The New American Oil Empire Built on Sand
By F. William Engdahl
11 September 2019
Image credits: Joshua Doubek - Fracking the Bakken keeping American energy
independent Usage Rights: This file is licensed under the Creative Commons
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Over the course of the past decade
the United States, following decades of relative stagnation in oil production,
has surprised many to become the largest oil producer in the world, exceeding
Russia as well as Saudi Arabia. Latest daily production is just above 12.1
million barrels a day. In November 2018 for the first time in decades the US
became a net oil exporter. The geopolitical implications to this energy boom in
a world where oil determines the growth of entire economies, would appear to be
great. Almost all the increase owes to the exploitation of what is called shale
oil, unconventional oil found in shale rock formations. The US Department of
Energy projects a rise to 8.8 million barrels daily from US shale oil alone, a
new record. Now though, we are seeing the first clear signs that the “shale
boom” could implode even faster than it rose. The implications for American
foreign policy and global geopolitics and economics are significant .
The ‘Fracking’ Revolution
The idea of extracting oil or
natural gas embedded in shale rocks has been known for years. However shale
oil, or tight oil as it is known, first became economical with introduction of
new horizontal drilling techniques combined with oil prices of $100 a barrel or
more. This was about two decades ago.
In hydraulic fracturing or
fracking, oil embedded in shale rock thousands of feet down is injected with a
high pressure mix of water, lots of it, mixed with chemicals and sand. The de
facto sand blasting creates fissures where oil can flow into the oil pipeline.
The actual drilling of a shale well is only about 30-40% of the total cost. Up
to 55-70% are from completion which includes actual fracking. The independent
oil consultancy, Wood Mackenzie, recently estimated that the USA held an
impressive 60% of all world shale reserves that are economically viable at oil
prices of $60 per barrel or less.
Now it begins to get interesting.
The current price for the West Texas Intermediate marker grade of oil is around
$58 a barrel, where it has been for months. The price has not shot up as many
expected despite the disruptions in Venezuela, in Iran and around the Persian
Gulf. This puts shale well production, much of which today is in the Permian
basin in West Texas or Bakken in North Dakota, at a delicate point.
When Saudi Arabia and the Arab OPEC
producers decided to flood the market in 2014 with cheap oil in order to force
the US shale producers into bankruptcy, the results were disastrous for the
OPEC countries financially, but new technology advances allowed the major part
of US shale oil production to survive at far lower prices. That, combined with
a Federal Reserve Zero Interest Rate Policy (ZIRP), made borrowing to produce
oil attractive for shale companies. Now, with two years of gradual Fed rate
increase policies, shale companies are beginning to show signs of major stress.
Economic Troubles
Little known is the fact that
despite all technological advances and economies of scale, the USA shale oil
industry as a whole has yet to turn a net profit. At a juncture when world GDP
growth begins to look very bleak, whether in China or in the EU or Emerging Markets
like Brazil or Argentina or Turkey, US shale companies face a critical
juncture.
The year 2018, according to
projections of the International Energy Agency was supposed to be the year that
the shale industry finally turned a profit. The IEA wrote in early 2018 that
“higher prices and operational improvements are putting the US shale sector on
track to achieve positive free cash flow in 2018 for the first time ever.”
Since it began, until the Saudi price crash, that is from 2000-2014, US shale
companies as a whole according to IEA estimates, already generated a cumulative
negative free cash flow of more than $200 billion. With glowing predictions for
a “new Saudi Arabia, and banks willing to lend to after the 2008 financial
crisis, money poured into shale. Companies claimed once infrastructure was in
place the profits would soon flow. It didn’t. Despite over two years of rising
world oil prices, some 33 US publicly traded shale companies had a combined
negative cash flow of $3.9 billion in the first half of
2018.
But with possible war with Iran and
the unrest in Venezuela combined with projections of a growing US economy, the
US shale industry told their bankers that 2019 would be the year finally of net
profit. The reality has been the opposite. Shale company combined capital
expenditures for the first Quarter of 2019 alone have exceeded operating cash
flow by a whopping $5 billion. And now with oil prices stuck seemingly at
$58 and the prospects for economic slowdown, not only abroad but more recently
in the USA itself, many bank lenders to the US shale oil bonanza are having
second thoughts.
Unconventional means more cost
Unconventional means by definition
more costly to produce. Shale, unlike conventional oil reservoirs, deplete far
faster than normal oil wells. In many cases a shale well loses 70% of
recoverable oil the first year. The Permian Basin has been measured at 22% a
year. To justify taking on debt via junk bonds and other lending to continue
producing, shale companies went to the best, so-called “sweet spots” and
projected the optimistic numbers into the future.
