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The Shale Misunderstanding: An Introduction

Professor Ferdinand E. Banks
ferdinand.banks@telia.com
October 16th, 2013

Normally I wouldn't bother to broach this subject again, because for the last decade or so, economic and political misunderstandings (and delusions) are everywhere and inescapable, and so a sensible contribution might not be appreciated. But according to a recent article on the important site 321 Energy, the shale revolution is just beginning - in other words, the good shale times are just starting to roll. The thesis offered in this short paper is that on the basis of existing evidence, that tantalizing belief is doubtful.

The economics of shale oil and natural gas is not a new love for this humble teacher of energy economics. I mentioned shale oil in my book on oil (1980), and just a few months later I gave what I thought was a brilliant lecture on the subject of oil and gas at a workshop in Vienna. The same evening I was informed by an American business executive that if I were serious about shale, then I was a "fool", because there was not sufficient water in his part of the United States (U.S.) to 'fuel' the shale production process. As a result, when I published my book on natural gas (1987), I made sure that the word 'shale' was not mentioned, although of course the basic technology employed to obtain shale natural gas (by some variant of fracking) was well known. (Fracking involves pumping water, sand and chemicals into a deposit under high pressure, and which - in conjunction with horizontal drilling - liberates gas or liquids and causes them to reach a well. Here I can note that once I attended many conferences at which 'horizontal drilling' was a magic expression, although it often proved to be considerably less than magic in practice.)

I would like to repeat once more what I consider to be the best outcome of this shale 'hullabaloo', which is that while shale oil and gas might turn out to be valuable assets, and not just for a few financial institutions, energy firms, and so-called players, they are unlikely to be sung about in a karaoke where patrons are especially concerned with the 'common good' . From the point of view of orthodox economic theory, things have not always happened on the shale oil and gas scene that should have happened, and probably some things have taken place that were definitely not expected or desired. As an example of the latter I can mention a brilliant firm like the energy giant Exxon taking a shale gas 'bath' for 31 billion U.S. dollars (or more).

SOME ESSENTIAL BACKGROUND

I mentioned the site 321 Energy above because they have published between 50 and 100 of my articles, and more important they have published hundreds of short and easily read articles by other researchers on oil, natural gas, nuclear and coal. All of these items are available in their archives. The recent article that caused me so much unease was an interview carried out by the 'boss' of the site OilPrice.Com, Mr James Stafford, who almost a year earlier strongly objected to my saying that one of his contributors had published an article on his site which indicated that the United States possessed as much oil in proved and hypothetical reserves as the rest of the world combined, and then some. The good Mr Stafford labelled my opinions and research "garbage".

Garbage is a sensitive word for me, because after I was expelled from Infantry Leadership School (at Fort Ord, California), I was assigned to work on a garbage truck for several months. Even worse, when I had got into the rhythm of handling and disposing of garbage, and more significant spending a large part of my very generous free time in the nearby beach community of Carmel, I was relocated to Fort Lewis, which is near Seattle (in Washington State). In any event, what Mr Stafford did was to find a well-known economist, Professor Tyler Cowen, who obviously has an excellent knowledge of the relationship between energy and the macroeconomy, although his belief that the shale gas "revolution" is on the high road is without justification. This is a situation that reminds me of the pronouncements about shale oil made by the chief economics editor of the (London) Financial Times, who on several occasion I described as trying to hitch a ride on the shale gas gravy train, although he is completely and totally illiterate when the subject is energy economics.

But let's be clear about one thing. Although I taught international financial economics and macroeconomics at Uppsala University (and in Prague and at several universities in Australia), I must confess that at the present time I make a point of staying away from the details of that subject. What I do know however - and perfectly - is that it is very unlikely that (ceteris paribus) enough natural gas and oil can be removed from the various shale deposits now available in the U.S. to return that country to a semblance of the macroeconomic stability (or sanity) that existed a few years prior to 2008. In case you have forgotten, it was in the middle of that year when the price of oil touched 147 dollars a barrel, and the global economy went off the rails.

