Shale Oil Boosters Aren't Charlatans

by: Robert Wagner

I recently read a SA article titled "Why Shale Oil Boosters Are Charlatans in Disguise," and while I found some of the concepts interesting, I simply have to disagree with its conclusions.

Without even getting into in depth analysis, and simply applying a "keen sense of the obvious," it is relatively easy to refute the "Charlatan" claims.

1) Shale oil is the product of the free market. People that know the industry best are risking their own money and succeeding. More importantly they are succeeding in spite of extreme opposition from governments and green "pressure" groups.

2) Shale gas is making all the right enemies. The people that stand the most to lose are getting nervous. Saudi Prince Alwaleed claims that "fracking is a threat to all oil producing nations in the World." Clearly what the Prince intended to say was that fracking was a threat to OPEC and most importantly Saudi Arabia. Fracking in no threat to America.

3) Shale oil has the potential to make Israel a major energy player. No, that was not a typo, Israel. Israel is also making huge natural gas discoveries. Fracking and shale oil have the potential to tip some very delicate geopolitical balances, and thus have developed some very powerful and well funded enemies.

4) The oil dependent nation of Abu Dhabi bankrolled what I consider a modern masterpiece of propaganda, the anti-fracking movie Promised Land. The deceitful, dishonest and misleading tactics are done so subtly and convincingly that they are certain to confuse the issue for anyone that attends a showing. Those efforts aren't likely to be highly effective, but the very fact that Abu Dhabi is making an anti-fracking movie for the US market shows their anxiety. "Charlatans" are unlikely to cause such unease in the oil rich Middle-East.

5) Shale oil and gas production is increasing rapidly without major government subsidies and assistance, in fact they face just the opposite, government regulations and obstructions. Unprofitable and unpromising industries do not expand rapidly. Here in the Midwest, evidence of the success of fracking is everywhere. Unless my eyes are lying to me, there is a serious problem with this anti-shale oil and gas argument.

Those are just the 10,000 foot view observations about shale oil and gas, basically the "things that make you go hmmm!" Bottom line, during a time of unusually slow economic growth and high unemployment, fracking offers tremendous potential to solve some of our Nation's greatest challenges. Unlike wind, solar and other sources favored by the current administration, EPA and green "pressure" groups, shale oil and gas fracking create real products, real jobs, real growth, real potential and offer real hope. Because the tremendous success of fracking dwarfs any solution offered by the administration and green 'pressure" groups, people have to expect the opposition to double their efforts to distract the voting public's attention away from their failures and fracking's successes. That is the unfortunate window through which shale oil must be analyzed, a window tainted, blurred and distorted by unscrupulous political tactics. Politics doesn't follow market principles, and that is what make analyzing this industry so difficult.

On to the analysis of the article:

The first paragraph of the article along with the title, are what caught my attention, and inspired me to write this article.

Something has bothered me of late: why is the price of crude oil still elevated? Other commodities have taken a battering since 2011. Gold, copper and iron ore - all are way down off their peaks. But oil has seemingly defied gravity. And that's despite increased supply from shale oil in the U.S., still soft demand particularly in the developed world and declining rates of inflation growth across the globe.

Oil is a consumable commodity, whose finite supply is in continual decline. Oil in converted into CO2 to generate power. Once that oil is burned, the oil no longer exists. New oil must be discovered to replace the oil that has been burned. As time has passed, all the low hanging fruit in the oil patch has been picked, so oil producers must drill deeper and in more remote locations to continue to provide the additional supply. Drilling deeper and in more remote locations is far more expensive than oil production of the past. A higher oil price is required for new development to be encouraged if we are going to keep up with growing demand.

The basic economics of energy are infinitely different from metals and precious metals. Precious metals aren't consumed, and iron and copper are highly dependent upon economic growth and much can be recycled. The supply of gold is continually increaseing as more and more of it is mined, and the reason it has fallen in price is because the fear of financial collapse has subsided. Copper and iron prices have fallen because of slack demand and increased supply, largely due to the global recession. Comparing oil to gold and metals is simply comparing apples to oranges, and OPEC controls the apple market.

