Home Banking Fracking – A Bubble Waiting to Burst?

Fracking – A Bubble Waiting to Burst?

by internationalbanker

By John Manning – john.manning@internationalbanker.com

Hydraulic fracturing, or fracking, has been making the headlines consistently in the past few years and it has left much of the layman public with the impression that it is something new or modern, but shale oil and gas extraction has a very long history which dates back to the 19th century. In the 1860s the injection of liquid in hard rock formations was used to stimulate oil wells. In the 1930s, the first attempts were made to stimulate the release of oil and gas from the rock with a non-explosive liquid, most commonly acid which etched the sides of the well to release the oil and gas. Almost 20 years later, Stanolind Oil used a two-step process which involved first a new etching liquid, gasoline thickened with napalm, to increase the output from existing oil and gas wells. The gasoline was followed by the injection of a gel breaker into the limestone formation where the well was to release more gas. Though the output increase was not substantial, it was the start of a whole new industry. 

In the following decades fracking mostly focused on natural gas extraction, initially in loose formations where the release of the gas was easier, since at the time gas companies did not have the technological capacity or equipment to use the degrees of pressure used in fracking today. For a while in 1974, when the Safe Drinking Water Act was passed, shale oil and gas producers had to comply with requirements set by the Environmental Protection Agency. These regulations restricted the materials allowed in the fracturing process and also imposed a permit-based regime for any injection of fluids into the rocks. But before the end of the year the EPA ruled that the fracking industry should be exempt from these requirements as its primary aim was not the injection of liquids but the recovery of natural gas. These were sensitive times, too soon after the oil crisis in the early 70s, so the US was trying to create some form of energy independence. It was already one of the, if not the largest single consumer of fossil fuels. 

By 1999 technology had advanced far enough to make possible the application of high enough pressures to allow oil and gas producers to tap previously inaccessible deposits. In 2005 the real boom began, following President George W. Bush’s approval of the exemption of the industry not just from the Safe Drinking Water Act but also from the Clean Air and the Clean Water Act, which totally untied the hands of oil and gas producers. In a 2004 report, the EPA said some of the liquids used to fracture shale rock were toxic but concluded that the threat they posed was insignificant for drinking water. After a failed attempt in the House of Representatives to pass a bill repealing the industry’s exemption from relevant legislation — the Fracking Responsibility and Awareness of Chemicals Act – the coast was clear for companies whose eyes were set on the shale oil and gas deposits in the country. 

The process of hydraulic fracturing involves first drilling a well, sometimes vertically but more commonly horizontally  and then injecting a mixture of liquids – water, sand and chemicals – at very high pressure. The mixture opens up the shale rock and allows for oil and gas to escape. The USA is by far the biggest producer of shale oil and gas today with six main shale oil and gas plays across the country. These include Eagle Ford in Texas; Bakken, in Montana and North Dakota; the Marcellus shale in the Appalachian basin in the East; Haynesville, which spans across Louisiana, Arkansas and Texas; Niobrara, which runs through Nebraska, Wyoming and Colorado; and the Permian basin, which spreads across west Texas and southeastern New Mexico. 

According to the Energy Information Administration these six plays have accounted for almost 90% of the growth in oil production and 100% of the growth in gas production in the country during the last few years. Bakken and Eagle Ford are the leaders in oil, with Bakken yielding some 500 barrels per well per day as of April this year from new wells, and Eagle Ford accounting for a bit below that. In gas, Marcellus and Haynesville are the leaders. The Marcellus shale yielded around 6.5 billion cu ft per day in April, and Haynesville accounted for a bit over 5 billion cu ft. According to EIA projections, by 2040 shale gas will reach 100 billion cu ft per day and account for half of all domestic natural gas production. Oil output from shale plays was around 3.25 million barrels per day last year. Total oil production is projected to reach around 9.6 million barrels per day by 2020, of which shale oil should account for around 50%. The estimated reserves of shale crude oil in the US were put at 48 billion barrels and its shale gas reserves were seen at 1,115 trillion cu ft, according to Advanced Resources International, which compiled a report on the global shale oil and gas reserves last year. 

