How Wall Street Enabled the Fracking 'Revolution' That's Losing Billions

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The U.S. shale oil industry hailed as a โ€œrevolutionโ€ย has burned through a quarter trillion dollars more than it has brought inย over the last decade. It has been a money-losing endeavor of epicย proportions.

In September 2016, the financial ratings service Moodyโ€™s released a report on U.S. oil companies, many of which were hurting from the massive drop in oil prices. Moody’sย found thatย โ€œthe financial toll from the oil bust can only be described as catastrophic,โ€ particularly for small companies that took on huge debt to finance fracking shale formations when oil prices wereย high.

And even though shale companies still aren’t turning a profit,ย Wall Street continues to lend the industry more money while touting theseย companies as good investments. Why would investors doย that?

David Einhorn, star hedge fund investor and the founder of Greenlight Capital, has referred to the shale industry as โ€œa joke.โ€ย 

โ€œA business that burns cash and doesn’t grow isn’t worth anything,โ€ said Einhorn, who often goes against the grain in the financialย world.ย 

Aren’tย investors supposed to be focused on putting money towardย profitable companies? While, in theory, yes, the realityย is quite different for industries like shale oil andย housing.

If the U.S. financial crisis of 2008 has revealed anything, it is that Wall Street isn’t concerned with making a โ€œshitty dealโ€ when it meansย profits and bonuses for its traders and executives, despite their roles in theย crash.

Wall Street makes money by facilitatingย deals much like a Vegas bookie makes money by taking bets. As the saying aboutย Las Vegas goes: โ€œThe house always wins.โ€ What’s true about casinos and gambling also holdsย true forย Wallย Street.

Wall Street caused the 2008 financial crisis, with some of itsย architectsย personally benefiting. However,ย while a few executives profited, the result was a drop in employment of 8.8 million people, and according to Bloomberg Newsย in 2010, โ€œat one point last year [2009] the U.S. had lent, spent, or guaranteed as much as $12.8 trillion to rescue theย economy.โ€

JP Morgan (along with much of Wall Street) required large sums of money in the form of bailouts to survive the fallout from all of the bad loans made, which brought aboutย the housing crisis. Is JP Morgan steering clear of making loans to the shale industry? No. Quite theย opposite.

As shown in this chart of which banks are loaning money to shale companyย EOG Resources,ย while all of the big players in Wall Street are in on the action, JP Morgan has the biggestย bet.ย 

To understand why JP Morgan and the rest of these banksย would loan money to shale companies that continue to lose it,ย it’s important to understand the gambling concept of โ€œthe vigorish,โ€ or the vig.ย Merriam-Webster defines vigorish as โ€œa charge taken (as by a bookie or a gambling house) onย bets.โ€

Wall Street makes money by taking a cut of other peopleโ€™s money. To a gamblingย house, it doesn’t matter ifย everyone else is making money or losing it, as long as the house gets itsย cut (the vig) โ€” or as it’s known in the financial world โ€”ย fees.

Understanding this concept gives insight into why investorsย haveย lent a quarter trillion dollars to the shale industry, which has burned through it. If you take the vig on a quarter trillion dollars, you have a big pile of cash. And while those oil companies may all go bankrupt, Wall Street never gives back theย vig.

Trent Stedman of the investment firm Columbia Pacific Advisors LLCย explainedย to The Wall Street Journal at the end of 2017 why shale producers would keep drilling more oil even when the companies are bleeding money on every barrelย produced:

โ€œSome would say, โ€˜We know itโ€™s bad economics, but itโ€™s what The Streetย wants.’โ€

And โ€œThe Streetโ€ generally gets what it wants, even when it is clear that loaning money to shale companies that have been losing money for a decade and are already deep in debt is โ€œbad economics.โ€ But Wall Street bonuses are based on how many โ€œfeesโ€ an employee can bring to the bank. More feesย meanย a bigger bonus. And loans โ€” even ones that are clearly bad economics โ€” mean a lot moreย fees.

Shale Oil Companies Are ‘Creatures of the Capitalย Markets’

In 2017 โ€œlegendaryโ€ hedge fund managerย Jim Chanosย referred to shale oil companies as โ€œcreatures of the capital markets,โ€ meaning that without Wall Street money, they would not exist. Chanos is also on record as shorting the stock of heavily leveraged shale oil giant Continental Resources because the company canโ€™t even make enough money to pay the interest on itsย loans.

