Note kindly translated by Anne-Marie de Grazia
The exploitation of shale oil (and gas) has opened up considerable possibilities as far as the size of available resources is concerned. It has permitted the United States to reach the goal of energetic independence for gaz (but still not for oil), albeit at an enormous cost to the environment, not yet entirely assessed. This translated on December 30th , 2014 into a liberalisation of the American legislation relating to the export of oil products. The boom in shale oils and gas explains a large share (probably more than 50%) of American growth since 2011, as the exploitation of these reserves gave a tremendous boost to industry. The environmental cost has lead numerous states to introduce ever more constraining legislation.
The exploitation of shale fuels has also had important geopolitical consequences. It is often said that it might give back to the United States the upper-hand against the OPEC countries but also against Russia. This question is therefore of particular importance as it stands at the cross-roads of ecology, economy, finances and geopolitics. The financial dimension of this exploitation is certainly the one remaining the most ignored. And yet, as is the case with ALL emerging industries, the industry of shale fossil fuels has resorted significantly to the finance industry and has also blown a sizeable speculative bubble around itself. This results from a very small initial capitalization (a normal situation in the case of an emerging industry) but also of a financialisation which at present is holding sway over the American economy. So that this bubble results from the shift from a “pseudo-validation” of the values so committed, to a “pre-validation” according to the pattern described by Cedric Durand in his Le Capital Fictif.
Drillings seem to be cost-effective, if one considers the latest of them to date, only above a price of $80 per barrel. Older drillings have had initially a lower threshold of cost-effectiveness (around $50-$60) but the exhausting of these drillings forces companies to use technologies which have now become more costly. It is advisable therefore to examine closely the economic logic of shale oil.
A sane basis and a speculative drift.
The exploitation of shale oil rests on the boring of a well, at first vertical then horizontal, followed by the injection of chemical compounds destined to fracture the rock and to squeeze out the oil with the help of hydrogen-poor compounds. Additionally, an external adduction of heat is needed. These compounds are generally mixed with water, and one of the first problems of this industry has been its water consumption and the pollution of nearby aquifers. The drilling’s yield decreases strongly during the first year already. One can consider that many drillings, taking into account exploitation costs, stop being cost-effective from the fourth year on. We must signal that the threshold of cost-effectiveness, which was initially foreseen at around $30 per barrel, is at present rather around $60/$70 per barrel, and this only as far as direct costs are considered.
What makes it nevertheless interesting is that the initial production is strong and that the investment costs are relatively low. A small company can therefore acquire a concession (with a drilling permit for 5 to 10 years) and put it rapidly in operation. With high oil prices, the initial return is considerable. It allows either to reimburse the loans initially requested, or to resell the concession to another company, who has less know-how than the first one. In the case of a sizeable drop of production at the end of the first year already, this is equivalent to a rip-off pure and simple. The first company makes a large profit and the second one must deal with rapidly collapsing yields. In fact, this gives to the shale oil industry a “Ponzi scheme” dimension, from the term used in finance to describe financial pyramids where the first depositors are paid with the money from the depositors following. Indeed, investments are made largely on credit, sometimes at amounts of up to 100%. The first company must be able to resell its concession very fast if it doesn’t want to be penalized by the interest rates. Whence the necessity to produce as fast possible sizeable quantities of oil, at the expense of future yields, in order to be able to sell a concession with an appearance of high profitability. This also explains the rapid rise in the volume of oil produced, which contributed to unbalancing the market.
The financialisation of the production of shale oil.
We have alluded to loans. In reality, it is the whole production cycle which is broadly financialised. First of all, the concession and the initial capital are covered by a loan, the company committing in fact very little capital. This is easily understandable when one considers the high initial risks in this activity. These loans are taken out with small local American banks. The latter rapidly securitise these loans, which pop up all over the American financial sector. The costs of interests come to add themselves to the drilling and operating costs. It appears then, even if systematic studies are missing, that this brings the threshold of cost-effectiveness to above $80 (some authors even venture amounts in the order of $100) per barrel.
The companies also take insurances (this is called technically hedging) for the case of a drop in rates. Here again, it is not known in what proportions. But these insurance contracts rarely have a lifetime superior to six months to one year. There don’t seem to be any having been concluded after September 2014, as it appears that with oil prices beginning to go down brutally after September 2014, the cost of these insurance covers has become exorbitant. Most of the companies which are insured will therefore be so only until the month of June 2015. These insurance contracts have also been securitised on the model of the CDS (Credit-Default Swaps) which played a major role in the subprimes crisis. The securitising of loans as well as of insurances has been a major factor in the development of American finances. But this securitising has also lead to a spreading of the risk as soon as the shale oil industry stops being profitable, which is the case today.
With the very sharp drop in the price of the barrel, it is clear that the industry is losing money. One can say the same about the tar sands of Canada (Alberta). As soon as insurances will stop covering the losses (in the case of those companies which took up insurance) the closing of a great number of companies will become inevitable. The drop in the sales of concessions and the rapid decrease in the number of new operations being started, are a very clear sign that the whole of the shale industry has already reached a crisis. This will confront American (and Canadian) authorities with a double problem:
- An industrial problem at first, because a large number of small companies exploiting these concessions will go bankrupt in the coming months. This will lead to a stop in production, and the volume of oil produced in the United States will drop spectacularly during the second semester of 2015. Moreover, the massive unemployment resulting will reverberate in the sector of services. The United States will therefore be faced with an “industrial crisis,” granted of a local dimension, but of a large amplitude beginning in the Summer of 2015.
- Then a financial problem, because these bankruptcies will transform into « bad loans » a very large share of the « securitised » loans held by American banks. This could be the equivalent of a new « subprimes crisis » in the summer or early fall of 2015.
The geopolitics of the crisis of the « non-conventional oil » industry.
The consequences of this will most probably not be merely economic (and financial) but also geopolitical. It is clear that the American government has leaned on the shale industry in the hope to reduce its dependence on oil imports. It is clear that it has, at the beginning, instrumentalised the decrease in oil prices in order to weaken the position of Russia, but also of Venezuela. Yet should the prices remain low beyond the Summer of 2015, the United States themselves will be hit very hard by the double crisis, industrial as well as financial. The bright shale oil “baby,” on which so many hopes were resting, will turn into a cumbersome, fouled-up baby.
It would therefore be logical for the price to rise again by March 2015. But one cannot steer the markets like combat airplanes. If it is clear that prices will go up in the second semester of this year, nobody can say if this will be enough to ward off the crisis, or at what level. In fact, the best strategy for Russia would be to delay this rise. If the movement of prices should lead to the double crisis indicated above, we would end up having:
- (1) A brutal drop in production which could push the prices up to $90, even $100 per barrel (whereas if they rise at the end of the 1st quarter 2015 already, the prices will stabilize around $75 per barrel).
- (2) A weakening of the American position as an effect of the industrial and financial crisis, which will be noticeable in autumn 2015.
- (3) This weakening of the United States will translate into a relative weakening of the dollar and a correlating rise in the Euro which – combined with the rise in oil prices – will put in jeopardy the tiny growth hoped for in Europe (and particularly in France).
The question therefore is to know if Russia and the OPEC countries can wait out the autumn of 2015. As far as Russia is concerned, this seems assured. But it is much less so in the case of the OPEC countries. Moreover, the big American companies themselves can have an interest in the crisis, which would allow them to buy up at a small price hundreds of concessions. The hopes raised by shale oil therefore run the risk of turning into a nightmare in the coming six months, in particular for the American authorities.
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