Epic Disappointment
Those
inhabiting the economic wish-space got a case of the vapors last week
when the Paris-based International Energy Agency (IEA) published an
annual report stating that the USA would overtake Saudi Arabia as the
world's leading oil producer and reach the long-touted nirvana of
"energy independence." The news was greeted in this country with
jubilation. Thus, peak credulity meets peak bullshit.
It's been clear for a while that authorities in many realms of endeavor
- politics, economics, business, media - are very eager to sustain the
illusion that we can keep our way of life chugging along. But under the
management of these elites, the divorce between truth and reality is
nearly complete. The financial system now runs entirely on accounting
fraud. Government runs on the fumes of statistical fraud. The business
of oil and gas runs on public relations fraud. And the media runs on the
understandable wish of the masses to believe that all the foregoing
illusions still work to maintain the familiar comforts of modern life
(minus Hostess Ho-Hos and Twinkies, alas).
And so the
story has developed that the shale oil plays of North Dakota and Texas,
which started ramping up around 2005 - the same year the world hit the
wall of peak conventional oil - and the shale gas plays in Texas,
Louisiana, Pennsylvania, New York, and Ohio would enable American
"consumers" to drive to WalMart effectively forever.
Now, it happens that the particulars of oil and gas production are so abstruse that the editors of The New York Times,
The Bloomberg News Service, CNN, and a score of other mass media giants
swallowed the IEA report whole, with fanfares and fireworks, and a
nation afflicted with doubt about its future swooned into the first week
of the holidays in celebration mode - we're soon to be number 1 again,
and the future is secure! Have a nice Thanksgiving and Christmas and
prepare to sober up in 2013. When the truth finally emerges from this
morass of dissimulation, the disappointment will be epic.
Here's why the shale oil story is not the "game changer" that the
wishful claim it is: the price required to get it out of the ground
(between $80-90 a barrel) will crush the US economy. Since prices are
already in that range, the economy is already being crushed. The result
is an economy in more-or-less permanent contraction. As demand for oil
falls with declining economic activity the price of oil falls - below
the level that makes it worthwhile to conduct expensive shale oil
drilling and fracking operations.
Meanwhile, in the
background, as economies contract and economic "growth" of the type our
system requires no longer happens, the problems in finance and banking
get a lot worse. This is largely because interest on borrowed money can
no longer be paid back. Loans are defaulted on. As this happens, banks
become insolvent. Governments play games with public money - including
"money" they "create" out of thin air - to prop up the banks. None of it
alters the sad fact that there is not enough real money in the system.
The result of all these desperate monkeyshines is the impairment if
capital formation. That is, the failure to accumulate new wealth. The
lack of new wealth, along with declining prospects for the repayment of
loans, leads to a shortage of credit, especially to businesses that
require large supplies of it to keep gigantic complex operations like
shale oil and gas going
Shale oil (and shale gas) share
some problematical properties. The cost of drilling each well is a big
number, $6-8 million. The wells deplete very rapidly, over 40 percent
after one year in the Bakken formation of North Dakota. The oil is not
distributed equally over the whole play but exists in "sweet spots." The
sweetest sweet spots were drilled the earliest and the quality of the
remaining potential drill sites is already in decline. The current trend
shows declining first-year productivity in new wells drilled since 2010
running at 25 percent.
There are over 4300 wells shale
oil in the Bakken formation of North Dakota producing about 610,000
barrels a day. In order to keep production up, the number of wells will
have to continue increasing at a faster rate than previously. This is
referred to as "the Red Queen syndrome" which alludes to the character
in Alice in Wonderland who famously declared that she had to run
faster and faster just to stay where she is. The catch to all this is
that the impairments of capital formation are working insidiously in the
background to guarantee that the money will not be there to set up the
necessary wells to keep production at current levels. In other words,
shale oil (and shale gas) are Ponzi schemes. The story in the Eagle Ford
play in Texas is very similar.
I haven't even mentioned
the concerns about fracking and its effect on ground water, and won't go
into it here, except to acknowledge that it presents an additional
range of concerns.
The current price situation in shale
gas is different than shale oil. The drilling frenzy in shale gas
produced a glut, which drove down prices from a $13 a unit (thousand
cubic feet or mcf) to around $2 at its low point earlier this year.
That's way below the price that is economically rational to drill and
frack for it. The price collapse has played havoc among the companies
engaged in shale gas, though it has been a boon to customers. A lot of
the drilling equipment has moved to the North Dakota oil fields. There
will be less shale gas in the period ahead and the price will go up. It
has got to go above about $8 a unit or there will be no reason for any
company to be in the shale gas business. But as is always the case in
such a correction, the price will surely overshoot $8, at which point it
will become unaffordable to its customers. The volatility alone will
make the business of shale gas drilling impossible to maintain. Forget
about the USA becoming a major gas exporter.
You probably
get the point by now, so I will only add a couple of out-of-the-box
considerations vis-à-vis the prospect of the USA becoming energy
independent.
-- Production is getting so low in the Prudhoe
Bay fields of Alaska that the famous pipeline may not be able to
operate. If the flow of oil reaches a certain low volume, it takes
longer to make the long journey. The oil cools down and gets sludgy and
some of the water that travels with it will freeze. This could destroy
the pipeline. The capital is not there to retrofit the pipeline for a
depleting oil field in a region that is difficult and expensive to work
in.
-- Exporting countries (the ones that send us oil) are
depleting their reserves and using more of their own oil, resulting in
annually declining export rates. China, India, and other
still-modernizing nations compete for a growing share of that declining
export flow.
-- I have barely hinted at the geopolitical
forces roiling behind the sheer business dynamics. But here's an
interesting one: the time will come when the US will invoke the Monroe
Doctrine to prevent Canada from sending its oil and tar-sand byproducts
to nations other than ourselves. Just wait.
Finally, I
have one flat-out prediction, one I have made before but deserves
repeating: Japan will be the first society to consciously opt out of
being an advanced industrial economy. They have no other apparent choice
really, having next-to-zero oil, gas, or coal reserves of their own,
and having lost faith in nuclear power. They will be the first country
to enter a world made by hand. They were very good at it before about
1850 and had a pre-industrial culture of high artistry and grace -
though, granted, all the defects of human psychology.
I
don't think the US can make that transition in an orderly way. We're too
stricken with techno-narcissism and grandiosity. What troubles me is
how we will greet the epic disappointment that waits for us when we
discover that the journey to WalMart is over. My guess is that being
predisposed to superstition and religious fanaticism, the American
public will violently reject science and rationality and retreat into a
world of shadows. We're already well on our way. The IEA report will
just accelerate things.
