The 'fracking revolution' has transformed the economics of oil production globally, with the US becoming a bigger producer than Saudi Arabia and – after decades of dependency on oil imports – even being able to export some of its surplus production.
US shale oil is unusual, too, in being privately owned: most of the world’s oil reserves (over 70 percent) are in state hands. Like the North Sea 30 years ago, in a world dominated by state-owned companies and publicly owned reserves, US shale could look like a new frontier for private operators on the search for fat profits.
New technology, high oil prices, and plentiful cheap credit have encouraged the boom. Some $200bn has been borrowed to invest in fracking in the last few years, accounting for 15 percent of the entire $1.3tr US junk bond market. Investors were, in effect, betting on continuing high oil prices making their investments profitable for years to come.
Last year’s slump in prices trashed that calculation. From a mid-year high of $115 per barrel, by the end of 2014 the price per barrel had fallen by more than 40 percent. More than half of US shale rigs have been laid up since October.
The driver, last year, was the behaviour of OPEC – the Organization of Petroleum Exporting Countries. OPEC is a cartel agreement among major oil producers that seeks to manage the international market for oil. With oil prices already plunging over the summer, OPEC could be expected to ease off on production. Restricting supplies should, thanks to the magic of the market, produce a decent increase in the sale price of oil. Instead, with Saudi Arabia taking the lead, OPEC decided to continue production levels. No agreement on restricting output could be reached. Prices slumped.
The economics of oil production are simple – crude, even. The upfront investment needed to sink a new well is significant. After that point, however, the variable costs – including pay – are a minimal part of the expenditure. That’s the case even when, as in Norway, oil workers’ average annual wages are $179,000.
These high initial costs, relative to lower running costs, mean that once a well is drilled the owner has a huge incentive to keep on drilling – even at very low prices. If they can cover their immediate costs, which are low relative to the initial outlay, they can make a profit in the short run.
But that creates a ratchet effect: once a well is drilled, only a spectacular fall in the price of oil will stop oil from being pumped. The more oil is pumped, however, the lower the price is likely to fall. Each producer, in this scenario, is trapped into producing more and more, driving down the price further and further. This effect has meant the slowdown in US shale output has been far slower than might have been expected, given the dramatic decline in price.
Photo by Adam Cohn via Flickr
It’s only with a cartel, like OPEC, that this ratchet can be broken. Because it is formed by states, rather than private producers, OPEC can afford to run against the logic of the market. In the case of Saudi Arabia, with cash reserves of around $800bn, it can afford to run against the market logic for a very long time. OPEC seeks to maximise revenues for its members. Generally, that means all members agreeing to restrict supplies, and then holding to their agreement. Instead, confronted with falling oil prices, OPEC has worked to increase its supplies, apparently working directly against its own interests.
Disentangling motivations from the conflicting claims is unclear. But the net effect of this drive to expand was to plunge major non-OPEC producers into serious crises. Late last year, attention was focused on Russia. The Russian Government is dependent on oil and gas revenues for about half its income, a dependency it shares with other large oil and gas exporters. This means that any decline in oil and gas prices immediately squeezes government revenues, alongside its wider economic impact.
However, the Russian Government also has deep pockets, having built up reserves estimated at around $400bn during the boom years of the 2000s. The plummeting oil price was expensive, but not disastrous if prices stabilised – as, eventually, they did, in early 2015.
The major victim of the price plunge was not Russia, but the US fracking industry. The critical number in all this is the 'break-even' price of oil. This is the oil price at which any given well starts to turn a profit. For US fracking, that’s $70-77 a barrel. At current oil prices, US frackers are staring at heavy losses. Conventional oil is far cheaper, with the break-even price in the Middle East running at $10-17 a barrel.
But since many oil-producing countries are financing themselves on the back of oil sales, imposing taxes to fund state expenditures, the true break-even price (including the cost of paying for the government) for most major producers is far higher. For Saudi Arabia, the 'fiscal' break-even price (including payments needed to keep the government afloat) is around $92 per barrel. For other OPEC producers, it can be far higher - $116 per barrel in Iraq, for instance.
So low prices impose a significant loss on these states. But since they are states, rather than heavily indebted private producers, they should (in theory) be able to bear the losses. Even with reserves on the scale of Saudi Arabia’s, it is a high-risk strategy: something like a game of chicken, with OPEC relying on US shale’s shaky financing to lead to its collapse. It may be working: major US shale operators, drowning in debt, are suspending dividend payments to shareholders in a bid to conserve their cash.