China's refined copper output rose 28 per cent year on year. Iron ore output was up 11 per cent and zinc production by 12 per cent. All three recorded new monthly record highs...Deutsche expects strong copper demand, in particular. That will be welcome news to copper producers, who face a global surplus next year.

The reason oil prices remain high is simple supply and demand. Even with the decline of demand from the developed market, overall demand for energy has continued to climb.

This increase in demand has created a global shortage of energy. Shortages aren't usually associated with lower prices.

OPEC has been succeeding in maintaining the price of oil, as both OPEC and non-OPEC production have "struggled" to keep up with demand. I'm not real sure taking a vote to restrict production at an OPEC meetings counts as "struggling" however but the result has been restrained production.

Those above charts represent how things are, not where they are going. Yes, up until now, OPEC and particularly Saudi Arabia, has been the big man on campus. Shale oil and gas however threaten to shift the balance of power. Oil and gas production in the US has surged. The US is projected to be the largest energy producer in the world by 2015 thanks to shale. It is important to note that no articles claim the US will become the largest energy producer because of wind, solar or biofuels. Even President Barack Obama promotes his "climate change" agenda standing in front of giant pipeline segments, ironically sitting idle in inventory because he is blocking the Keystone Pipeline. But that is the nature of politics.

On many points, I agree with the author. Cheap, abundant and clean energy is desirable, and is essential to maintaining the expectations of higher standards of living all peoples strive for. Cheap energy built the developed world, and cheap energy will be needed to build the developing world.

He says cheap energy has been central to the extraordinary economic growth generated since the Industrial Revolution. And without that cheap energy, future growth will be permanently impaired. It's a bold view that's solidified my own thinking that higher energy prices are here to stay. The link between cheap energy and economic growth is fascinating and worth exploring further today.

Unfortunately, many people take the attitude that only the developed world should be afforded such a privilege. I don't think this is a winning political strategy to support climate change legislation, and I doubt it will win over many voters.

'My take from Stossel last night was that Bill Nye was more worried about population than CO2. Denying emerging nations cheap energy well lead to disease and starvation. Which is eerily similar to John Holdren's solutions'

Another point of agreement, contrary to Al Gore's opinion, is that the internal combustion engine was instrumental in greatly improving standards of living. BTW, cities populated by automobiles are infinitely cleaner than cities populated by horses.

The second key development was the invention of the heat engine by Scottish engineer James Watts in 1769, although a more efficient version was produced later in 1799. This invention allowed society to access vast energy resources contained in oil, natural gas, coal and so forth. In other words, the industrial revolution allowed the harnessing of more energy to apply vast leverage to the economy.

The points of agreement continue.

The creation of surplus energy during the Industrial Revolution and subsequent explosion in economic and population growth isn't an accident. They're tied at the hip.

Beyond those points however I start to disagree. The author defines a valuation model called the"Energy Return on Energy Invested" equation. Basically it says that as the marginal gains from energy production decline, the cost should go higher. No argument there, but that doesn't apply to fracking. Shale oil and gas are profitable largely because huge technological advancements have made it profitable at going market rates. The cost of fracking has been dramatically decreasing, not increasing. Had it not been for the increased supply produced by fracking, energy prices would likely be much higher.

Morgan's research suggests that going from EROEIs of 80:1 to 20:1 isn't disruptive. But once the ratio gets below 15:1, energy becomes a lot more expensive. He suggests the ratio will decline to 11:1 by 2020 and the cost of energy will increase by 50% as a consequence.

The biggest point of disagreement comes from this quote and graphic.

