The US Will Never Control the Price of Oil
How American oil independence is, in reality, a bad idea from an economic and geopolitical perspective.
When we talk about fracking, thoughts usually turn to the environment. But that’s only a small part of the story. Fracking is changing the geopolitics of the world. It’s creating the illusion of moving America towards energy independence. This is impacting Saudi Arabia and Russia; influencing politics in Texas, Ohio, and Pennsylvania; and, counterintuitively, it may be making the US a loser nation.
In this week’s WhoWhatWhy podcast, bestselling financial journalist Bethany McLean, the author of The Smartest Guys in the Room (a book about the Enron scandal) talks to Jeff Schechtman about the real consequences of fracking.
The discovery of fracking, a way to extract oil and natural gas from shale rock, has turned America into the world’s top producer of both. This may upend global politics, destabilize Saudi Arabia, and loosen Russia’s stranglehold over Europe. Surprisingly, the outcome may not be so good for America.
McLean tells Jeff Schechtman that the fragility of the economics of fracking, along with the disregard for renewables, is what may turn a temporary boom into a long-term bust.
She reminds us that while Texas alone may be poised to become the #3 oil producer in the world, the future of oil has more to do with Wall Street than with geology. Because fracking rests on a flimsy financial foundation, its future is far less secure than people realize.
The most important ingredient in fracking isn’t chemicals, McLean says, but capital. She explains how the financial crash of 10 years ago actually made fracking viable in the first place. However, many on Wall Street are now dialing down their investment in gas and oil in favor of renewables. It appears that a collision is fast approaching between Wall Street and the White House over energy policy.
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|Jeff Schechtman:||Welcome to Radio WhoWhatWhy. I’m Jeff Schechtman. I think it’s fair to say that when most of you hear about fracking, the first thing that comes to mind is the potential environmental damage. This has been a big story over the past several years. What you might not think about is how fracking is changing the geopolitics of the world. How it’s helping America towards energy independence, which in a counterfactual way, may not be a good thing. But at the same time, it’s also impacting Saudi Arabia and Russia in ways that affect power politics throughout the world.|
|It’s not only geopolitics. The fracking industry in Texas, Ohio, and Pennsylvania, and New Mexico is impacting politics right here at home. Just ask candidates running in those states. Add to this the importance of the industry’s deep, symbiotic ties to Wall Street, plus a cast of characters in the fracking business that could easily produce a modern day ‘Giant’ or ‘Dallas’. Bringing all of this together is my guest, Bethany McLean. Bethany McLean is the co-author of the bestseller The Smartest Guys in the Room, about the Enron scandal. She’s the author of All the Devils Are Here: The Hidden History of the Financial Crisis. And most recently, her book Shaky Ground gave us insight into the US mortgage business.|
|She’s a contributing editor at Vanity Fair. It is my pleasure to welcome Bethany McLean here to Radio WhoWhatWhy to talk about Saudi America: The Truth about Fracking and How It’s Changing the World. Bethany, thanks so much for joining us.|
|Bethany McLean:||Thank you so much for having me.|
|Jeff Schechtman:||Before we begin, let’s talk a little bit about what fracking is. Explain it in its most basic terms to our listeners.|
|Bethany McLean:||Fracking, as it has come to be known, and that’s not the word the industry likes for it, is a combination of, instead of drilling a well as old-school drilling was done, you drill horizontally. You use an injected mixture of water, sand, and chemicals in order to basically force oil and gas up through the ground, and from rock that was never meant to or never thought that it could yield oil and gas.|
|Jeff Schechtman:||This practice, although it has certainly become much bigger now, and we’ll talk about the reasons why, has been around for a long time. I mean, I think that the earliest examples of this were happening back in the mid-50s, early-60s.|
|Bethany McLean:||Yes, it has been around for a very long time. People have tried multiple things in an attempt to get oil and gas out of the ground in places that we knew it was, but the ground wouldn’t yield it. The problem was always that the wells wouldn’t produce enough to be viable, until this really changed. A guy named George Mitchell is widely regarded as the technological pioneer here, who figured out the mixture that made it work to make a well produce enough gas, in that case, to make it viable.|
