The Faltering Economics of Fracking

Steven Cherry Hi this is Steven Cherry for Radio Spectrum.

Many things have changed in 2020, and it’s an open question which are altered permanently and which are transitory. Work-from-home may be here to stay; as might the shift from movie theatres and cable tv networks to streaming services; pet adoption rates are so high that some animal shelters are empty and global greenhouse gas emissions declined in record numbers.

That last fact has several causes—the lockdowns and voluntary confinements of the pandemic; an oil glut that preceded the pandemic and continued through it; the ways renewable energy—especially solar energy—is successfully competing with fossil-fuels. According to the Institute for Energy Economics and Financial Analysis, an Ohio-based non-profit that studies the energy economy, more than 100 banks and insurers have divested or are divesting from coal mining and coal power plants. Their analysis also shows that natural gas power plant projects—for example one that’s been proposed for central Virginia—are a poor investment, due to a combination of clean-energy regulations and the difficulty of amortizing big power-plant construction in the face of a growing clean-energy pipeline, expected to grow dramatically over the next four years.

Such continued growth in clean-energy projects is particularly notable, as it comes despite high job losses for the renewable energy industry, slowing construction activity, and difficulty in finding capital financing. Those same headwinds brought about a record number of bankruptcies in the fracking industry.

My guest today is eminently qualified to answer the question, are the changes we’re seeing in the U.S. energy-generation profile temporary or permanent? And what are the consequences for climate change? Kathy Hipple was formerly an analyst at the aforementioned Institute for Energy Economics and Financial Analysis and is a professor in Bard College’s Managing for Sustainability MBA program.

Kathy, welcome to the podcast.

Kathy Hipple Thank you, Steven. It’s great to be here.

Steven Cherry Kathy, your background is broader than most. You did a long stint on Wall Street at Merrill Lynch, but you’re also on the board of Meals on Wheels in Bennington, Vermont. There are issues of environmental justice in our decisions about what kind of energy generation to finance and where, and we’ll get to that. But first, it seems like the economics behind our energy sources are shifting almost faster than we can keep up. Where are we at currently with the economics of fossil fuels—coal, petroleum, natural gas?

Kathy Hipple Well, you’re right. It has seemed that 2020 saw an acceleration of trends. But this is not new. This has been going on for at least a decade, that fossil fuels have been in decline from a financial standpoint. And the energy sector—which currently only includes oil and gas companies, that does not include renewable energy—finished last place in the market for the decade between 2010 and 2020. It also finished last place in 2020, 2019, and 2018. So this is a sector in financial decline, long-term financial decline. And as we know and because I’m a finance professor, finance is all about the future. So the market is telling us that the future is not fossil fuels. Which is why the energy sector is now only 2 percent—a little over 2 percent—of the S&P 500. And in the 1980w it was 28+ percent. So we now have a world economy that is much less dependent on fossil fuels financially than it has ever been.

Steven Cherry Wall Street firms have promised to lead the charge toward sustainable energy use, but the world’s largest asset manager, BlackRock, a year after it said it would divest its portfolio from fossil fuels, still has something like $85 billion invested in coal companies, the worst of the fossil fuels in terms of pollution and greenhouse gases.

Kathy Hipple Yes, BlackRock has been a disappointment in many respects. They are not walking their talk. Their talk is impressive, but their follow-through, as you say, they’re still heavily invested in coal, still heavily invested in financing gas and oil projects around the world. And they are also moving into clean energy. But they have not yet done the divestment that many activists have called on them to do and that the Larry Fink letter suggests that they will do.

They have not been as transparent as they probably should be in terms of how they are working with management of companies to see if they are actually promoting the energy transition or if they are reporting on Taskforce for Climate-related Financial Disclosures, TCFD. So I do think that they grew their asset base tremendously in 2020, but they have a long way to go before they will become a climate leader on the investment side.

Steven Cherry It’s impossible to talk about new drilling without talking about fracking. A 2019 study of 40 dedicated U.S. shale oil companies found that only four of them had a positive cash flow balance. Much of the easiest drilling has already been done. Investors haven’t been getting good returns even on them. And the price of oil generally is pretty low. The thing that has puzzled some observers is that besides the economic damage wrought by fracking financially, it seems to be driven more by enthusiasm than results. Does fracking make sense financially?