Non-conventional sources of oil will provide little respite. Shale oil and gas have EROEIs of 5:1, while tar sands and biofuels are even lower at 3:1. In other words, policymakers who pin their hopes on shale oil reducing energy prices are seriously deluded...And further technological breakthroughs to better locate and extract oil are unlikely to help either. That's because technology uses energy rather than creates it. It won't change the energy equation. While some unconventional sources offer hope, such as concentrated solar power, they won't be enough to offset surplus energy turning to a more balanced equation.

The first problem is that there is no way to include wind and solar on a graph like that and have any meaning. If I have a gallon of 93 Octane fuel and burn it, I will get X number of BTUs produced. It doesn't matter how many times I run that experiment I will always get approximately the same number of BTUs per gallon. Fossil fuels are unbelievably efficient, reliable, predictable and consistent. That is why they are a favorite of the energy industry, you know what you get when you buy a fossil fuel. Wind and solar are completely variable, inconsistent and highly unreliable. Solar will never power homes and factories at night, never. Solar will never provide reliable power in the polar regions when nights can lasts for days, weeks and even a month. Wind is almost always changing and has large variances depending on the season. The only reliable numbers you can give for wind and solar are wind tunnel/laboratory controlled experiment numbers, and those almost never exist in the real world.

In fact, Germany is being horribly caught out by precisely the same delusion about renewable energy that our own politicians have fallen for. Like all enthusiasts for "free, clean, renewable electricity", they overlook the fatal implications of the fact that wind speeds and sunlight constantly vary. They are taken in by the wind industry's trick of vastly exaggerating the usefulness of wind farms by talking in terms of their "capacity", hiding the fact that their actual output will waver between 100 per cent of capacity and zero. In Britain it averages around 25 per cent; in Germany it is lower, just 17 per cent.

The more a country depends on such sources of energy, the more there will arise - as Germany is discovering - two massive technical problems. One is that it becomes incredibly difficult to maintain a consistent supply of power to the grid, when that wildly fluctuating renewable output has to be balanced by input from conventional power stations. The other is that, to keep that back-up constantly available can require fossil-fuel power plants to run much of the time very inefficiently and expensively (incidentally chucking out so much more "carbon" than normal that it negates any supposed CO2 savings from the wind).

The second problem is that tar sands and shale gas are put near the very bottom. Tar sands and shale gas are absolutely booming in the free market, whereas we have to heavily subsidize wind and solar, yet wind and solar chart far higher on the graph. Fracking has been so successful that it has driven the price of natural gas so low that wells had to be shut in. Fracking is so effective at lowering the price of gas that they are putting themselves out of business. Wind and solar businesses are going out of business left and right once the tax subsidies run out, and only really exist because of government programs and regulations.

This following chart demonstrates how falling natural gas prices and market forces have resulted in approximately 1/2 of the natural gas wells being shut-in. This graph also stands as a warning to anyone rushing to buy natural gas contracts because of soaring prices being driven by the recent polar vortex. There is plenty of capacity out there just waiting for the right time and price to restart production. I would expect any jump in natural gas prices to be temporary at best...that is unless we start to export LNG on a major scale.

Friday's price of $5.20 per thousand cubic feet was the first time gas had crossed the symbolic $5 threshold in three and a half years, although the current price is still roughly a third of the gas price before the 2008 financial crisis and the surge in domestic production since then.

My final point of disagreement is with this quote.

Now I don't have total buy-in to Morgan's thesis. It certainly solidifies my thinking that the era of cheap energy is indeed over. It provides a unique and compelling way to think about this. And the proof is seemingly all around us. It explains the high oil prices and the surge in agriculture prices (agriculture relies on energy inputs).

I had the misfortune to live through the Jimmy Carter era, where everyday we were being told about the oil shortage, the 10 year supply of oil remaining, gas lines, Disco, bell bottoms, platform shoes and the coming ice age. As a young boy I was absolutely horrified.

