The fracking boom in the US has frequently been hailed as a remarkable economic achievement for drastically reducing the country’s dependence on foreign energy resources. In fact, it did more than just help the US achieve “energy independence”. By 2013, driven by a sharp rise in oil exports, the US overtook Saudi Arabia and Russia to become the world’s largest producer of oil. US production levels currently stand at close to 20 billion barrels per day, or one fifth of global output.
Although these numbers suggest the emergence of a vibrant and competitive sector, nothing could be further from the truth. The industry is not financially viable and is essentially being kept on life-support in the form of government subsidies and heavy debt leverage. Indeed, most companies operating in the fracking sector can be classified as what have come to be known as “zombie” companies.
The basics of fracking
Hydraulic fracturing, or fracking, is the process of drilling down into the earth and subsequently directing a high-pressure water-sand-chemicals mixture at the subterranean rock to release gas or oil stored inside. Combined with a technique called horizontal drilling, it becomes possible to extract gas and oil from shale, which is how the US started tapping the vast reserves located across the country.
Fracking has, however, been extremely damaging to the environment and the health of local populations that reside in the areas where it is taking place. The fracking process requires massive quantities of water laced with toxic chemicals, which often find their way to local drinking water. In spite of these and other well-known negative consequences of fracking, the government’s support for the industry has been unwavering since its infancy.
The government starts developing the industry
The US government’s interest in developing the fracking industry originally arose from the desire to revive domestic gas production, leading to support for the industry via numerous channels. Starting with the first successful display of Massive Hydraulic Fracking by the Department of Energy (DOE) in 1977, the US government has been closely involved with all the major technologies developed for horizontal drilling by means of a variety of subsidies and cost-sharing schemes. Tax relief worth billions of dollars were offered to all unconventional gas extracting companies from 1980 to 2002. Dan Steward, the former Mitchell Energy geologist, whose company introduced the first successful horizontal well, summed it up perfectly when he was asked to describe the government’s role in the shale industry during an interview with The Breakthrough Institute:
“They did a hell of a lot of work, and I can’t give them enough credit for that. [The DOE] started it, and other people took the ball and ran with it. You cannot diminish DOE’s involvement.”
He went on to explain how important the government had furthermore been in terms of indirect support, such as the exploration and mapping of shale resources throughout the US. Hence, it should come as no surprise that the government places great value on keeping the industry alive.
The importance of fracking for the US economy
What started with an attempt to rescue domestic gas production eventually morphed into an oil production boom of unprecedented proportions. After replacing most of the nation’s imported oil with domestic production, fracking has come to power the massive growth of oil exports over the last few years (see chart below). In 2019, for the first time in 70 years, the US became a net exporter of oil.
Outcompeted in manufacturing in almost every area, energy products have come to replace manufactures as the major US export, currently accounting for 15% of total exports. Indeed, oil and gas production have displaced manufacturing as the main driver of US industrial production since 2011 (see chart below). Numerous recent studies have shown that a ban on fracking would cause millions of jobs to be lost and reduce GDP by trillions of dollars.
Piling on the debt while burning through cash
Aside from the government support for the fracking industry outlined above, many have argued that the US Federal Reserve’s policy of low interest rates since the 2009 financial crisis has made a major contribution to the fracking boom.
This is not only because it allowed fracking companies to have access to cheap financing, but also because it made the industry more attractive to investors. Due to the aggressive monetary policies of the major central banks in the advanced countries, traditional safe investments such as government bonds and equities offered low rates of return, which lured many to try their luck in the oil and gas sector.
As Desmog points out, the fracking companies need not even be profitable for lenders to make money. For example, the fracking company Continental Resources spent close to $300 million on interest payments in 2017, which was one and a half times its net income generation. By the end of that same year, the company managed to raise an additional $1 billion from a sale of notes to refinance its growing pile of debt.
Bond issuances by gas and oil exploration and production companies have in fact soared since 2009. From 1995 to 2008, bond sales averaged at about $15-$20 billion annually, while over the last 10 years the amount rose to $60-$70 billion per year. The amount raised through syndicated loans has been even higher, leading to net debt increasing by about $150 billion each year since 2011 (up from $100 billion a year between 2006-2010), most of which is held by Wall Street. This is not bad for an industry which has had negative cash flows for some 75% of the time over the last 10 years.