|Jeff Schechtman:||The viability of it really is an economic question, even to this day, because one of the things that you spend a lot of time on in Saudi America is the fact that this is such an expensive process, so capital intensive.|
|Bethany McLean:||I think that’s something that is not well understood about this industry. When people think about controversy over fracking, they think environmental controversy. There’s a financial controversy as well, that is less well understood. I came to believe that the key ingredient in fracking wasn’t so much chemicals as it was capital. Because this is such an expensive proposition, it requires billions upon billions of dollars in capital.|
|All of that … It’s very strange, because we’re talking at the 10-year anniversary of the financial crisis, and the availability of that capital was actually a direct result of the financial crisis, in a very strange way. Because the Federal Reserve cut interest rates so dramatically in the wake of the 2008 financial crisis to reboot the economy, that actually helped spur fracking, because these companies were able to borrow money at low interest rates. So this availability of capital is a key question about the future of fracking.|
|Jeff Schechtman:||Why is it so capital intensive, but more specifically, why has Wall Street been so willing to pour more and more money into it?|
|Bethany McLean:||Well, the second one is a more complicated question than the first one. It is so expensive, because this is an expensive process to steer a drill bit a mile down in the ground, and sometimes up to three, four miles horizontally, and all the ingredients that go into it, especially the millions of tons of sand that go into it, cost money. But the other reason it’s so expensive is that, unlike a vertical well, a fracked well shows huge declines in year two, meaning it produces far less gas or oil than it did in year one. It’s not as if you draw the well and it keeps producing and there you go. You drill the well and it dries up. In order to keep producing you have to drill another well. And so you get on this treadmill of constant new reinvestment that’s required just to hold your production flat.|
|The reason why Wall Street has been willing to finance this so far boils down to a few things. One is a lack of other areas in our stagnant worldwide economy, fracking is one of the few areas that’s shown growth. These companies have often been valued off things like number of acres they own or the amount of oil and gas they are producing, not off profits. It’s a little bit reminiscent of the first dotcom boom when, you may remember that companies were valued as a multiple of eyeballs, right. When they are not traditional measures of profits, Wall Street looks at nontraditional measures. People have been able to make money. Wall Street has been able to make a lot of money by arranging financing for these companies. It’s, I think, always an important lesson to remember about Wall Street that Wall Street can make a lot of money even when the industry it’s financing does not make money.|
|Jeff Schechtman:||A lot of that money has come from fees, because fracking, as far as the oil side of it is concerned has not really been a profitable exercise.|
|Bethany McLean:||Right. I looked at one company that I profiled pretty extensively in my book, a guy named Aubrey McClendon who was in some ways one of the pioneers of fracking. Not on the technological side but because he really pioneered the capital raising. He was the evangelist for fracking who went around the globe and convinced investors to give him billions of dollars. I calculated that over the years, from 2001 to 2012, Chesapeake Energy, his company, raised 15 billion dollars in debt, 16 billion dollars in equity, and paid Wall Street over a billion dollars in fees. And that’s just one company.|
|Jeff Schechtman:||The other part of fracking really involves natural gas. That’s been a little more successful as an enterprise.|
|Bethany McLean:||It’s interesting. Fracking started with natural gas. Even when we were fracking for natural gas there was a belief that oil would never work. And then entrepreneurs, chief among them, a company called EOG, which ironically enough was spun out of the old Enron, made it work. There’s really a question these days as to which one works better and the decline rate for natural gas wells are actually far less steep than they are for fracked oil wells. There’s a belief, even among skeptics in this industry, that natural gas is closer to making economic sense than oil ever will be.|
|Jeff Schechtman:||Talk a little bit about the geopolitics of this and the fact that we hear so much about all the oil and gas we’re producing here in America. All this talk about energy independence. It has an impact in terms of potential renewables but it also has, as you talk about it, geopolitical impact in terms of the effect that it’s had on Saudi Arabia and Russia, two other big energy producers.|