Explaining second quarter 2019
profits, the CEO of one of the most successful companies, Scott Sheffield of
Pioneer Natural Resources warned in early August that most of the oil from
so-called “sweet spots,” or “tier 1 acreage,” has already been extracted. “Tier
1 acreage is being exhausted at a very quick rate,” Sheffield stated.
To counter faster depletion rates of
shale wells, companies have resorted to technical changes in terms of sand,
closeness of drilling and other means. As the drilling is forced to go to less
ideal areas, one oil industry source likened it to walking up the down
escalator, drilling more just to stay even. That costs more per barrel.
Now an alarming new industry report
suggests that the shale oil producers, at least in the rich Permian Basin, have
been faking their numbers or under-reporting the shale wells completed to make
the numbers look better. A detailed report by energy analysts at Kayrros
indicates that oil companies in the Permian Basin greatly under-reported the
number of shale oil wells completed in 2018. Kayrros estimates that more than
1,100 wells were completed in the Permian Basin but not reported as required by
law. That would mean a significant 21% greater number of completed wells to
produce the same volume as had been reported. That means the average well is
far more expensive per barrel and far less efficient. Kayrros advisory chairman
and CEO of Schlumberger, Andrew Gould remarked, “With far more wells
contributing to Permian and US oil production than accounted for, current shale
oil production is substantially more water- and sand-intensive than is commonly
believed.” Kayrros estimates that in 2018 in the Permian Basin alone that
actual demand for special grade sand was under-estimated by 9.2 billion pounds
and water under-estimated by 12.5 billion gallons. That’s a lot of sand and a
lot of water. At some point the companies will be importing sand from the
deserts of Arabia at that rate. The environmental costs of shale oil fracking in terms
of water, contamination, earthquakes are enormous and need a separate
treatment.
To worsen the energy outlook, the
spectacular oil production growth rates in the US appear to be stagnating, a
worrisome sign given the fact that shale wells deplete annually at anywhere
between 20-40% per year or more compared with around 4% for conventional wells.
Earlier estimates suggested that the largest US shale region, Permian Basin,
would reach its economic peak around 2025 or after.
A recent study of shale production
by J. D. Hughes, an oil geologist who has followed the industry closely,
suggests that with productivity per well peaking or even in some regions like
North Dakota actually declining, oil companies are being forced to pour more
money in, drill more just to replace lost output. In 2018, the industry spent
$70 billion on drilling 9,975 wells, according to Hughes, with $54 billion
going specifically to oil. “Of the $54 billion spent on tight oil plays in
2018, 70% served to offset field declines and 30% to increase production,”
Hughes wrote. He added, “production will fall as costs rise. Assuming shale
production can grow forever based on ever-improving technology is a
mistake—geology will ultimately dictate the costs and quantity of resources
that can be recovered.”
Add to this all the huge debts of
the shale oil companies are a growing problem. According to the Wall Street
Journal some $9 billion worth of debt is set to mature over the second half of
2019 and banks are becoming reluctant to continue financing in a weaker
economy. Then a staggering $137 billion in debt matures between 2020 and 2022,
debt that was taken on to survive the 2014-15 oil market meltdown. Many
producers will likely go down, though giants like ExxonMobil will survive.
If major oil shale regions are
already beginning to shows signs of limits at present prices, and if decline
rates are about to significantly accelerate over the coming 2-3 years, it will
have major implications for US foreign policy as well as the economy. A major
factor in the recent actions of Washington in the Middle East and even
Venezuela has clearly been driven by a sense that America no longer depends on
foreign oil and can take greater geopolitical risks. Oil and the remarkable
shale boom were largely behind this impression.
The Trump Administration began in
2017 as one of the most oil-friendly in recent history. Rex Tillerson, CEO of
ExxonMobil, was named Secretary of State. Texas oil-friendly Governor Rick
Perry headed Energy Department. Others were named who favored expansion of
shale oil as a national priority. If this domestic shale oil support suddenly
begins to vanish, it will send major new shock waves around the globe at a time
when shock waves are coming from every direction. It’s not the end of the Oil
Age, but it could soon be the end of the USA shale oil boom, one fueled on
mountains of debt, horrendous environmental destruction and wishful thinking.
In turn that could trigger a global oil price shock that will turn the economy
dramatically down.
F. William Engdahl is strategic
risk consultant and lecturer, he holds a degree in politics from Princeton
University and is a best-selling author on oil and geopolitics, exclusively for
the online magazine “New Eastern
Outlook”
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