Kathy Hipple Fracking does not make sense financially and it never has. That is the big dirty secret—even when oil prices were well above $100/barrel and natural gas prices were much higher than they are now. These companies, year in and year out since 2010, had been cash flow negative in aggregate. Occasionally you’ll get one or two companies that will outperform their peers. But in aggregate, the oil—the frackers that are going after oil, largely in the Permian Basin in Texas and New Mexico—have been cash flow negative each and every year; and in even worse shape than the oil price fractures, are the fossil gas (sometimes called natural gas) producers, largely in the Marcellus-Utica basins in Appalachia.

They have been in extremis and they have produced negative cash flows again, even when gas prices were much higher than they are now. So the business case for fracking has never been proved; it’s a poor business model—as you mentioned, the decline rate is very high, which means you have to continue to put money into drill new wells. And the industry has never found a way to be profitable and to be cash flow positive.

In fact, one of the former CEOs of the largest gas frackers, EQT, said he had never seen an industry, in a sense, commit suicide the way the fracking industry has done. So you’re right, it’s been a terrible investment. It’s been driven by enthusiasm and a lot of investors saying wait until next year. But largely the investor base has moved away from this sector. The sector has no access to the public markets for either equity or for debt. Many banks have walked away from them. They’ve closed their loan portfolios. One prominent bank sold their entire energy portfolio for roughly 50, 60 cents on the dollar. So the sector probably can only go forward if it has access to higher-risk capital or higher-cost capital. And these will be investors who are willing to gamble on a sector that has never yet shown a financial success.

Steven Cherry There’s a lot of political momentum behind fracking, especially in western Pennsylvania and places like that, North Dakota. What is one to do when there’s such a disconnect between the politics and the finances?

Kathy Hipple That’s a great question, Steven. The industry has lost a tremendous amount of its economic and financial power, but it retains a lot of political power. And that is particularly true in places like Texas and in Pennsylvania, as you mentioned. However, I think that the public view about fracking has started to change. In fact, there was an interesting study that the counties in Pennsylvania that had more fracking, in fact, did not vote for Trump at the same level they had four years earlier, and that the public is starting to really question whether they want to have pipelines under their land, whether they want to have orphan wells or wells for gas and for oil that have just been abandoned. And they’re really questioning whether the number of jobs the industry promises will ever materialize.

Often the industry comes to a state and says we will produce this many jobs. And in fact, most of the jobs are in construction and they’re short-term jobs. And they are reasonably high-paying jobs, but often the jobs are imported from construction workers outside the state. And once these wells are drilled, they don’t require people to man them. So these are not good long term sources of revenue for these local counties, communities, or states.

Some of my students, interestingly enough, did a study on a wind farm in a small county, Paulding County, in Ohio, and they showed that the long term revenue produced from the wind farm was actually very stable income and that the county could make use of these—they were called payment in lieu of taxes—PILOT funds to finance their school district, to finance special ed, to finance DARE officers (stay off drug officers), and that a lot of counties throughout Texas, for example, are really very dependent now on income and revenue streams coming from wind. So I think as more municipalities are looking at the long-term stable income that comes in from a wind farm, for example, versus the boom-bust cycle of the oil and gas industry, clean energy will begin to be much, much more appealing—even more so than it is now.

Steven Cherry Historically, a lot of that revenue to communities are really ... there’s sort of no better example of that than Alaska and in fact, in mid-November 2020, in other words, in the lame duck period between election and inauguration, the Trump administration opened up ANWAR, the Alaska Arctic National Wildlife Refuge. In fact, this was our impetus for first contacting you for this show. It’s now mid-January as we record this. Where are we at with ANWAR?

Kathy Hipple Well, it’s a beautiful, pristine part of the world and it’s very high cost to produce oil from that part of the world. And since there’s a glut of oil and a glut of gas on the market worldwide, one questions whether there’s any rational reason for drilling there. But it was one of the final moves by the Trump administration to rush through the process of allowing bidding on these lands.