|Bethany McLean:||It’s another really important and not so well understood part of the story. You may have seen the headlines last week that the US became the biggest oil producer in the world, ahead of Saudi Arabia and Russia for the first time since the 1970s. That’s in large part due to fracking. The economist I spoke to for my book said that fracking was one of the top five things reshaping geopolitics. We don’t think about energy as much these days as perhaps we used to but it’s still a critical ingredient in human life, right? World Wars have been won and lost over who had access to how much energy and it’s just as critical today as it ever was.|
|So you can see the impact of the amount of oil the US is producing in various ways and then there are other ways in which people speculate the impact will show up. One way you can see it is the state of Saudi Arabia today which is struggling. We’ve seen unprecedented upheaval with the young Prince Mohammed bin Salman, essentially staging a palace coup and taking over. He’s got a plan to wean the country off oil because he has to. The country can’t survive without oil prices around, most estimates have it around $80 to $90 a barrel. We’re significantly below that now in large part due to the amount of oil the US is producing.|
|There’s a belief that the natural gas the US is producing will eventually enable us and Europe more leverage with Russia. The reason for that is that Europe depends on Russian gas for a great majority of its natural gas supply. The idea is that if you could import US natural gas, that offers Europe an alternative to Russian gas and allows them some leverage in negotiations where previously they’ve had none. This is further off but people speculate that that could be the ultimate outcome of the US being such a prolific producer of natural gas.|
|Jeff Schechtman:||Why is it the price of oil, at least in Saudi Arabia, being propped up by the fact that so much of it goes to China?|
|Bethany McLean:||Only in retrospect can people even begin to understand what influences the global price of oil. It’s one of the humbling things about working on this book, was the recognition that everybody who’s attempted to predict the future of fracking, as well as everybody who’s ever attempted to predict oil prices has been wrong. It’s hard to understand even now why oil prices have plunged so dramatically. They were well above $100 a barrel until 2014 in large part due to Chinese demand. Part of it is production coming from the US. The remarkable growth in US production is offsetting some of the supply constraints that you might otherwise see.|
|Jeff Schechtman:||All of this of course is happening at the same time that there’s greater and greater focus on renewables. Talk a little bit about this nexus.|
|Bethany McLean:||One of the things that I came to believe in the course of working on this book was that for us to beat our chests proudly about American energy independence because we’re producing so much oil is to take pride in the world as it is and perhaps render us losers in the world as it’s going to be. What I mean by that is, I was very surprised to talk to really smart financial types and find that they are spending a lot of time, a lot of brain power, trying to figure out when the age of renewables is going to be here. That’s as hard to predict as the future of oil. Depends on so many factors from the rate of improvement and battery technology to cost efficiencies and solar et cetera, et cetera. Everybody thinks it’s coming. Once it comes the price of oil will go into a secular decline and it will never recover.|
|We don’t even have to be at the end of the oil age, we just have to see that the end is coming. I think it will be unfortunate if we were to stop paying attention to renewables. If we were to stop paying attention to renewables and focus instead, sort of myopically, on the current day’s production of oil and gas.|
|Jeff Schechtman:||There’s also the impact of globalization and the fact that it is harder for the US to have as much influence as it used to in terms of setting the price of oil.|
|Bethany McLean:||Right. So that’s one of the reasons I came to believe that this whole concept of energy independence was flawed if not fraudulent in a way. Because the idea that we can turn the clock back to the 1970s, when America could control the price of a barrel of oil is absurd. The price of a barrel of oil is set on the global market by events beyond anybody’s control. We won’t regain that control no matter how much oil we’re producing. American drivers, American consumers are going to pay for their oil based on events in Libya, Nigeria, the Middle East, elsewhere in the globe. We can’t turn the clock back.|
