Book Review: Saudi America

book cover  

Before I read the book, I had already read a few articles about it, saw a youtube video, and listened to two podcasts. It was the last podcast, on NPR's new Stateimpact Pennsylvania Energy Explained, that triggered me to actually get the book ...

Well, its not a full length book ... Columbia Global Reports, the publisher, calls these "novella-length books" that "offer new ways to understand the world" and "that can be read in a few hours". I am not a fast reader, but putting in a few hours a day, I was through after five days.

As a scientist researching environmental effects of the fracking boom, McLean's book was of interest to me as a different perspective on the US shale boom. Aside from the peer-reviewed literature I had read Vikram Rao's insightful book Shale (Oil and) Gas - The Promise and the Peril, which focuses on environmental and technological aspects of the shale boom, as well as on policy and economics. But Rao (a materials science engineer) was overly optimistic, more in the 1st Edition, 2011, but still in the 2nd Edition, 2015. He summarily dismissed the notion that shale oil and gas production is a "Giant Ponzi Scheme", a notion that is at the center of McLean's "Saudi America".

While, as a journalist, the author neither endorses the notion of a Ponzi Scheme, nor uses that terminology in the book, a central theme of Saudi America (aside from "fascination" with Aubrey McClendon) is the fact that the fracking industry as a whole is, after 10+ years of operation in the US, still deeply financially indebted to Wall Street. That is because, despite repeated statements to the contrary, overall cash-flow in the industry is negative, aka no profits are produced for stakeholders, losses are. And that may not change any time soon.

Fracking is expensive, ... and does not pay off (yet)

Drilling deep wells with increasingly longer laterals, hydraulic fracturing of the laterals, and subsequent production of oil and gas is not cheap. It requires a substantial, and continuous influx of capital to pay for hardware, labor, infrastructure, and related services. Such costs are weighed against the revenue from selling the produced oil and gas on the global market. As many costs are reasonably fixed, oil prices largely dictate whether a well makes a profit or not. Thus, there are several estimates of the level of raw oil prices at which companies "break even" (when costs of production per barrel of oil are equal to the market price of said barrel); and such numbers typically float around $50 a barrel. McLean usefully explains that this is a simplistic point of view ...

Neither is the break-even price fixed, as production costs vary by well, region, service costs, land and water costs, etc., nor do consumers usually get to see all the math behind these company calculations. As McLean highlights, and a recent WSJ investigation confirmed, many companies have not revealed all the costs they incur, and some have inflated their production projections in an effort to woo investors to keep financing continued exploration and new production. They do this, e.g. by showing only the highest well production curves, or the wells with the most modest annual decline curves, to investors, journalists, and the public. In turn, while investors are mostly interested in returns, and, in aggregate, continue to supply the industry with loans to keep production at high levels, the fees they earn from continued loans to the industry provide for recurring inflows of cash to Wall Street.

Because the capital business model requires making a profit, and profits are ultimately tied to production, the industry is basically forced into a "drilling treadmill", constantly aiming to replace rapid annual decline in production with newly drilled wells, financed by outside capital instead of investment of own capital from profits. As McLean reluctantly admits, that is akin to a (involuntary) Ponzi Scheme.

McLean does not conclude on this arguably very important aspect of the shale boom, and this bothered me until the last chapter of the mini-book ... in her Epilogue she highlights and appears to embrace the thoughts of Charlie Munger ("the [...] Warren buffet sidekick"), who, among others, argues that hydrocarbon resources are too important to be burned and rather ought to be used "as slowly as possible" for much more important purposes such as fertilizer and advanced materials production. This was, interestingly, also V. Rao's main argument of why the shale boom would ultimately be profitable: namely because of products such as natural gas liquids (NGL), including ethane, that serve as vital raw materials for the chemical industry, and sell at much higher prices on the world market.

Other considerations

While much of the book focuses on historical events that brought us the shale boom, using former Chesapeake Energy CEO Aubrey McClendon as recurring anchor, McLlean also explores the geopolitical dimensions of the US as an increasingly important gas and oil exporter. Not surprisingly, the overturning of the 1970s export ban in 2015, and OPEC's decision not to drop production levels amidst a glut in oil supply, driving down oil prices and causing the 2015/16 shale bust, make for interesting reading in the 2nd part of the mini-book. Since this history is still unfolding, with some twists such as the Kashoggi assassination occurring after the book's publication, McLean (rightfully) does not even try to make any predictions as to future developments. However, she poses a very important question in her 2nd-to-last chapter: Should we really pursue a continued, and arguably bolstered fossil fuel energy strategy, for geopolitical or other reasons, when the transition to renewable energy production is both necessary and inevitable?

My take-home message

While, as a scientist, some of McLean's writing appeared "imprecise" and at times repetitive to me, I appreciated the historical and economical viewpoints of the mini-book. It arguably achieved its offering of "new ways to understand the world". While we, often incessantly, argue the environmental impacts of the shale boom, what may ultimately cause the shale bubble to collapse is not its environmental footprint. Who could care less about that in the times of Trump ...? No. What Saudi America highlights is that what enabled the shale boom in the first place, namely the 2008 financial collapse and the subsequent ultra-low interest rate period, could also ring in its demise as we enter a new period of increasing interest rates, and increasingly skeptical investors demanding accountability on top of profits.

I recommend you get the book, get a new perspective, and start arguing the financial aspects of the shale boom to your decision makers ... they care much more about money than the environment, and they need to know that billions of $$ sink into shale every year, creating few winners and many losers. Make them think about how much more "winning" could be achieved for all by investing in renewable energy instead.

(Note: Author name mispellings fixed on 17 Jan 2019)


Posted by gws on Wednesday, 16 January, 2019

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