Tuesday, October 23, 2012

Investors Discover That Fracking Costs Exceed (In The Not-So-Obvious Way) Expected Financial Benefits: What The New York Times Fails To Say

The New York Times Sunday Business section this week ran an article about the trouncing that investors in hydraulic fracturing companies are suffering.  A subhead to the print version of the article calls it a “gut punch to investors.”  It’s happening because the cost of fracking is exceeding the value of what’s being produced.

Fracking Cost Exceeds Benefit

Economists and environmentalists might say: That’s news? . .   We always knew that fracking was so destructive to the public's assets and environment that it wasn’t worth the cost.  But the news the Times story is delivering is different: Fracking investors are losing their shirt because the fracking boom is so much of a boom that it's going bust.  As the Times puts it the gas rush has:
    . . .been a money loser so far for many of the gas exploration companies and their tens of thousands of investors.
    The drillers punched so many holes and extracted so much gas through hydraulic fracturing that they have driven the price of natural gas to near-record lows. And because of the intricate financial deals and leasing arrangements that many of them struck during the boom, they were unable to pull their foot off the accelerator fast enough to avoid a crash in the price of natural gas, which is down more than 60 percent since the summer of 2008.
(See: After the Boom in Natural Gas, by Clifford Krauss and Eric Lipton, October 20, 2012.)

The most interesting thing about the Times article is likely what was left out, the multiple implications it didn’t address.  We’ll get to all that in moment.  First, what the Times did cover.

Fracking Companies Headed Toward Bankruptcies

Although the Times doesn’t use the term it looks like “bankruptcies” are, no doubt, in the future for some of the companies.  That, at least, is what I would glean from information supplied like the following:
    •    Rex W. Tillerson, the chief executive of Exxon Mobil, is quoted in the article saying:  “We are all losing our shirts today,” Mr. Tillerson said. “We’re making no money. It’s all in the red.”

    •    Now the gas companies are committed to spending far more to produce gas than they can earn selling it.

    •    We learn of situations where an  “agreement, negotiated by Goldman Sachs, came with some important strings attached: Exco [Resources] had to keep all 22 rigs drilling for gas, even as the price was dropping.” so that drilling wells continues “even if [Exco] now insisted that it made no economic sense.”

    •    Aubrey K. McClendon, a chief executive of Chesapeake Energy, one of the industry's really big companies is quoted as saying, “At least half and probably two-thirds or three-quarters of our gas drilling is what I would call involuntary.”

Picking on T. Boone Pickens

In this vein, the Times story tells a supporting anecdote about that Exco Resources contract that features Texas oilman, T. Boone Pickens.  I’ve previously quarreled with Mr. Pickens for misrepresenting that lots of fracking has been done before and that what is suddenly massively underway in this country isn’t a brand new technology, the likes of which we haven’t seen before.  In the Times anecdote Mr. Pickens learns that things are shaping up different enough so that he is encountering surprises himself:
    “Quit drilling,” T. Boone Pickens, the Texas oilman, barked to his fellow board members at Exco Resources, . . . .  “Shut her down.”

    * * * *

    There was only one problem: under the contracts that Exco signed, it couldn’t stop drilling.

    * * * *

    Mr. Pickens was furious. “We are stupid to drill these wells,” he said in a recent interview.
In unfolding the anecdote the Times works in that in the late 1980s Mr. Pickens lost his company, Mesa Inc., “when drooping gas prices hurt its ability to repay debts and pay dividends.”

Wall Street Bankers Behaving Badly Again

The article portrays the hammered investors as being the victims of perhaps unscrupulous investment bankers likening the investors’ situation with the “recent credit bubble,” saying:
the boom and bust in gas were driven in large part by tens of billions of dollars in creative financing engineered by investment banks like Goldman Sachs, Barclays* and Jefferies & Company.
(* Barclays is the British bank for which two Brooklyn subway hubs were recently renamed by the city MTA, together with a sports arena that was deeply subsidized by New Yorkers with some help from federal taxpayers as well.)

According to the Times:
After the financial crisis, the natural gas rush was one of the few major profit centers for Wall Street deal makers, who found willing takers among energy companies and foreign financial investors.
Remember how in the aftermath of the financial crisis Goldman Sachs was excoriated for and then avoided prosecution by paying a record $550 million fine to the SEC (many argued it was too low) for playing both sides of the housing mortgage market, promoting housing bonds while at the same time betting that money could be better made from the coming downturn in that market?  The Times has a gas drilling industry-based version of this investment banker story, once again involving Goldman Sachs selling, in conjunction with Jefferies & Company, a debt position in one of these fracking companies while the bankers are at the same time betting on a market decline.

Goldman gets passing mention while the Times focuses in on a Jefferies & Company banker, Ralph Eads III, whom it describes as “a pitch artist” of “unrestrained enthusiasm” and probably a bit of a manipulator as well.  (The Times recounts that Eads was involved with what regulators charged was the creation of “an artificial gas shortage in California” in 2000; Eads’ counter-characterization was that the company he worked for had just come up with “creative financial transactions.”)

Selling a Toxic Product In Which You Don’t Believe

Focusing in on Eads to build its story to a very big extent the Times says that Eads participated in structuring a deal that personally benefitted Eads and his colleagues “far more than the people writing the big checks.”  Giving examples of Eads' hard sell to investors the Times reports he acknowledges their “bluster” but invokes “caveat emptor” (buyer beware) in saying that his investors should be exercising good judgment in deciding whether to invest notwithstanding that a managing director at Oppenheimer & Company describes Mr. Eads as being like a “bartender serving drinks for people who can’t handle it.”