World consumption of oil is still going up. If it were possible to keep it rising during the 1970s and 1980s by 5 percent a year as it has in the past, we could use up all the proven reserves of oil in the entire world by the end of the next decade....Because we are now running out of gas and oil, we must prepare quickly for a third change, to strict conservation and to the use of coal and permanent renewable energy sources, like solar power.

I then went to college, took economics and watched Ronald Reagan prove that everything I had been taught as a child was an absolute lie. Oil production exploded, gas prices collapsed, inflation and interest rates plummeted, unemployment dropped and "stagflation" was never mentioned again. It was like I had grown up in the Twilight Zone, and it taught me to never listen to politicians that don't embrace the free market. Ronald Reagan's solution was simple, unleash the free market and problems will solve themselves. Unfortunately, those lessons have been forgotten, and we seem to be repeating the mistakes of the 1970s all over again, except this time it is global warming, no, scratch that, climate change.

Problem is, no matter what nonsense politicians use to support their policies, if the policies are anti-free market, they simply aren't likely to work. Reagan lowered taxes and regulations and relied on growth to solve America's problems. Today we are relying on regulations, subsidies, entitlements, extended benefits, redistribution and taxation to solve our problems. That is a prescription for economic contraction, not growth.

What does that have to do with investments?

The facts are, the current administration's approach to solving the Nation's problems have a lot to do with investments. The transition from Carter to Reagan greatly improved investment results, and unless major changes are made, it is unlikely that the current energy policies will be able to withstand many more elections. After 5 years of promises, voters are rightfully expecting some results, and success stories are few and far between. The outlook for fracking, shale oil and energy companies will be greatly altered if the Republicans take the Senate in 2014 and White House in 2016.

The reason is simple, Republicans don't buy into the global warming/climate change theory that is being used to prop up all these government programs and regulations. It is unlikely that the manufactured industries of wind, solar and biofuels will survive a Republican backlash. If uber-green Germany is turning its back on global warming/climate change policies, they have no chance of surviving in America. The UK also appears to be jumping ship, and abandoning their global warming agenda. The truth looks to be finally winning out, at least overseas. Unfortunately here in the US, it looks like the Don Quixotes of climate change plan to carry on the fight, even while we are experiencing the worst winter in decades.

The EU's reputation as a model of environmental responsibility may soon be history. The European Commission wants to forgo ambitious climate protection goals and pave the way for fracking -- jeopardizing Germany's touted energy revolution in the process.

I'm a believer that the truth will eventually come out, and the right decisions will eventually be made. The reason I'm so convinced that this global warming/climate change movement will meet the same fate as the coming ice age scare on the 1970s is simple, the "science" supporting such claims is simply fundamentally flawed. In a past career I worked in healthcare, and believe it or not, the theories used in global warming are widely used in medicine. Laser eye surgery is based upon the very principles of the green house gas effect. Talk to any ophthalmologist that understands how a krypton, yag or argon laser works, and they will be able to explain to you why CO2 is not the cause of global warming or climate change.

During eye surgery a laser has to pass through multiple tissues before it is "activated." The laser has to pass through the cornea, aqueous fluid, lens and vitreous fluid before it reaches the retina. All the clear tissues and fluids transmit the laser light, and are unaffected by the light. The laser lights remains unaltered until it gets to the retina. That situation is analogous to the sun's radiation traveling through the universe unchanged until it gets to the earth's atmosphere. Visible light passes unchanged through the atmosphere until it hits a blacktop driveway or red car seat and is converted from electromagnetic radiation to thermal radiation i.e. heat.

That is exactly what happens with ophthalmic laser eye surgery. A laser light is flashed into an eye and nothing happens to the eye until the laser reaches a tissue that will absorb it instead of transmitting it. The front part of the retina is very vascular, full of blood vessels and red. The back part of the retina is black and full of pigment. If I wanted to burn the inner layer of highly vascular red retina I would choose a green colored laser because blood transmits red light, and absorbs green light. If on the other-hand I wanted to burn deeper layers of the retina I would use a red laser. The red laser would be transmitted through the red blood vessels, and wouldn't be converted to heat until it reached the black pigment that lines the back of the retina. In reality I wouldn't do the surgery, I would refer the patient out to have it done, but the concepts are the same.