Speaking of details, this might be the place to emphasize what could turn out to be a gigantic shale scam. Everybody who is sincerely interested in this topic should realize that in the promised land of shale exploration and production, the United States, the 'rig' count is declining, which suggests that production is falling. Moreover, and just as important:

1. Estimates suggest that the physical depreciation of shale deposits are increasing, and not, as expected, decreasing as additional knowledge is accumulated about the structure and specific geology of various shale oil and gas properties. The simple truth is that estimated decline rates are so large that I do not feel comfortable discussing or thinking about them. In the Bakken (oil) region, which is constantly cited and praised to the high heavens, it is now believed that the average decline could turn out to be 75-85 percent in the first five years, as compared to a much lower average for conventional oil fields. A similar decline rate is expected for shale gas in most deposits.

2. As usual, I will repeat again something pointed out by the CEO of Exxon, which is that no shales outside the U.S. have shown themselves amenable to the kind of fracking practiced in the U.S., and more alarming poor results have been obtained from some U.S. shales (as well as a high rate of depletion. This is the thing that first suggested to me that shales containing oil and natural gas might not provide the rewards often predicted by a large number of self-appointed energy experts. There is talk of decline rates in some shale deposits reaching 50% after a few years of production.

3. The cost of drilling for shale oil and natural gas is increasing, and not increasing by a small amount, unless readers consider increases by a factor of 'four' in the same number of years to be small. It is interesting to me that Leonardo Maugeri - at the present time a fellow at Harvard University - has estimated that maintaining production in the Bakken deposit would cost 11 billion dollars a year for new investment, while the Post Carbon Institute has put the figure at more than 30 billion for all shale deposits in the U.S. I wonder however if these are the calculations we need for estimating future investment costs, given the physical exhaustion/depletion taking place in typical shale deposits. Something I do not wonder about though is that the very large difference between the price of natural gas in North America and Asia may not continue indefinitely, and if - or when - that price gap is closed, it might be unpleasant for the industrial and household sectors in the U.S. While I am at it, I might as well say that if you are interested in the oil prospects of the U.S., the man to turn to is Professor James Hamilton of the University of California (San Diego).

THE COMMON GOOD AND ITS ECSTASIES, AND A CONCLUSION

In one of the forums that I contributed to, before being brusquely informed that my modest talents were no longer required (or desired), I often complained about people reading newspapers instead of books in order to obtain the knowledge they need to understand theoretical or applied energy economics. The problem - as I saw it - had to do with the sub-optimal backgrounds of the editors of some of those publications, most of whom have never studied engineering or economics. I have already mentioned an editor of the Financial Times, and another excellent example of journalistic incompetence involves an editor of the Wall Street Journal. Read what he says about the way that global energy has and should develop:

Yet, beyond our merits, the Lord has recently smiled on us in
in the form of shale gas...Don't bet on Mr Medvedev. Bet on
the crude logic of Russia's declining energy power, which
Western policy should do everything possible to exploit, to
deliver better behaviour in Moscow.

This is the work of an editor of a famous U.S. newspaper, and not the office boy or a shareholder. Note the expression "Russia's declining energy power", when in point of truth Russia's "energy power" can only increase. One of the reasons why it will increase is that Russia is the largest country in the world, and a sizable fraction of its geology is similar to that of North America (and thus can also expect a shale oil and gas bonanza of sorts). Another is the availability of the dynamic Chinese market. Today China has 100 million cars as compared to 250 million in the U.S., but expectations are that by 2030 there will be 300 million cars in China. In case you are concerned with the future price of motor fuel, and this estimate of Chinese automobile ownership is correct, then I suggest that you should hope that the shale gas revolution that Professor Cowen expects to take place in the United States also takes place in China and Russia.

Almost certainly there are plenty of scholars in North America and Europe who will tell you that the Russians are inherently incapable of exploiting their geological wealth, for example their massive 'shale power', but it so happens that for those of us who know the story of the main battle tanks of Russia and the U.S. during WW2, a bet on Mr Medvedev and his colleague Mr Putin makes a lot of sense. That story does not indicate that the Russians are unable to shove a pipe into a hole in the ground and obtain oil or gas if they are actually present.

