Oil, Gas, Inflation, and Cheap Money

-Boom_Town_ballyhoo-_-_sponsored_by_the_A&R_Department_-_at_the_Post_Gym_LCCN98513372.tifToday’s Mises Daily article covered the impact of government subsidies and infrastructure on the fracking boom. But there is another big player in the oil and gas boom that is routinely ignored by “energy independence” enthusiasts who claim the sky is the limit for fracking: cheap money from the central bank.

Energy companies are employing massive debt schemes to finance exploration and initiation of extraction plans. According to Bloomberg

Quicksilver acknowledges the company is over-leveraged, said David Erdman, a spokesman for Quicksilver. The company’s interest expense equaled almost 45 percent of revenue in the first quarter. “We have taken concrete measures to reduce debt,” he said.

Drillers are caught in a bind. They must keep borrowing to pay for exploration needed to offset the steep production declines typical of shale wells.

“Interest expenses are rising,” said Virendra Chauhan, an oil analyst with Energy Aspects in London. “The risk for shale producers is that because of the production decline rates, you constantly have elevated capital expenditures.”

Chauhan wrote a report last year titled “The Other Tale of Shale” that showed interest expenses are gobbling up a growing share of revenue at 35 companies he studied. Interest expense for the 61 companies examined by Bloomberg totalled almost $2 billion in the first quarter, 4.1 percent of revenue, up from 2.3 percent four years ago.

Yes, “interest rates are rising,” but they’re still extremely low in the big scheme of things, thanks to the unending new money flowing from central banks. Even with rising rates, however, fracking operations, in order to remain viable, will need to keep borrowing since, as it turns out,  fracking is extremely expensive. Bloomberg explains:

The path toward U.S. energy independence, made possible by a boom in shale oil, will be much harder than it seems.

Just a few of the roadblocks: Independent producers will spend $1.50 drilling this year for every dollar they get back. Shale output drops faster than production from conventional methods. It will take 2,500 new wells a year just to sustain output of 1 million barrels a day in North Dakota’s Bakken shale, according to the Paris-based International Energy Agency. Iraq could do the same with 60.

Consider Sanchez Energy Corp. The Houston-based company plans to spend as much as $600 million this year, almost double its estimated 2013 revenue, on the Eagle Ford shale formation in south Texas, which along with North Dakota is one of the hotbeds of a drilling frenzy that’s pushed U.S. crude output to the highest in almost 26 years. Its Sante North 1H oil well pumped five times more water than crude, Sanchez Energy said in a Feb. 17 regulatory filing.Shares sank 7 percent.

The U.S. oil industry must sprint simply to stay in place. U.S. drillers are expected to spend more than $2.8 trillion by 2035 even though production will peak a decade earlier, the IEA said. The Middle East will spend less than a third of that for three times more crude.

So, if we read through the lines just a tiny bit, we can see that the fracking boom towns, like those that dot Noth Dakota, Wyoming, and Colorado, are resting on a shaky foundation of cheap money. If interest rates move into more normal territory, then the funds for fracking will dry up even before the wells do (which is pretty fast).

You can’t blame the fracking frenzy on just some parochial search for profit, though. Energy policy is always of great interest in DC. On the foreign policy front, of course, “energy independence” is always of importance because it allows the American state a free-er hand to meddle in oil-producing countries without wild fluctuations in domestic oil prices. The fact that it’s largely illegal to export American oil means that more domestic production means more control over domestic supplies without having to worry about OPEC turning off the spigot.

There are more mundane domestic concerns as well. Energy prices, including oil and gas for heating homes, and also gasoline, are a big part of the consumer price index. If domestic energy prices can be kept under control by turning up the volume on fracking operations, then it’s easier to push the idea that inflation is low by pointing to the CPI.

Bloomberg again: 

Energy prices have become disinflationary in the U.S. as America comes closer to attaining energy independence, which has been bolstered by the proliferation of hydraulic fracturing, or fracking, of the nation’s shale deposits.

While a Labor Department report last week showed that fuel helped lift consumer prices 0.3 percent in December, the most in six months, energy expenses for all of 2013 still decreased.

And on top of all of this is the fact that the states, which can collect huge tax revenues from fracking operations, love it, and it can create booms for local economies.

For example, last week’s state-by-state GDP map shows some interesting growth patterns:

gdpmapWe can see that the highest growth is, for the most part, concentrated in the interior West.

Some conservative web sites rather simplistically tried to make the case that this proves the triumph of Red State Republicanism.  While it is likely true that conditions for economic growth are in fact better in places like Texas and Nebraska than they are in New York and Pennsylvania, why are the red states of the east, such as Tennessee and Alabama showing such lackluster growth?