The strategy seems clear. By using its market power to squash oil prices now, OPEC producers can hope to deter future investors from US shale – and indeed other high-cost alternative sources, like Arctic drilling. In doing so, they can continue to claim a major share of the market, and maintain their own dominant position.
That, at least, was the situation at the end of last year and into this year. And with US shale reeling, output dropping over the year, OPEC has hinted at future tightening of production, leading to a rising oil price once more.
But events in China point to difficulties ahead. 'Black Monday' saw China’s stock market boom come crashing to a halt, with share prices falling through the floor despite heavy-handed government intervention – including a pledge of $485bn to buy shares. China’s markets may now look calmer, but the bursting bubble has made clear that the country’s extraordinary, decades-long transformation into an economic superpower is now winding down.
China’s seemingly insatiable demand for raw materials, including oil, is easing off. And as it eases off, the oil price has started to look shaky once more. OPEC’s costly gamble may now be falling foul of a slowing global economy.
ABOUT THE AUTHOR
James is Chief Economist at the New Economics Foundation (NEF), where his work focuses on macroeconomic policy areas, developing responses to austerity. Before joining NEF, James worked as a policy advisor at HM Treasury, covering regional economic development, and science and innovation policy, and as senior policy advisor at the Royal Society.
James has a first class degree from the London School of Economics in economics and economic history, and a masters with distinction in economics from Birkbeck College, University of London. James completed his PhD at the School of Oriental and African Studies (SOAS), looking at the modelling of financial flows. He has written widely on economic policy and was a co-author, with Costas Lapavitsas and others, of Crisis in the Eurozone (London 2012).
The Paris Climate Conference:
Playing Craps With Our Planet's Future
This article was originally published in
Common Dreams, 1 September 2015
under a Creative Commons License
The climate change talks to be held in Paris this December (COP 21 in UN lingo) are all about how much risk to the livability of our planet we’re willing to accept.
And the dirty little secret is, we’re accepting a hell of a lot right now, and we’re imposing even more on our children and future generations.
- The agreed upon target, 2 degrees C, is dangerously high and the pre-agreements going into Paris assure we won’t even meet that;
- The best case assumptions built into the IPCC’s carbon budgets designed to stay below 2C assume a 34% probability of failure;
- Most of the IPCC carbon budgets require our progeny to invent and build a massively expensive technology to clean up the carbon we’re releasing. The effort would dominate the economic activity of their entire society, choking off other economic activity; and
- Even if we manage to hold temperatures to 2 C, the carbon budgets will assure that we’ll acidify our oceans and usher in irreversible sea-level rise.
Let’s look at the facts.
2 degrees C is too high, and COP 21 isn’t on target to meet it in any case: The press accounts are referring to the 2 C limit as the “maximum safe level.” Scientists are more careful, referring to it as a “speed limit” or “guardrail,” and even this phrasing implies a level of protection that the 2C limit simply doesn’t afford.
Doubt that? So far, human actions have increased the temperature by .85 degrees C over pre-industrial levels, and look what that’s done. We’re experiencing record-setting droughts; widespread desertification, an explosion in the number and frequency of forest fires; increases in extreme weather events; mass extinctions; irreversible melting of the polar ice caps, Greenland and large parts of Antarctica, and the centuries of rising seas and costal inundation this will inevitably cause; and we’re seeing the bow wave of a massive migration of environmental refugees. Finally, we’re acidifying the oceans, turning them into giant jellyfish incubators in which edible seafood can’t survive.
If that’s what .85 C has done, imagine what 2C would do. Or, better yet, don’t imagine, look to the geologic record. As James Hansen and 16 co-authors note in their paper, "Ice melt, sea level rise and superstorms: evidence from paleoclimate data, climate modeling and modern observations that 2C global warming is highly dangerous."
Worse, the agreements countries have announced in preparation for the Conference (called “intended nationally determined contributions” or INDCs) clearly show that the Paris COP will fall far short of what’s needed to prevent us from exceeding even a 2 C temperature increase.
The IPCC’s Carbon Budgets --Playing Craps with the Planet: Settling on 2C as an acceptable limit is bad enough, but the way we are using carbon budgets borders on criminal negligence.