Professor Tyler Cowen recognizes that what he calls The Great Stagnation "first shows up in the data in 1973, when income growth slows and productivity growth falters." I pointed this out in my oil book and also my book Scarcity, Energy and Economic Progress (1977), and the reason I pointed it out is that I was familiar with the research of Professors Dale Jorgenson and Edward Hudson, although it was barely noticed by most economists, and the same is true now. Cowen also says that "It's hard to avoid the conclusion that this has something to do with the end of the age of cheap energy."

Many friends and neighbours have avoided it, but in the interview Professor Cowen gave Mr Stafford he suggests that the "shale gas boom" will bring an end to the present era of expensive energy. This is probably - though not certainly - wrong, at least in the short run, however I do not intend to discuss my reasoning on this subject in the present contribution, though I allude to it in my forthcoming energy economics textbook (2013).

What I will say here is that Professor Cowen undoubtedly knows a great deal about how the global economy works, as compared to the gentleman who was kind enough to make him the subject of an interview. Unless I am mistaken, and I am fortunately not in the habit of being mistaken about certain things and people, Mr Stafford desires to be thought well of by a group of movers and shakers who want the world to believe that talk or thought about energy limitations is nonsense. I am also optimistic about energy, but sceptical about natural gas and - in particular - oil: the lies being told about oil are almost too grotesque to accomodate. Moreover, many of those gentlemen who want the rest of us to accept their crank evaluations of energy issues are not interested in what is known as the common good, but instead are desperate to join the ranks of the super-rich. While I might be willing to help them to reach their economic goals if some money changes hands, I prefer to avoid accepting their wisdom.

I will conclude this exposition by noting that there has been an intense discussion in France about fracking. France is thought to have two very large deposits of shale hydrocarbons. The U.S. Energy Intelligence Agency (EIA) has published estimates suggesting that France possesses 137 trillion cubic feet (=137 Tft³) of technically recoverable natural gas in France, which amounts to several decades of French consumption if consumption remains at the present level. Ostensibly the reason for not exploiting this gas is environmental, although of course the purpose is political. The present French president will likely require some votes from persons who object to fracking on environmental grounds, and like Ms Merkel in Germany, when the issue is money or votes, things like logic or the common good are not taken into consideration.

REFERENCES

Angelier, Jean-Pierre (1994). Le Gaz Naturel. Paris: Economica.

Banks, Ferdinand E. (2013). Energy and Economic Theory. Singapore, London and New York: World Scientific. (Forthcoming).

______. The Political Economy of World Energy: An Introductory Textbook'. (2007). Singapore, London and New York: World Scientific.

______. (2000). Energy Economics: A Modern Introduction. Dordrecht: Kluwer Academic Publishers.

______. (1987) The Political Economy of Natural Gas. London and Sydney: Croom Helm.

______. (1980). The Political Economy of Oil. D.C. Heath & Co. Lexington and Toronto: Lexington Books.

______. (1977). Scarcity, Energy and Economic Progress. D.C. Heath & Co. Lexington and Toronto: Lexington Books.

Clarren, Rebecca (2013). 'Fracking is a feminist issue'. MS (Spring).

Cobb, Kurt (2011). 'Can we believe everything we've heard about shale gas? OilPrice.Com.

Crooks, Ed, (2013). 'Gas export opponents ignite US shale debate'. Financial Times (March 26).

Hughes, J. David (2013). Drill Baby Drill. Post Carbon Institute (February).

Mazur, Karol (2012). 'Economics of shale gas'. EnergyPulse (3 October).

Michel, Jeffrey H. (2013). 'Fracking und die Europäische Energieversorgung.' Stencil. Ing. Büro für Energieforschung.

Neumann, John von and Oscar Morganstern (1944). The Theory of Games and Economic Behavior. Princeton: Princeton University Press.

Stevens, Paul (2010). The Shale Gas Revolution: Hype and Reality. Chatham House.

Professor Ferdinand E. Banks
ferdinand.banks@telia.com
October 16th, 2013