The tissues of the eye act in the same manner as green house gases do in the atmosphere. Different wavelengths of laser light are either transmitted or absorbed/converted to heat by tissues of the eye, and infrared radiation is either transmitted through the atmosphere or absorbed/converted to heat by the green house gases. Sunlight fills the vacuum of outer-space, yet outerspace is extremely cold. Electromagnetic radiation, i.e. light, only turns to heat once it is absorbed by something and converted to heat. Not all things absorb all wavelengths of light. Windows for example simply transmit light, and do not convert it to heat. To understand what is causing global warming you have to understand what green house gases act as windows and transmit light, and what ones act as blacktop, absorbing/converting it to heat.

Fortunately, that question is answered in every introductory atmospheric physics text book. I have never found a text book that claims anything other than CO2 absorbing at 2.7, 4.3 and 15 microns, three very narrow bands within the infrared (NYSE:IR) spectrum. Graphs like this are widely published, and used in our class rooms.

They all clearly show the earth emitting radiation around the 10 micron range, most of, if not all, missing the range that CO2 absorbs around 15 microns. The temperature difference between 10 microns and 15 microns is nearly 100 degrees C. The earth emits radiation consistent with a temperature near 15 Degree C, and CO2 absorbs radiation consistent with a temperature near -80 degree C. Don't take my word for it, you can check that claim here. Unless the computer is lying to you, the CO2 theory has some real problems. That is why I'm so confident this movement will eventually fail, the calculators don't have a political agenda. In their rush to push this CO2/Global Warming theory, they obviously forgot to do their homework. Much like the people that created Bitcoin, people seem willing to overlook serious flaws simply because they just want to believe and it fits their political agenda. At normal global tempertures, CO2 acts as a window to outgoing IR radiation, it does not absorb it, or at least not much of it.

The other chart found in text books across the globe is the infamous chart used in Al Gore's movie, An Inconvienient Truth. It totally debunks the theory of man made climate change. It is a 400k year record of atmospheric CO2 and temperature and at no time over the last 400k does it show climate not constantly changing. The chart looks like a saw blade, with past temperature peaks well above the level we are at today. The only thing constant about the last 400k years of climate is change. If climate wasn't changing I'd be worried, now that would be unusual. What is most frightening however is that the chart is used to prove man is causing climate change. How anyone can look at the last 400k and reach the conclusion that man is the cause of climate change is beyond me. It is as if the entire world has lost their critical thinking skills. What next? 2+2=5, War=Peace, Freedom=Slavery, Ignorance=Strength?

In conclusion, I simply couldn't let an article calling shale oil boosters "Charlatans." People called Reagan a Charlatan. People that argued against the coming ice age were called "Charlatans." The people behind fracking and shale oil aren't "Charlatans," they are the entrepreneurs that are creating an industry that has the potential to reshape the world and upset its geopolitical balances. Fracking and shale oil are creating real jobs, not only in drilling but in steel, transportation, refining and construction. Fracking and shale oil have had a material impact on the economy and price of energy, and have pushed America towards energy independence. Fracking and shale oil are the greatest job creating economic stories we have in America outside maybe Silicon Valley. Having grown up in the 1970s I watched the de-industrialization of the mid-West. Never in my lifetime did I ever think I would see steel and jobs return to Youngstown Ohio. Fracking has proven me wrong on an epic scale, and the people in Ohio are very very very happy for those "Charlatans" that embraced Ronald Reagan's supply-side approach to creating all those jobs in spite of all the opposition from the government, EPA, green "pressure" groups, the media and our educational system.

Disclaimer: This article is not an investment recommendation or solicitation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Full Disclaimer and Disclosure Click Here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.