And it will be interesting to see. Very few bids came in. And it doesn’t mean anybody will go forward because this is not economically producible oil, given current prices of oil. Any firm that puts money into this is likely at the end of the day to lose money.

Steven Cherry You know, back in the mid 2010s, Shell ended up abandoning a $7 billion drilling project in the Arctic, are the oil companies really enthusiastic about drilling there?

Kathy Hipple No, it doesn’t appear that they are. In fact, if you look at most of 2020, there were massive historic write-downs among the big oil companies around the world. The large oil companies did not participate in bidding for the land and water. They ... A couple of smaller companies did. But the larger companies have largely stayed away.

Steven Cherry So is unwarned more of a symbol of a conflict between business and environmentalism?

Kathy Hipple I wouldn’t have put it in those terms, but I think that’s an excellent way to put that.

Steven Cherry The Biden administration promised an enormous infrastructure program oriented toward environmental concerns and shifting to a clean energy economy. Leaving aside the political difficulties in getting any such legislation through Congress, how big a program could we have and still remain within the bounds of good economic sense?

Kathy Hipple I don’t know the exact dollar amount to answer that question, but there’s still a tremendous amount of low hanging fruit with infrastructure spending and energy-efficiency spending. We always talk about moving to clean energy and renewable energy, which is fantastic. There’s an enormous need to build that out in this country. But there’s also a lot of low-hanging fruit about just energy efficiency, which ends up getting kind of short shrift when we talk about the energy transition. That could be billions and billions building out an electric-vehicle-charging system around the country. We need to move very quickly to decarbonize. Many of the countries’ plans are 2030, 2040, 2050. The urgency is to act immediately, to act now. And I’m extraordinarily happy that the Biden administration is moving as quickly as they are—just a few days into their administration.

Steven Cherry I was going to ask you about electric vehicles. It looks like Detroit is finally getting serious about them. How does that change the energy generation situation and the grid distribution system five years from now, 10 years from now?

Kathy Hipple Well, it’s essential to decarbonize the economy and much of the use of oil is for vehicle travel. The more vehicles can be electrified, the less need there will be for oil in this country. The United States has fallen behind Europe in terms of EVs and China is coming along very, very quickly and very aggressively. So the United States has a long way to go.

And part of it is that people do have a concern about range anxiety. There are not enough high-speed chargers. Many people live in apartments, and if they live in apartments, they can’t charge their vehicle overnight. They may not be going to an office, which you alluded to in your opening statement. So they can’t charge there. So if you live, for example, in New York City, where I split my time between Vermont and New York City, if you live in an apartment building, it’s very difficult in New York City to reliably have an EV. And that has to change and it has to change very, very quickly.

Steven Cherry Perhaps we could say a word about nuclear power. We’ve had three really bad accidents and almost three-quarters of a century, four, if you count Three Mile Island. That’s either a lot or a little, depending on how you look at these things. France still gets a steady 63 percent of its energy from nuclear. In fact, it only gets 10 percent from fossil fuels. Now, there are a number of new designs, including one that puts small nuclear plants on barges in the ocean. Is there a future for nuclear construction, new nuclear construction outside of China, which has been continuing to move that way?

Kathy Hipple I am not the world’s expert on nuclear power, but what I see, the cost of solar dropping 90 percent and wind dropping 70 percent and battery storage dropping quickly. I keep seeing estimates for new nuclear power and it is surprisingly continuing to increase. So it is very difficult for a new energy plant, whether it’s gas or whether it’s nuclear, to compete with the dropping cost or the declining costs of solar, wind, and battery storage.

So I don’t see in the United States that there’s a future for certainly not large nuclear. The question would be is how long do the existing nuclear plants continue to operate in the United States? And most of the energy forecasts to get to net-zero by 2030, 2040, 2050, do assume that the currently existing nuclear plants continue to operate, but they do not generally call for new nuclear.

Steven Cherry Finally, there are issues of environmental justice that are economic, for example, the air pollution caused by fossil fuel extraction and consumption falls disproportionately on minorities and the poor. This is something that you’ve studied as well.

I think that the issue of environmental justice has always been there, but it has gained a tremendous amount of traction in the past couple of years, I think, especially in 2020, when it became increasingly clear how disproportionate the poor communities were being affected by fossil fuels, which includes also petrochemical plants.