The answer: This map shows that GDP growth is especially strong in oil and gas producing states (Wyoming and Colorado), and in states with close ties to the industry, such as Texas.

Nowhere is this connection to recent economic growth more obvious than in North Dakota which registers a whopping change of 9.7 percent (year over year). The Bakken shale formation up there has created boom conditions for that economy.

Thus, we can see that the politicos will favor cheap and easy fracking as long as possible. If the party needs to kept going by more tax breaks, or subsidies, or more easy money, then the friends of the oil and gas companies in DC will make sure that the favors keep flowing. Of course, when inflation becomes undeniable, and as cheap money becomes not-so-cheap, the party will be over.


  1. Not to harp on the point, but it strikes me that THIS is where the fine minds at Mises should be focusing their attention, not wondering whether or not we’d be fracking as much if interest rates were higher:-



    Alarmist, Al Gore style exaggerations in the report aside, look at the interventionism, authoritariansim and scope for rent seeking, etc, contained in the supposed ‘solution’ to this non-problem.

  2. You need to be very careful relying on sources like Bloomberg for info on fracking. Ex Mayor Mike and his crew are Big Corporate. Eco- cronies par excellence and his New Energy Foundation is a constant source of prowind/ solar anti-hydrocarbon bias.

    Fracking may or may not have to take place in a world subject to the usual distortions of the state and its money printers, but is nevertheless a triumph of ingenuity and entrepreneurialism. Only the US has a legal structure where landowners own the subsurface minerals and have therefore been incentivized to allow drilling and don’t forget that the success could be even greater if Leviathan gave up its outrageous hold over ‘federal lands’ wherein the practice has scarcely yet been allowed.

    Every month almost that goes by, the many competing frackers seem to find better, more efficient ways to get more oil and gas out using less rigs in less time and with less impact to those around them and hence at a lower cost.

    As for infrastructure, they’d be happy to build some themselves if only Obama, the EPA, and the Sierra Club actually allowed them to do so.

    • The alleged environmental impact isn’t a focus of my research. The fact of the matter is that fracking is extremely expensive and requires huge amounts of debt for an unreliable return. Without constant quantitative easing, (that is, subsidy form the Fed) the industry will collapse.

    • The alleged environmental impact isn’t a focus of my research. The fact of the matter is that fracking is extremely expensive and requires huge amounts of debt for an unreliable return. Without constant quantitative easing, (that is, subsidy form the Fed) the industry will collapse.

      Unless,. of course, oil prices go through the roof, which they may do.

      • Well, good sir, you are looking for a bogeyman, might i suggest that your focus should start with why it is that oil prices are ‘going through the roof’ i.e. why they are have been stuck at higher ‘real’ or wage adjusted levels for longer than ever before. That elevation does,after all, have SOMETHING to do with why so many think they can make money drilling shale.

        I think THAT is where you might find a role for crass inflationism – and not just in the US; for the tendency of state intervention to punish energy- (among many other resource-) producers and to subsidize all too many consumers ( not least indirectly by providing doles and indulging in soft budget spending on its own account); and by its horrible, immoral and wholly counterproductive foreign policies.

        My point is that, if you rightly want to bemoan the role if the state in energy, as in any other business, there are many more valid avenues of attack than giving even more airplay to the hardly disinterested lobbies who hate shale with a passion because of its signal role in delaying their much vaunted (authoritarian state-driven) ‘decarbonization’ of the economy and in dispelling their Malthusian imaginings and their inveterate hatred of entrepreneurialism in all forms.

        Might I suggets you also look at who is collaborating so closely with that other Great Man, Henry Paulson, in his latest self- appointed ( and, one supposes, self- enriching) role as the burster of our ‘climate bubble’ here? Ex-mayor Mike and the thoroughly disagreeable Steyr.


  3. The trouble for the optimists becomes apparent when we look at the ND Bakken data and the 10-K filings. The first shows that over the past two years doubling the number of operating wells has failed to increase production rates as the average daily rate has fallen from 140 bpd to 126 bpd. Given the fact that shale wells produce at much higher rates in their first year in operation that should send up serious red flags. But if that is not enough all we need to do is to look at the 10-Ks. These show that the producers have serious funding gaps and that their small losses (or profits) are created by accounting choices that choose to ignore the true depreciation rates for each well. The geologists use a production model that does not reflect the actual production data and the depreciation schedules are set by model, not reality. As such these have about as much validity as most of the output produced by macro models or by the IPCC’s climate models. Given the incentive to keep the game going it is easy to see why Wall Street and the government are happy to play along. What gets me is why otherwise rational and skeptical individuals are so eager to close their eyes and believe.

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