Shale Gas 'Revolution' Could Turn Out to Be Mammoth Spin Job

Includes: CVX, UNG, XOM, XTO
by: Ferdinand E. Banks

The story of oil is simple, and so in my energy economics courses I tend to have little patience with students who cannot comprehend its main features. Gas was the same until recently, but now gas issues have been complicated by a widening and deepening of natural gas markets (due e.g. to the demand generated by the impressive economic growth taking place in China and India), and also talk about shale gas. There are many mistakes that are repeatedly made in the analysis of natural gas markets, and given the widespread circulation of what Professor Vaclav Smil calls misinformation and biases, it should be recognized many more are going to be made in the very near future.

Among other things, my excursions in the blogosphere have convinced me that certain people are hard at work trying to convince the television and ‘blog’ audiences in the U.S. that their energy troubles are almost over because of the huge amounts of shale gas that – ostensibly – can be economically extracted in various parts of that country. Moreover, if this turns out to be true, then it is likely that the same could apply to many other parts of the world, since the shale gas phenomenon is largely a matter of technological improvements that can be easily transferred between countries or continents. At the same time it should never be forgotten that what some observers call the shale gas ‘revolution’ might turn out to be no more than one of those mammoth ‘spin’ jobs that are mainly concerned with increasing somebody’s money and power. Personally, for reasons given below, I remain sceptical to a large part of the shale gas song-and-dance, but admittedly I could be completely wrong. I certainly hope that I am.

According to David Rotman (2009), the editor of the Technology Review, shale gas is capable of dramatically changing the global energy map. This may be true, but if not, then certain investments that should be made in other energy resources and alternatives may not be made because of a lack of interest and/or money, and thus when existing energy strategies and efforts are more carefully examined, and perhaps judged sub-optimal, very expensive alterations may be necessary. This kind of thinking is nothing more than an appendage to Richard Bellman’s ‘Principle of Optimality’, which is based on the mathematical notion of recursion, and suggests that excessive haste can be a mistake. In addition, more attention should be paid to obtaining superior forecasts.

The consultant Henry Groppe has claimed that shale gas will not provide the boost in reserves often claimed, citing a ‘natural depreciation’ of shale gas deposits that often attains 45 percent in the first year of exploitation. If he is correct, a small amount of integral calculus, in conjunction with a concept know in capital theory as ‘depreciation by evaporation’, will show that many persons intent on waltzing into the upper-income bracket by acquiring shale properties should be very careful.

As some of us know, in evaluating a difference in opinion of the above nature, specific professional credentials should play a crucial role. If we return to the individuals mentioned in the previous paragraphs, on one hand we have a gentleman who edits an important technical publication, and presumably has some scientific background, while on the other we have a world-class expert on petroleum matters, Henry Groppe, who is a graduate engineer and former officer in the United States Navy, with 40 years of experience as a petroleum consultant, and a penchant for being correct.

I can also refer to a brilliant article by Puru Saxena in ‘321 Energy’ (2010) for a thorough insight into this question. In the process of summing up a long and valuable discussion, he expressed some reservations concerning shale gas prospects. One of the people who should read and attempt to understand this article is Amy Myers Jaffe, whose performance some years ago at the Rome conference of the International Association of Energy Economics left me reaching for the aspirin. Then it was oil, but now it is shale gas, and the article she published in the Wall Street Journal (2010) is at best a clumsy attempt to take advantage of the lack of scientific depth that permeates the world of academic energy economics, and which is partially responsible for the failure of voters and politicians to recognize and measure the energy security threats they are facing, and which will likely not go away if a few shale gas deposits are exploited.

While I believe that it will take more than a few articles and interviews before we know the precise scope of this resource (which, incidentally, has been exploited to a limited extent for a great many years), I am going to insist that all of my energy economics students take a few minutes to read the short article by Bill Francis (2010), in which he emphasizes the observation of Henry Grope that despite all the talk about shale gas, it provides only a very small part of the U.S. gas output. Similarly, readers should be aware that the CEO of the oil major Chevron (NYSE:CVX), John Watson, confesses that he will avoid investing in the shale gas sector. Mr Watson flatly declared that the price of shale assets is too high relative to expected returns to justify a large scale commitment by his firm. Put another way, he does not believe that shale gas has lived up to its publicity, and as a result he will not join many of his esteemed colleagues in investing millions or billions in that commodity – at least at the present time. For instance, in December of last year, ExxonMobile (NYSE:XOM) bought XTO Energy (XTO) because, ostensibly, of its strong position in shale gas. The cost was $31 billion in stock and $10 billion in XTO debt, which incited several long and highly critical discussions in the blogosphere.

Among the observers of the gas scene who chose to go public with their apprehensions was the former Chairman of the U.S. Federal Reserve (or Central Bank), Alan Greenspan. On several occasions he warned of possible traumatic spikes in the price of gas that could have very disagreeable macroeconomic consequences. In fact he went so far as to say that North America will forever be condemned to a volatile and inefficient gas market unless it can secure unlimited access to the vast world reserves of gas.

“Unlimited access” suggests that Dr Greenspan may have gone too far in his evaluation of the gas future, however according to Vicky A. Bailey, Assistant Secretary for Policy and International Affairs in the U.S. Department of Energy, “We will be hard pressed to meet demand that might represent a 50 percent growth in eight years, unless we can manage to locate and develop far greater domestic reserves than currently exist.” That was seven years ago, as was the last remark I heard on this subject by Alan Greenspan, but it is very definitely applicable today if shale gas is incapable of making more than a marginal contribution to the global natural gas supply.

Some years ago a well known professor of energy economics flatly stated that there was plenty of oil and gas in the world, and fortunately in regions where its owners would make these items available should buyers and potential buyers come forward with sufficient cash. In other words, if the owners of these resources did not have any plans to restrict supply in the manner described by the chief executive of an important gas exporting nation, who announced that a large share of the gas in his country belongs to future generations, and so he was extending its lifetime by producing less. At the same time, various claims were made about the efficiency of a complete ‘liberalisation’ (or restructuring) of natural gas markets, which is an even more grotesque proposition than the electric deregulations that were so harmful in places like California and Brazil and elsewhere.

Fortunately I had the opportunity to examine electric deregulation at great length during my tour at the Hong Kong Energy Studies Institute, and in the course of my lectures there made it clear in language that could not be misinterpreted that the main failure with that illogical and unnecessary experiment was not due to politicians and industry executives, but academic economists who insist on not understanding the lessons of both economic history and theory. You do not have to look very hard to see similar aberrations at the present time, and not just about gas, although given the enormous demand for all energy resources that will take place because of population increases, gas should be close to the top of the list of items whose shortage could pose a clear and present danger to the international economy.


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______. (2000). Energy Economics: A Modern Introduction. Boston: Kluwer

______. (1987). The Political Economy of Natural Gas’. London and Sydney: Croom-Helm.

Francis, Bill (2010). ‘Groppe’s argument for a doubling of gas prices’. Seeking Alpha (May 26).

Jaffe, Amy M.(2010).‘Shale gas will rock the world’.Wall Street Journal' ( May 10).

Rapier, Robert (2010). ‘EIA’s Energy Outlook for 2010 reveals disturbing figures’. OilPrice.Com.

Rotman, David (2010). ‘Natural gas changes the Energy Map’. Technology Review

Saxena, Puru (2010).‘Shale gas – miracle pill or empty promise’. 321Energy (May 5)