There is no doubt that the shale oil and gas boom has given the US the energy independence it sought in the 70’s. The country is no longer strategically dependent on crude imports and has increased its own oil product exports. The boom has pushed down domestic gas prices and estimates show it has secured supplies for both the US and Canada for a whole century. At the same time, fracking has made it possible for power producers to generate electricity at around half the amount of CO2 emissions that coal-powered plants produce. EIA projects that in 2020 CO2 emissions related to the energy industry will be 9% below the levels from 2005, and in 2040 they will be 7% lower than the 2005 figure. In this sense hydraulic fracturing is a green energy option. However, there are a few rather controversial issues related to this industry. Speaking economically, shale oil and gas extraction is a cost-intensive industry. It needs expensive equipment and technology. It also requires a lot of drilling – much more than conventional oil and gas recovery. Another, quite fresh, problem is that estimates about the actual recoverable shale oil and gas reserves in the US are being revised and this revision has seen the estimates drop. Then come the environmental concerns which are not to be underestimated and that are starting to impact the industry, 70 years after the passing of the Safe Drinking Water Act. 

Between 2006 and 2010, an average 43,240 new wells were drilled annually, according to data cited in a Case Western Reserve Law Review article on the economics of fracking. The average cost per well was calculated at $2.38 million, of which around a quarter is directly related to the fracking process itself. However, it should be noted that not all of these wells were drilled in shale basins, which implies that the actual costs for shale oil and gas wells are higher. This is supported by calculations specifically made for wells in shale basins: in Bakken, a well cost between $8 million and $10 million over the four-year period. Of this, some $1.5 million to $2.5 million was the direct cost of fracking. Since then inflation has increased these figures. Another factor that is pushing up costs associated with shale oil and gas recovery is the continual need for rigs that can drill deeper wells. It is worth remembering that hydrocarbons are finite reserves and after exhausting the shallower parts of deposits, producers need to go deeper and must come up with new techniques to extract these reserves. Deeper deposits need stronger stimulation, i.e. heavier fracturing. These factors have had an upward pressure on industry costs; the change in the average price per well in the Woodford shale area in Oklahoma has increased from $2 million to $5 million-$6 million. These figures should be seen in the context of an industry that very quickly depletes the deposits where it drills. The maximum-production life of a shale well is just a few months, after which output declines sharply, necessitating the drilling of more wells to keep a relatively stable level of production. 

These economic aspects of shale oil and gas extraction to a large extent explain why fracking is very likely to remain a uniquely American phenomenon, almost impossible to replicate elsewhere in the world, although attempts have been made with varying degrees of success. According to Leonardo Maugeri, former senior executive vice president of strategy and development at Italian oil giant Eni, drilling intensity is among the main factors that make fracking difficult to replicate. He points out that 60% of all drilling rings in the world are located in the US. 95% of those can drill horizontally, which is the preferred method for shale oil and gas wells. This represents a unique capacity for hydraulic fracturing but coupled with the fact that a large portion of the biggest shale oil and gas plays in the country are in areas with a relatively low population density, it is what makes the necessary drilling intensity possible and relatively sustainable. 

Compare the total number of wells drilled in the US to the total number drilled in the rest of the world: in 2012, 45,468 wells were drilled in the US, of which 28,354 started producing in the same year. Canada brought 3,450 wells online in the same year. In the rest of the world, just 3,921 wells were brought online. The difference is impressive and it becomes even more impressive when one considers the fact that this intensity has to be maintained to compensate for the fast drop in output from shale oil and gas wells. The peak of production is in the first month after a well goes online. By the end of the first year of operation, output declines by 40% to 50%. By the end of the second year, the rate had declined another 30% to 40%, and in the third year by another 20-30%. Shale oil and gas wells do not have very long lives, especially when compared with conventional deposits, which can be exploited for decades. 