|Jeff Schechtman:||Talk a little bit about Aubrey McClendon. You mentioned him earlier. He was really a visionary in a way, both good and bad with respect to understanding what was happening with fracking.|
|Bethany McLean:||Yes, I was always fascinated by Aubrey McClendon for years before I embarked upon this book because I thought he was one of those larger than life characters that comes along so often in the business world and really proved that old adage ‘truth is stranger than fiction’. You couldn’t invent a character like Aubrey who was just as fearless as he was reckless and had these great dreams of the shale revolution and America’s ability to produce natural gas, really changing the world. He was also a guy who embraced an enormous amount of risk and lost a lot of money, other people’s money and his own. I came to see him as emblematic of the American fracking revolution in some ways. He was both the good side of the industry in the passion, the daring, the entrepreneurship, the desire to change the world and the bad side, which was a total inability to manage risk and just unbridled demand for more. More, more, more.|
|Jeff Schechtman:||Talk about McClendon’s death which still is shrouded in mystery in some ways.|
|Bethany McLean:||Yes. He’d been indicted the day before for antitrust accusations by the justice department and the criminal indictment would have made him lose everything. That morning he was driving at a high speed, seemed to make no effort to avoid the collision and hit a concrete bridge going at I think 80 miles an hour. They’ll always be speculation that it was suicide although the police department ultimately ruled it an accident because there was no proof that it was suicide. The caption of the Oklahoma police department said “We’ll never know 100% what happened.”|
|It was interesting because McClendon’s death came in the spring of 2016 when it looked like the fracking revolution might be over. Saudi Arabia had, in some people’s view, tried to reestablish control of the oil market by refusing to cut production which sent prices plummeting. The idea was, this would drive US fracking companies, which are already financially precarious, out of business. And it was. Some 150 US companies went bankrupt. US production fell by about a million barrels. It really looked like when McClendon’s death came it was kind if the punctuation mark underscoring the end of this industry. But it wasn’t.|
|Jeff Schechtman:||What is it that caused it to make a comeback?|
|Bethany McLean:||If you talk to believers they’ll cite a couple of things. They’ll say the technological improvements are making it more economic to get fracked oil and natural gas out of the ground. People look to the Permian basin which is this well-known area of Texas and New Mexico, it’s been producing oil for a century. Everybody believed it was tapped out and that most of the wells in the Permian were done. When fracking came to the Permian suddenly there was this explosion again of production from this region. It appears that the cost structure in the Permian is better than other places. In other words companies with good land there are a lot closer to making money than companies that have operated elsewhere. The real reason that the industry came back was that the capital didn’t go away. Wall Street was still there. Private equity firms have been pouring immense amounts of money into this industry.|
|Supporting young teams of drillers who are going out and building their own companies and that’s really why the industry didn’t going away, is that the capital hasn’t dried up.|
|Jeff Schechtman:||In looking at the broader economic framework and as you mentioned earlier we’re marking this 10th anniversary of the crash, what should we be worried about if anything with respect to all the capital that is currently invested in fracking?|
|Bethany McLean:||Well, I think there are two big worries about this. One is that a lot of pension funds have not been able to earn a return and this super low interest rate environment has put money into riskier assets namely private equity funds, sometimes hedge funds that invest in the debt of companies including fracking companies and if the industry doesn’t pan out as everyone expects that will put even more pressure on pension plans than there are already under it to be able to pay retirees. I think the other bigger issue is almost more of an existential one in the sense that we don’t … Energy isn’t front and center in most of our minds anymore, particularly if you live in an urban environment. It’s just something you take for granted. But It’s critically important in many areas of modern life. I mean your iPhone wouldn’t work without it. Your electric car depends on electricity generally from natural gas.|