Tax rates for oil and gas producers are as low as 1% in states like Oklahoma, where the subsequent short-fall in revenue forced the state to cut back on education spending, while the tax rate in North Dakota, the second-largest oil-producing state after Texas, is 11.5%. The usual corporate tax rate in the US is 21%.
The necessity of high oil prices
When oil stood at $100 a barrel in the mid-2000s, optimism in the US fracking industry was high. Sentiments quickly changed when oil prices started plummeting in 2014, eventually sliding to under $35 a barrel in 2016 (see chart below).
As reported by The Guardian, the price drop was disastrous for the fracking industry, which saw the number of operating oil rigs drop from a high of 1,920 to a low of 480 over the space of just two years. Debt-laden fracking companies defaulted on $70 billion worth of debt, with over 200 of them eventually declaring bankruptcy. This period clearly illustrates the necessity of high oil prices for the US fracking industry and makes it obvious why the US government goes to great lengths to hold up the price of oil.
This necessity of high oil prices is not shared by the majority of the US’s international oil-producing competitors. This is because in spite of all the subsidies and financial support the US government gives to the fracking industry, its costs of production rank among the highest in the world at $49 a barrel. Only oil production costs in Brazil and the UK are higher.
In stark contrast, the cost of oil production in the gulf states lies at around US$10 per barrel and is thus a fifth of the cost of US shale, while Russian and Venezuelan production costs are less than half of US-American at around US$ 20 per barrel. The chart below is a scatter plot of oil production costs per barrel and output levels across different countries, suggesting that, should oil prices fall significantly, the US has the most to lose.
Controlling supply to prop up prices
The preceding graph shows clearly that the US has a vested interest in keeping oil prices high by controlling the supply of oil, especially the supply by lower cost producers. Managing oil output to buoy oil prices was the rationale for the establishment of the Organisation of Petroleum Exporting Countries (OPEC) by the largest oil producing countries. Notably, the US and Russia, who are not part of the OPEC, produce far more than OPEC members in relation to their potential output.
The chart below compares oil output to proven oil reserves for each country, as a rough measure of actual output relative to potential output. It may be seen from this chart that the US is at one extreme in producing above its potential while Venezuela is at the other extreme.
In fact, Venezuela holds the largest proven oil reserves in the world at 302 billion barrels, or 18% of global reserves. Then come Saudi Arabia and Canada, followed by Iran and Iraq. Some of the countries with the largest proven reserves are producing well below their potential, largely as a result of US direct and indirect efforts to disrupt their supplies.
The significance of this disruption can be seen in the following chart that considers the likely impact on the structure of global oil production if Venezuela, Iran, Iraq and Libya begin producing according to their potential (as per OPEC’s quota rule of production according to reserves), with and without a consequent significant reduction in the price of oil. Scenario 1 assumes no price reduction while scenario 2 assumes a price reduction commensurate with the massive increase in supply by countries with relatively lower costs of production.
One can see that as a consequence, the US would lose a third of its current global oil production share in scenario 1 and two-thirds in scenario 2. Both scenarios would be catastrophic to the US fracking industry and, by implication, the US economy.
Iraq, along with Venezuela, was one of the first competitor oil producing countries to be targeted following the infamous 2001 report on “energy security”, commissioned by the then US Vice-President Dick Cheney. The report outlined the need to control natural resources ―mainly oil― in the Middle Eastern region.
Subsequent to this report, a US- and UK-led coalition invaded Iraq in 2003 under the pretext of destroying Iraq’s alleged stock of “weapons of mass destruction”, resulting in, among other things, the disruption of oil production in the first few years of the occupation. The plan however, as CNN and the Guardian have described with reference to the above-mentioned 2001 report, was from the very beginning to privatise Iraq’s oil and let production be controlled by mainly US and British petroleum companies. CNN commented on the ensuing recovery in Iraqi oil production once foreign companies assumed complete control:
Iraq’s oil production has increased by more than 40% in the past five years [as of 2013] to 3 million barrels of oil a day (still below the 1979 high of 3.5 million set by Iraq’s state-owned companies), but a full 80% of this is being exported out of the country while Iraqis struggle to meet basic energy consumption needs.