Another reason why the US fracking boom is unlikely to be repeated elsewhere is that while in North America the industry developed gradually and with the major support of regulators and politicians, in Europe, it is a newer thing and it is gaining negative publicity alongside reports and research about the adverse effects of the technology. Environmentalists have been very active in making all the risks associated with fracking known to the public and there have been protests against companies planning to drill for shale oil and gas from Latin America to the Balkans. According to Leonardo Maugeri, the biggest hurdle for fracking which will prevent it from spreading across Europe and the rest of the world is the fact that the drilling intensity cannot be sustained in highly populated areas. But for many other critics, things like the huge water consumption that this industry requires, the danger of contaminating underground water with toxic substances and the increased risk of earthquakes are no less important. 

A report by sustainable leadership advocacy group Ceres found that the hydraulic fracturing of the approximately 40,000 wells drilled in the US since 2011 took 97 billion gallons of water. The figure is all the more striking given that around 75% of all fractured wells in the US are located in areas where water supplies are scarce and 55% are in areas characterized by drought. These areas are expanding across North America and water stress will become a more serious issue in the near future. Since there is no way for the fracking industry to reduce its water consumption in any significant way, environmental experts believe new, tougher water use regulations should be put in place in order to avoid a clash between the oil and gas industry and the other stakeholders, led by the farming industry and the general population. Although some shale oil and gas producers have started recycling part of the water they use for fracking, the amount is too insignificant at this stage. When this trend of increasing water stress is juxtaposed with the drilling intensity of the fracking industry, the problems looming over it become more pronounced. 

The quantity of water used in fracking is not the only problem. The storage of the water after  it has been used is also an issue. Complaints are piling up about inadmissible, potentially hazardous levels of methane in underground water wells used by households. The Associated Press released in January a review of evidence regarding water contamination in four states – Pennsylvania, Texas, West Virginia and Ohio – where the shale oil and gas industry is active. In Pennsylvania, at least 106 cases of water well contamination have been confirmed since 2005. In Ohio the number was limited, just six confirmed cases of contamination, and none of these were traced back to fracking. In West Virginia there have been 122 complaints regarding water contamination between 2010 and 2013, but only in four cases there was there evidence trading it back to oil drilling operations. Texas is the leader in the number of complaints, with more than 2,000 in the four-year period, but none of these have been confirmed by state authorities. 

Industry experts like Maugeri maintain that the perceived risks of fracking associated with water contamination are greater than the actual ones. However, there is insufficient transparency on the operations of oil and gas producers and this significantly contributes to the concerns among the population. Then there is another environmental risk that has stirred a lot of opposition to fracking: earthquakes. At the end of May the Environmental Protection Agency revoked a permit it had granted Windfall Oil & Gas for a 7,300-foot deep injection well for the storage of wastewater from fracking operations. The EPA based its decision on ample public comments highlighting the potential danger of earthquakes resulting from the filling of the well. Two months earlier, the Ohio Department of Natural Resources suspended drilling operations at a site in Mahoning County after an earthquake shook the area on March 10 on suspicion that the quake may have been caused by horizontal drilling there. There have been more than 100 quakes annually since 2010 with a magnitude of 3 or more on the Richter scale. The annual average for the thirty years from 1980 to 2010 was 21. The primary culprit is wastewater wells – they are drilled deep and with a capacity to hold the millions of gallons used in fracking. According to seismologists this could have increased the pressure on already existing tectonic faults and led to the increased number of earthquakes. They have already found a causal link between wastewater wells and two quakes with a magnitude of over 5 that occurred in 2011. 

The latest blow to the industry, however, has had nothing to do with perceived and actual risks. It has to do with a downward revision of the estimated shale oil and gas reserves in the country. A new report from the Energy Information Administration has revealed that the Monterey shale basin in California, which was previously thought to hold 15.4 billion recoverable barrels of crude, making it the most promising untapped deposit, actually holds just 4% of this amount, or 600 million barrels. Exploitation of the Monterey shale was to create 2.6 million new jobs and add $24.6 billion in tax revenues by 2020. This is a heavy blow, and when it is added to the other pressures on the industry, it resonates all the more deeply as it raises questions about the deposits that have already been exploited, the reserves of which are being reported by the oil industry itself. The future of energy will be all about sustainability and within the fracking industry sustainability is in rather short supply.


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