Fracking, over the past decade has been an attractive investment for investors – particularly private equatiy firms. An international energy agency (IEA) report from 2018 states that “Global oil production capacity is forecast to grow to reach 107 million barrels per day by 2023 … this is [spearheaded by] the US, thanks to the shale revolution”. It is perhaps unsurprising that one of the leading areas of oil production also attracts large volumes of investment.
As well as its status as an emerging market area, the capital intensity of a fracking operation creates a large demand for the debt investors clamour for. According to Columbia University’s Center on Global Energy Policy, debt in the industry swelled from $50bn to $200bn between 2005 and 2015. However, with fracking now a more established technique, a more scrupulous examination of industry highlights some rather glaring shortcomings.
A sustainable fuel?
Fracking is primarily employed to produce natural gas, touted by many as an essential to facilitate transition to green energy. This is because natural gas produces less carbon than oil (let alone coal -which can produce 2x the amount of CO2 of natural per unit energy) when burned. Therefore a superficial glance makes fracking operations more sustainable and hence more attractive to the ethically minded investor.
However, this presents only half of the story. Natural gas is primarily formed from methane, which itself a greenhouse gas – in fact, it is more potent than CO2. This may not immediately appear relevant, however, in the US, where fracking is dominant, regulations are also very relaxed. This means many fracking installations are not sufficient to prevent leakage of the gas to the atmosphere. Only 2% gas leakage is sufficient to make the products of fracking in effect as polluting as coal, research suggests fracking has average leak rates of 4-5%. Investors should consider carefully the measures taken by their firm of choice to prevent these issues from occurring.
This does not even begin to account for localised environmental issues, most famously detailed in the documentary Gasland. With locals facing by increased frequency earthquakes,
A profitable investment?
While fracking has lead to the US becoming the world leading oil exporter, it is a more technically complex operation than conventional drilling. As a result of this operation is more expensive, making fracking less profitable than conventional oil production. Following Saudi Oil production hikes in 2014, over 150 fracking companies went bust, a similar pattern may be expected following Q2 2020 volatilities. Even in 2019, a relatively stable year, $26bn of fracking debt was written off. Bethany Mclean, business and economics editor of the NY Times said of the industry “It’s on much shakier ground than people realise”.
Mclean identifies three key factors which make fracking a higher risk industry than investors have so far considered. First, as fracking’s advent was around the time of 2007 crisis, the industry was able to take advantage of large interest rate cuts and other stimuli to raise vast sums of capital which may not have been so forthcoming in a more typical fiscal environment.
Second, as pension funds found themselves less able to turn profits from conventional, fixed-income investments, they turned to private equity companies, who, as previously mentioned, had a high propensity to invest in fracking – providing around 1/3 of all capital raised by the industry.
Investments in fracking may not have been made “in a rational economic enviroment”
Finally, as a new industry it has attracted large volumes of investors with faith in its high growth potential. This, Mclean argues makes the industry of particular concern given it has not yet show the propensity to turn the kinds of profits it has been valued to by the market in other words, the investments that have been made in fracking over the last 2 decades may not have happened in a “more rational economic environment”. Jyoti Tottham of the NY times adds that fracking is “built on cheap money, and we don’t know how long that is going to last”.
Even majors, who might be expected to have the knowhow to turn profits have struggled to retain shale value, Chevrons shale assets falling by 25% in value and Exxon’s by 50% over 5 years.
Bullish investors and analysts point to the apparent green credentials and improving technologies being developed in the industry, to suggest that growth may be expected to continue to remain strong. As long as capital continues to flow into the world of fracking, technology will improve, making extraction cheaper until it is eventually profitable. Further, as a major job creator the US government may be incentivised to continue to support the industry if more shutdowns begin to occur. These arguments, however are at best speculative, as compared to some rather concrete evidence that fracking is not currently profitable.
Mclean ventures so far as to compare fracking investment to Enron and the dotcom bubble of the early 2000s. In both cases, industries that were not currently making profit were projected to make major profits (fracking firms promise IRRs of up to and beyond 80%), and both were seen to be key growth areas in the economy. While the sustainable investor would be advised to carefully evaluate their investments in the industry, all investors should be conscious of the potential instability of fracking.