|The real question to me is how much oil and natural gas would we be producing if the capital dried up. If the financial environment turned less forgiving what would happen to our fracking revolution? I think understanding that it’s weaker than everyone thinks and that this surplus of American oil and gas may not be here to stay is really important to because it’s the future of our nation in many ways.|
|Jeff Schechtman:||Is it a zero-sum game with respect to capitalists? This money that might otherwise be going into renewables?|
|Bethany McLean:||It is to some extent although there is still money going into renewables but most experts believe we’ve fallen behind China and the race to develop renewables and I think some component of that is the diversion of capital into oil and gas and away from renewables. I think that’s really, really shortsighted.|
|Jeff Schechtman:||What do you think McClendon would think of where the business is today if he were still around?|
|Bethany McLean:||That’s a really good question. I would guess he would be celebratory for everything that it’s done to change the world. He was not one to worry about enriching himself at the expense of his shareholders or to worry about mammoth debt loads and negative cash flow which is what characterizes the industry. It’s hard for me to argue that those things would faze him today. But there’s one thing that he might be a little bit distraught about and that I actually think in the end he was right about. He was a huge evangelist for natural gas. He believed that we should be trying to convert our transportation into structure and as much as possible to natural gas because we really do have a very long supply of very cheap natural gas. The situation isn’t as clear with oil and I think he might be distraught that we have made so little progress on that part of his vision.|
|Jeff Schechtman:||What does this mean for the Saudis at the moment? The recent pulling of the potential IPO for Aramco. Where does this leave the Saudis, all of this?|
|Bethany McLean:||I think not in a good place and I think that’s a really scary issue for coming years. The low oil prices put immense pressure on Saudi Arabia. Not because it cost them much to get a barrel of oil from the ground. It doesn’t. It’s probably the cheapest place in the world to get oil from the ground. But Saudi Arabia has built up a mammoth public spending infrastructure that requires … The latest numbers I’ve seen are anywhere from $80 to $90 a barrel of oil in order to support it. It’s this interesting concept known as the physical breakeven. What does it take an oil-dependent nation in order to support its population. What price for a barrel of oil does it need? The price for Saudi Arabia is higher than the current price of oil and has been for a long time and the kingdom has been bleeding through its reserves and so it was supposed to take its national oil company Aramco public.|
|Saudi Arabia just recently announced that wasn’t going to happen and the money from Aramco was going to be used to invest in this vision 2030 which was Mohammed bin Salman’s grand plan to wean the state from its dependence on oil and reshape the economy. It’s really unclear what happens now and I don’t think increased instability in Saudi Arabia is a good thing for America, no matter how you argue it.|
|Jeff Schechtman:||Finally Bethany, what’s the other thing that we should be watching for in terms of the geopolitics of this in terms of the power of fracking?|
|Bethany McLean:||Well, I think we’re seeing one aspect of it play out now which is that it’s a two-way street. So China has been importing our oil and you’ve seen China occasionally threaten to push back against Trump’s new tariff by taxing oil imports. So when you export and import it’s a two-way street, right? It’s made the world a little bit more complicated but what I really think is important is any potential leverage with Russia and Europe. Keeping a close eye on imports of natural gas to Europe on when that might happen, what the cost would be, what are factors that may get in the way. That’s something that could really affect the world in coming years.|
|Jeff Schechtman:||Bethany McLean, her book is Saudi America: The Truth About Fracking and How It’s Changing the World. Bethany, I thank you so much for spending time with us here on Radio WhoWhatWhy.|
|Bethany McLean:||Thank you so much for the wonderful questions and the interest.|
|Jeff Schechtman:||Thank you. Thank you for listening and for joining us here on Radio
WhoWhatWhy. I hope you join us next week for another radio
WhoWhatWhy podcast, I’m Jeff Schechtman. If you liked this podcast, please feel free to share and help others find it by rating and reviewing it on iTunes. You can also support this podcast and all the work we do by going to whowhatwhy.org/donate.
Related front page panorama photo credit: Adapted by WhoWhatWhy from fracking (dominiquechappard / openclipart).