More important, Eads was simultaneously playing the other side:
    Just as in the earlier real estate bubble, the main players publicly predicted success even as, privately, their doubts were growing, court documents show.

    * * * *

    Mr. Eads appears to have fared better. He had seen the coming crash, and, as any master salesman would, found a way to play both sides. He continued to persuade new investors of the great potential in shale while telling his longtime clients to cash out.

    * * * *

    Mr. Eads then helped arrange what will go down as one of the great early paydays of the shale revolution: the 2010 sale of East Resources, which Mr. Pegula had started with $7,500 borrowed from family and friends, to Royal Dutch Shell for $4.7 billion.

But Eads and Jefferies & Company, together with Goldman, were directing investor debt into the troubled Chesapeake Energy.

Bad News Implications Entirely Sidestepped By The Times

The Times article has a lot more information about the apparent targeted swindling of gas industry investors and it is all worth a careful read.  Here are pertinent observations missing from the Times article, not even hinted at in its content:
    1.)  While things are now this bad in terms of the cost equation for the investors, the fracking investment these investors made (and the industry as a whole) were never initially required to internalize all the negative costs to society of hydraulic fracturing.

    2.)  Bankruptcies of these companies are going to make it a problem when society then looks to defunct companies to:
        a.) clean up after themselves,
        b.) maintain wells and equipment in ways that prevents worse damage, and
        c.) pay damages to compensate those suffering from injury (that includes those companies who have been paying to truck in fresh water for people who can no longer drink from their wells.)
    3.)  The companies may still in the future be required to internalize some societal costs they haven't yet been required to internalize.  That would make their situation for investors far worse.

    4.)  Companies that have leveraged themselves by borrowing against assets they theoretically have in the ground will be vulnerable to a bursting bubble on this basis.  (A bigger bust is coming when the industry realizes that eventually it will be barred from extracting most of what the industry currently counts as in-the-ground fossil fuel assets.  The Times article ends with Mr. Eads making statements exactly contrary to this reality: “These shale assets are forever . . .They are going to produce for a hundred years.”)

    5.)  Meanwhile the costs of competing technologies are dropping although the gas glut has interfered with their development to an extent.
Collateral Damage In Other Industries?

If companies in competing industries, for example the solar power industry, were facing that same kind of shakeout while facing an unexpected glut of product, some solar companies going bankrupt and the more efficient ones rising to the top, there wouldn't be so much collateral damage accompanying that shakeout.. .

 . . . Hey, wait a minute: The solar industry is experiencing these kinds of problems at the moment!  My wife has a cousin who works with an electrical company that has been developing solar technology.  Right now they have shelved those research and development efforts.  The reason: The tremendous drop in cost of gas.  Similarly the coal industry, not an industry of the future since it is also fossil fuel, is going through shut-downs.

Those working hard to get out information about the hazards and destruction that fracking entails are, no doubt, going to consider, with some eagerness, promulgating the New York Times Business section story for its cautionary value in discouraging potential investment in fracking.  A reason they might have some reluctance to do that is because the story commences with a long industry-friendly reiteration of the industry narrative that the “gas rush has benefited most Americans.”  That is not true: You can’t claim benefit from fracking when you consider its long-term costs and detriment.  (The last National Notice article summarizing the detriments to take into account was:  Monday, October 15, 2012, Do They Really Think People Just Don’t Know What `Fungibility’ Is?: A Good Question To Ask As The Fracking Industry Tries To Pull Another Fast One.)

Accelerating Crash-Destined Vehicles: A Repeating Story

The Times metaphor about the industry being “unable to pull their foot off the accelerator” to avoid “a crash” (it also alternatively refers to “a train without brakes”) happens to dovetail with what I have said of the industry, that it is engaged in:
a premeditated “hit and run” strategy, looking to do as much as they quickly can while knowing the damage it will inflict, trying to do it before people realize how dangerous and destructive the new technology is, how devastating to the environment and before the lower and lowering cost of alternatives like solar are recognized to have overtaken and relegated the fracking industry to a curious antiquity.
The Times story is evidence that, maybe not so surprisingly, the industry’s bankers enriched themselves with this same quick hit strategy to take advantage of investors.

A Feint and Faint Find of Collateral Damage

Aside from the damage suffered by the investors as a result of such unethical treatment, does the Times acknowledge collateral damage anywhere else?  There are only these two paragraphs at the end of the article and they are insufficient:
    The bust has certainly hit the Haynesville (sic) [A town in Louisiana where Chesapeake Energy was drilling] hard. Some local landowners, having spent their initial lease bonuses, are now deeply in debt. Local restaurants and other businesses are suffering steep losses now that so many drillers have left town.

    “At this point we’re struggling,” said Shelby Spurlock, co-owner of Cafe 171 in the town of Mansfield. The restaurant is decorated with wall collages of drill worker uniforms from companies that are leaving the area. Once open from 4 a.m. to 10 p.m. and employing four servers, the restaurant has cut its hours and is down to two servers. “Our very existence is in danger,” she sighed.
Actually, with fracking and global weather change from irresponsible fossil fuel exploitation it's the entire country and the entire world whose very existence is threatened.

No comments:

Post a Comment