Fracking: From breaking shale to breaking even

But what exactly is it?

Fracking is shorthand for hydraulic fracturing, a drilling method that involves injecting water, sand and chemicals under high pressure through a well. The high pressure of all the components causes rocks to fracture and the sand keeps those fissures open, while the chemicals help ease the oil or gas out. The method itself has been around for decades, but the more recent development is the pairing of hydraulic fracturing and horizontal drilling.

This has allowed companies to start extracting oil and gas from less-permeable rocks such as shale, opening up vast new fields collectively called unconventional reservoirs. Conventional reservoirs, where extraction widely took place before the fracking boom, involve tapping into more permeable, spongier rocks, such as limestone, from which oil and gas flows, usually without artificial pressure.

Fracking has been groundbreaking for the US and the world. Up until 2000, US onshore oil-field development had stalled; fracking breathed life back into hydrocarbon production. In September 2019, the country became a net monthly exporter of crude oil and petroleum products for the first time since the US Energy Information Administration started keeping monthly records in 1973.

It also meant that the business of exploration became less speculative and almost like an assembly line. “With the new technology, all of a sudden your chances of being unsuccessful went way down," notes Dan Pickering, founder of Pickering Energy Partners. “The odds that you found oil were 90% instead of 30%."

That certainty comes at a price. Today, the West Texas Intermediate price at which a US producer can drill a new well profitably—its break-even point—is roughly $49 a barrel, according to the Kansas City Federal Reserve, which is a good approximate proxy for fracking since most US production happens using that method. That isn’t the most expensive barrel that can be produced profitably—many established offshore fields or onshore oil-sands deposits are pricier—but it is far dearer than drilling by the big, traditional oil exporters whose economies have been shaken by the fracking boom. A new well in Saudi Arabia can break even at a Brent crude oil price of less than $20 a barrel on average, according to Saudi Aramco, and an existing well breaks even below $10 on average.

While members of the Organization of the Petroleum Exporting Countries still collectively produce more oil more cheaply than anyone else, fracking has wrecked their pricing power. Whenever OPEC has cut back on its supply to prop up prices, US producers have tended to jump in to fill the gap. A 2019 study from the Dallas Fed found that long-dated oil futures have closely tracked the break-even price for US oil producers since 2014. The US has become the marginal producer when it comes to meeting long-term demand.

One problematic aspect of fracking is its quick decline rate. Drawing oil and gas out of a conventional well is much like slowly pouring soda out of a can. Fracking looks more like what happens when you shake the can and open it. Hydrocarbons come out quickly but start losing momentum rapidly, too. Production in the Eagle Ford oil field in Texas, for example, declines 60% in a well’s first year and more than 90% over the first three, according to a study from the Kansas City Fed. Conventional oil fields register decline rates of just 5% to 10% a year.

But a well can be fracked in months, not years. That short-cycle nature partly explains the way producers have conducted business. Energy companies, particularly publicly listed ones, have had to constantly drill new wells to maintain steady production. In many cases, they racked up substantial debt to fund new drilling, risking bankruptcy at times of depressed oil or gas prices. Hundreds of small firms and some big ones like Whiting Petroleum and Chesapeake Energy saw shareholders wiped out.

Of course, cycles are nothing new to the industry. Over the years, oil-price collapses have led to the demise of smaller, less well-capitalized firms, either through bankruptcy or consolidation. As a result, fracking increasingly is dominated by deep-pocketed players such as Exxon Mobil and Chevron.

Oil-price collapses often spur efficiency gains. The last time this happened in a dramatic way was between 2014 and 2016, when break-even prices dropped from $79 a barrel to $53, according to the Kansas City Fed. The side effect is stress on the ecosystem supporting frackers such as oil-field-services companies and more pressure on OPEC.

Frackers have repeatedly claimed to be more disciplined than in the past. Conventional producers have, too, almost as long as there has been an oil business. Booms and busts aren’t going away but fracking, despite its short time on the energy industry’s center stage, might have changed them permanently. Peaks and valleys are now more frequent.

Combine that with high costs and easy money and it is clear that this short-cycle industry could do with a longer-term memory, including from its investors.

This story has been published from a wire agency feed without modifications to the text.