Carbon budgets are established to determine the amount of GHG we can emit, and for how long. The greater the probability of staying below 2C, the lower the carbon budget and the sooner we have to get off it. Similarly, if we wanted to limit warming to 1.5 C – something most scientists agree poses less danger to people, the planet and the oceans – then we’d have a lower carbon budget and we’d have to get off carbon sooner.
So, higher odds of success require lower carbon budgets, lower odds of success allow more carbon to be released.
The IPCC uses three scenarios based on the probability of staying below 2C. That’s appropriate, given the uncertainties inherent in forecasting a system as complex as the climate. But the probabilities it is using are a 66% chance of succeeding, a 50% chance and a 30% chance.
So, for example, if we wanted to have a 66% probability of staying below 1.5C, our total carbon budget would be 2250 tonnes of carbon dioxide.  By the end of 2015, and the conclusion of the Paris talks, we will have burned through all but 200 billion tonnes of that budget. Since we are emitting about 40 billion tonnes per year (about 44 US tons), we will blow through the budget by 2020, the year in which the Paris agreements are to start being implemented. In other words, that ship will have sailed before any action is taken.
Contrast this with the carbon budget based on a 66% probability of staying below 2C, or 2900 billion tonnes of carbon dioxide (GtCO2e). By the end of 2015, we would have nearly 850 GtCO2 left, or twenty years worth.
Obviously, a better margin of safety would make sense; playing craps with the planet we live on is – to say the least -- irresponsible.
But the option to be prudent no longer exists.Here’s the sad truth: we’ve already blown past the carbon budgets required to have a 90% probability of staying below 2 C – let alone 1.5C.
Negative Emissions – or après moi, le deluge: There’s one other way of expanding carbon budgets: Pass the problem on to our children and their children, so we can burn more fossil fuels now and still appear to stay within our carbon budget. And that’s precisely what the IPCC carbon budgets do. They only work if we require our offspring to create extraordinarily expensive new technologies that will take massive quantities of carbon dioxide out of the air and safely sequester it.
No one knows how to do this, and the scale of this activity is so large it will leave little room for more productive economic activity.
To get an idea of just how crazy our current approach is, imagine you are about to board an airplane, when the engineer responsible for designing it tells you it has a 34% probability of malfunctioning. Would you proceed? Of course not.
A core precept of risk analysis and risk management is that dangers which are irreversible and consequential demand very high safety margins. People intuitively understand this, and that’s why the airplane example is so obvious. We’re genetically hard-wired to recognize risks that are proximate in time and place. We understand that when the alarms start sounding at 35,000 feet, we can’t simply exit the plane and grab another that’s flying by.
Yet, the same is true of our planet. If we screw it up, we can’t hop off and wait for another. But the scale of this danger is so large, and the time-frame sufficiently long (exceeding a single life-span) that we don’t experience this threat in the same way. Responding to this danger will require us to exercise wisdom, not simply rely on the genes we’ve been given by natural selection.
But when it comes to climate change, wisdom is obviously in short supply.
It's the physics, stupid: If we want a reasonable margin of safety for the world, we have to get off fossil fuels as soon as possible, preferably within the next five or six years.
Impractical? No more impractical than pretending it makes sense to adopt a carbon budget that risks global catastrophe simply because we failed take the action we needed to take in the past.
The amount of GHG we can emit without ushering in Armageddon is determined by physics, not politics. And as I said back in July, the approach we’re adopting in COP 21, poses an existential threat to humanity and the global ecosystem because "... in a clash between physics and politics, physics always wins."
The thing is, we have everything we need to get off fossil fuels within the next five to six years, except the wisdom and the political will.
 I have used figures for tons of carbon dioxide, whereas many of the IPCC’s numbers are expressed in tons of carbon. The IPCC also includes GHGs other than carbon, but other don't so you might see a variety of carbon budget numbers being used. The key is to always compare apples to apples. For those who wish, the conversion factor is: 1 ton of carbon is equivalent to 3.67 tons of carbon dioxide.
ABOUT THE AUTHOR
John Atcheson is author of the novel, A Being Darkly Wise, an eco-thriller and Book One of a Trilogy centered on global warming. His writing has appeared in The New York Times, the Washington Post, the Baltimore Sun, the San Jose Mercury News and other major newspapers. Atcheson’s book reviews are featured on Climate Progress.
Solving the Human Predicament
This article was originally published in
Millennium Alliance for Humanity and the Biosphere, 3 February 2015
REPRINTED WITH PERMISSION
The Millennium Alliance for Humanity and the Biosphere (MAHB) connects activists, scientists, humanists, and civil society to foster global change pursuant to shifting human cultures and institutions toward sustainable practices and an equitable and satisfying future.