If you look at Cancer Alley in Louisiana and the number of refineries and petrochemical plants that are in a very small area of Louisiana, it’s very difficult not to be very, very concerned about environmental justice issues and the concept of a just transition. It’s a very interesting one that really needs to be top of mind as we are very thoughtful about accelerating the energy transition. It’s simply as a matter of basic decency and fairness that we cannot have the pollution caused by fossil fuels to fall disproportionately on poor communities and especially black and community communities of color. Terribly unfair.

Steven Cherry In some ways this is a part of a broader question about externalities and how they get paid for either financially or in terms of things like cancer that have tilted our economy toward fossil fuel consumption for a century now. Is there anything that can be done about that?

Kathy Hipple Well, it depends on who you ask. If you asked, for example, Bob Litterman, he chaired the Climate Leadership Committee, and he has pushed hard for a ... essentially a carbon tax, but that if carbon was taxed and if the proceeds of the revenues generated by that was treated like a dividend in his view and that of, I think, his fellow Climate Leadership committee board members, that would go a long way toward addressing some of the social costs of carbon pollution. That’s one possible solution. Other countries are figuring out how to do it with cap-and-trade. But I think it’s only a question of time in this country before we have some kind of a reckoning. And one of the things the Biden administration is doing is trying to actually calculate the social cost of carbon pollution.

Steven Cherry Kathy, we’ve been speaking about oil companies as a sort of hegemony, but are there distinctions you want to make among them?

Kathy Hipple I think that’s a very interesting question, Steven. In the last few years, some of the oil—especially the large oil—companies, we call them oil majors or the integrated oil companies, have started to diverge. So the European oil companies, Shell, BP, Total, in particular, have taken a more forward-looking view toward the energy transition than have their American counterparts, Exxon and Chevron. Exxon and Chevron have largely continued along the path of doubling down on oil and gas production and petrochemicals, whereas Total, for example, has been very forward-thinking for about a decade. Now, are they doing enough? No. Still, a very small percentage of their capital expenditures are directed toward clean energy, but they are at least moving in the right direction. And Shell and BP are very involved as well, at least moving in that direction again—not quickly enough, not aggressively enough, to meet the Paris ... To be aligned with Paris. But at least we’re seeing that they are aware of the energy transition and they are not staking their entire future on oil and gas, but trying to move beyond that.

Steven Cherry Companies like BP have even set a date to be out of fossil fuels 2040 or 2050. How painful is that going to be for them? Are there loopholes that make this more of a PR commitment than a serious one?

Kathy Hipple That’s a great question. BP did actually say they would reduce their fossil fuel production and that the loophole is some of their joint ventures have been carved out of that. But that was one of the most significant because it said they will, along with Repsol another European oil company, did say that they would reduce production. And we need more of that. This industry is mature. It’s declining. We need a managed decline for that industry. And that will not happen if they are just making empty statements.

Steven Cherry Well, Kathy, it seems like we’re not really going to get to where we need to on climate change until we restructure the economy around it. So thank you for your work toward that and for joining us today to talk about it.

Kathy Hipple Thank you very much for having me, Steven. And congratulations on the work that you’re doing with your students at NYU.

Steven Cherry We’ve been speaking with Kathy Hipple, of Bard College’s Managing for Sustainability MBA program, about the clean-energy economy.

Radio Spectrum is brought to you by IEEE Spectrum, the member magazine of the Institute of Electrical and Electronic Engineers, a professional organization dedicated to advancing technology for the benefit of humanity.

This interview was recorded January 25, 2021 via Zoom. Our theme music is by Chad Crouch.

You can subscribe to Radio Spectrum on Spotify, Apple Podcast, and wherever else you get your podcasts, or listen on the Spectrum website, where you can also sign up for alerts of new episodes. We welcome your feedback on the web or in social media.

For Radio Spectrum, I’m Steven Cherry.

Note: Transcripts are created for the convenience of our readers and listeners. The authoritative record of IEEE Spectrum’s audio programming is the audio version.

We welcome your comments on Twitter (@RadioSpectrum1 and @IEEESpectrum) and Facebook.