Given the high costs of British oil production, it should come as no surprise that the UK has been the most enthusiastic supporter of US oil-related interventions.
On the back of a long period of meddling in the affairs of Iran, the US government decided to impose sanctions on the country’s oil exports in December 2014, causing Iran’s oil production to fall by 25% within a year. Production recovered when newly elected US President Trump lifted the sanctions in 2016, only to reinstate them in 2018 and bringing Iranian oil production down again by 40% (as of present). The hostile US attitude towards Iran appears to be increasing following its assassination of a top Iranian general, Qasem Soleimani, in January of 2020.
Venezuela too has long experienced US interference in its internal affairs, most notably the attempted coup of democratically elected Hugo Chavez in 2002, resulting in a temporary crash of oil production. It is worth noting that had the coup succeeded, the business leader who was to replace Chavez had as a first order of business to privatise Venezuela’s oil.
The most recent attack on Venezuela’s oil production started in December of 2014 (after the bulk of Venezuela’s current proven oil reserves were discovered), with the US congress’s approval of Law 113-278. This law basically drew a roadmap for financial restrictions and sanctions against Venezuela’s national oil producer, Petroleos de Venezuela (PDVSA), using the US’s influence in the international financial community (see Telesur 2019).
The attack on Venezuela’s oil production intensified in January of 2019 when the US started directly sabotaging oil production in the country and sanctioning its oil exports, coercing the international community to follow suit. As a consequence, oil production in Venezuela has fallen by 72% since December of 2014.
Under the false pretext that the Libyan head of state, Muammar Gaddafi, was about to commit genocide in the Libyan city of Benghazi ― a claim for which no evidence has ever been provided ― the UN security council approved a “military intervention” in Libya by another US- and UK-led coalition in March 2011. The coalition unleashed a series of airstrikes in the months that followed, supporting the rebel uprising that led to a full-scale civil war.
The ensuing destruction and chaos inflicted incalculable economic damage on the country, including structurally disrupting its production of oil. Oil production recently came close to completely shutting down, following the seizure of four key ports used for exporting Libyan oil by CIA-backed General Khalifar Heftar, leader of Libyan National Army, which is currently trying to overthrow the UN-backed government in Tripoli.
The recent collapse in global oil prices (-30% on 9 March, 2020) that has apparently resulted from the damage done by the novel corona virus puts the arguments outlined above into a certain perspective. With Russia refusing to further reduce the quantity of oil it is producing, the price of oil has fallen rapidly to levels that are more in keeping with production costs of the major oil producers, even allowing for the supply constraints imposed on many of the low-cost oil producing countries noted above.
Current oil prices (Brent, $35) may in fact not be a far cry from future sustainable levels should the US start to lose its grip on all the low-cost oil producers whose supply it has currently constrained. Production agreements could be permanently breached, or, even worse for the US, those countries with some of the largest oil reserves in the world could start producing closer to their full potential.
In either case, the implications for the US fracking industry and the US economy may well be dire. President Trump, however, appears to be living in the past:
Good for the consumer, gasoline prices coming down!— Donald J. Trump (@realDonaldTrump) March 9, 2020
- This post was updated from the original on 6/6/2020 with changes made to the formatting of several charts. None of the data were changed.
- In what must rank as one of the most banal articles by The Economist in recent times, and there are many competitors for this accolade to be found in this magazine, the research by Megan O’Sullivan was cited as showing how the US “replaced” oil supplies disrupted by “political developments” in countries such as Syria, Iran and Libya as a result of the accomplishments of the US shale industry.
- Costs of oil production used in this article are based on total costs, or the sum of operational expenditure and capital expenditure, divided by the current volume of oil production. Note that these would likely be lower for countries like Venezuela if it should start producing more and improving infrastructure related to costs.
- For a bit more context regarding the shift to oil and gas production in the US economy, read our post on the ongoing de-industrialisation of the US economy.