Fixed human behaviour tendencies have blocked action toward a sustainable future. Despite over 50 years of effort by scientists and environmentalists, the future of the human endeavour can no longer be taken for granted. This is due primarily to our nature. We have failed to realize our own behaviour patterns are the root cause of our predicament and have mistakenly believed that mountains of evidence would make the difference. For decades scientists have produced evidence describing the serious environmental threats we face. Their work has failed to ignite a significant public response because our message has not been delivered in a manner that addresses the drivers of human behaviour. We now understand humans are confronted with subconscious behaviour tendencies that served us well at an earlier period, but still remain in our incomplete evolutionary development. At our present stage of intellectual development, lingering malignant social constructs, especially capitalism and economic growth, impede our ability to move forward on environmental issues.
Illustration via Getty
Humans have the most highly developed brain of all living species. The cognitive part of the brain is responsible for our remarkable progress in technology and science. By contrast, when human relationships induce conflict or stress, the limbic and reptilian parts of the brain dominate, overriding rational cognitive thought processes. The innate survival instincts so essential in the past still tend to overwhelm our unique reasoning capacity. Emotional factors such as fear and anger hamper rational thinking. We overestimate the human intellectual capacity when the cognitive process is undermined by our regression to subconscious influences.
Human behaviour is strongly influenced by well-established norms. Ideas extending beyond broadly accepted patterns are frequently rejected because they do not conform to preconceived beliefs that, once established, are extremely difficult to dislodge. Once locked in place, they are obstacles to change. A striking example of this aspect of human behaviour is the never-ending debate on gun control in the United States. Any time the topic on the availability of guns occurs, the National Rifle Association (NRA) vehemently rejects any type of constraint on gun ownership, claiming “the right to bear arms” as an unalienable right that cannot be taken away. The right to bear arms became part of the United States constitution in 1791 and remains there to this day despite the evolution from muskets to AK-47s and despite abundant evidence that gun ownership fails to enhance security and creates an added public hazard.
Human behaviour contains a strong element of competitiveness, a natural occurrence in past times when survival was a daily struggle. Humans operated in a context where obtaining food and shelter were the key factors of living. Hardships bred a short-term view of life with little regard for the future. In today’s society the same characteristics can be seen in our seemingly insatiable consumption of resources and in our tendency to discount the future. These predispositions are displayed by our destructive treatment of the natural world, all in the name of unsustainable economic growth. We are caught in the trap of immediate self-gratification at the expense of our own life-support system.
The unique reasoning ability of humans has brought many benefits, but has also provided us with a problem with which we must cope. We are equipped with certain abstract knowledge unlikely to be possessed by most other animal species. Humans have a sense of self-awareness and are aware of their own mortality. We are constantly reminded by daily events around us that we are not immutable. By necessity, we have learned to deal with this knowledge by creating a number of defensive structures. We have subconsciously learned to deny reality. The denial may take the form of refuting or ignoring painful information that helps us avoid facing the issue. Denial often employs rationalization as an escape mechanism by finding reasons to discredit the information. Humans are capable of denial most frequently when the issue in question has a controversial aspect, but also occurs even when the information is widely accepted. The melting of the Arctic sea ice is a powerful example. It is recognized there is an urgent need to reduce greenhouse gas emissions. Despite this, oil companies and some governments are actively laying claim to areas believed to contain oil or gas reserves. The risk of potential global warming disaster is denied. Greed and vested interests prevail.
If we expect to move forward on environmental issues we will need to frame our message in a way that reaches the real drivers of human behaviour and removes the obstacles blocking change. Predicting disaster is not a driver because creating fear produces denial and paralysis. Providing more scientific evidence is helpful, but is not a driver because it has been tested for decades and found to be ineffective. At present a plan does not exist, but we now have an understanding of the elements influencing human behaviour that could be utilized in developing a blueprint for action. These elements would focus on the many positive attributes of human nature such as our proven ability to co-operate, our innate desire to protect our children, and our empathy for other creatures that share the earth with us. We have the intellectual capacity to create a plan using these and other human qualities. It is our moral responsibility to do so. The question is: “Are we brave enough to do it?”
ABOUT THE AUTHOR
Gerald Addy is a retired elementary school principal from North Vancouver with thirty-six years of service in education and currently serves as one of the directors of the Qualicum Institute.
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