meanwhile, there are real reasons to be concerned about the impact of fracking operations, including its impact on the environment and on infrastructure. As alarming as the environmental and health issues are concerning the carcinogenic (and radioactive) material found in fracking waste, the greatest economic cost comes to the taxpayer-funded roads. As a matter of fact, the cost of the road damage due to oil carrying heavy-haulers running night and day have surpassed the tax revenues generated by fracking in most states.

Indeed, many of the oil wells are located on federal land, so it shouldn’t be beyond our comprehension as to why the bureaucracy throws out any consideration of the capital stock of the roads. In an interview with the director of Cornell’s local roads program, he states that “It’s like the Wild West on those roads,” and “Everybody is making up their own rules.” It is more likely, however, that problems are due not so much to a lack of “rules,” but to a lack of true respect for private property when matters of ownership are confused and obscured by government when it comes to federal lands, private property, and mineral rights.

If roads were private, as was the land surrounding them, only through experience, a working price system, and trial and error, could an owner calculate the true cost of oil drilling. Furthermore, property owners would be motivated to ensure that fracking’s profitability would be sufficient enough to fix the severe wear-and-tear of the roads after drilling. Could fracking be sustained without subsidies and without free use of finite and fragile infrastructure? That remains unclear.

Although now more of our energy is coming from renewable and nuclear energy, oil and gas subsidies continue to be substantial, and since the latter are finite resources, more attention needs to be paid toward what will power up our future in the long term. Even Penn State geologist Terry Englelder, who is a leading proponent of fracking admits, “It cannot provide long term solutions.”


"Government Roads, Subsidies, and the Costs of Fracking" by Sal Ahmed is licensed under CC BY 3.0