And he has a point. In 2017 Continental spent $294.5 million on interest expenses, which is approximately 155 percent of its 2017 adjusted net income generation. When you canโ€™t even pay the interest on your credit cards, you areย broke.

And yet in 2017, investor capital was still flowing, with Continental Resources among those bellying up to the Wall Street trough for another billion inย debt.

โ€œIn 2017, U.S. [exploration and production]ย firms raised more from bond salesย than in any year since the price collapse started in 2014, with offerings coming in at around $60 billion โ€” up nearly 30 percentย from 2016, according to Dealogic. Large-cap players like Whiting Petroleum, Continental Resources, Southwestern, Noble, Concho and Endeavor Energy Resources each raised $1 billion or more in the second half ofย 2017.โ€

How big of a problem is this business of loaning money to an industryย burning through billionsย and burying itself in debt? So big that the CEO of shale company Anadarko Petroleum is blaming Wall Street and asking its companies to please stop loaning money to the shale oil industry. Yes, that’sย right.

In 2017, Anadarko CEO Al Walker told an investor conference that Wall Street investors were theย problem:

โ€œThe biggest problem our industry faces today is you guys. You guys can help us help ourselves. Itโ€™s kind of like going to AA. You know, we need a partner. We really need the investment community to showย discipline.โ€

The Wall Street Journal reports that Walker maintains: โ€œWall Street has become an enabler that pushes companies to grow production at any cost, while punishing those that try to live within theirย means.โ€

Imagine begging banks to stop loaning you money. And beingย ignored.

Growing production at any cost is the story of the shale โ€œrevolution.โ€ The financial cost paidย so far has been the more than $280 billion the industry has burned through โ€” money that its companies have receivedย from Wall Street and, despite the plea from Al Walker, continueย toย receive.

The Economist summarized the situation inย 2017:

โ€œIt [the shale industry] has burned up cash whether the oil price was at $100, as in 2014, or at about $50, as it was during the past three months. The biggest 60 firms in aggregate have used up $9 billion per quarter on average for the past fiveย years.โ€

Higher oil prices are now being touted as the industryโ€™s savior but, as The Economist noted, the shale industry was losing money even when oil was $100 aย barrel.

Still Wall Street keeps giving the shale industry money and the shale industry keeps losing it as itย ramps upย production. To be clear, this arrangement makes shale company CEOs and financial lendersย very rich, which is why the trend is likely toย continue. And why Continental Resources CEO Harold Hamm will continue to repeat the myth that his industry is making money, as he did at the end ofย 2017:

โ€œFor anybody to even put forth the suggestion we haven’t had great expansion and wealth creation in this industry with horizontal drilling and all the technology that’s come about the last 10 years, I mean, it’s totallyย ridiculous.โ€

No one will argue that Hamm and his partners on Wall Street are not extremely wealthy. Thatย has happened despite Hammโ€™s company and the rest of the fracking industry losing epic sums of money. The same year Hamm made that statement,ย his company couldnโ€™t even cover its interest expenses. To put that in perspective, Continental Resources couldnโ€™t even make the equivalent of the minimum payment on its creditย card.

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Watch What the Industry Does, Not Whatย Itย Says

Higher oil prices are yieldingย more stories about how 2018 will be the year that the shale industry finally makes a profit. Harold Hamm refersย to it as Continental Resources’ย โ€œbreakout year.โ€ย Interesting how potentially notย losing money for a year is considered a โ€œbreakout yearโ€ in the shaleย industry.

As reported on DeSmog, the industry certainly got a huge boost from the recent tax law, which will help its companies’ย short-term finances. Continental Resources alone took home $700 million in taxย relief.

Recent reports in the financial press detail how the new approach in the shale industry will be to focus only on profitable oil production, not just producing more barrels at a loss. As The Wall Street Journal put it in a headline:ย โ€œWall Street Tells Frackers to Stop Counting Barrels, Start Makingย Profits.โ€

In that very article, Continental CEO Hamm assures that he is on board with this new approach, saying, โ€œYou are really preaching to theย choir.โ€

But has Continental actually embracedย this new approach of fiscal responsibility andย restraint?

Not soย much.

The fracking firm appears to have done the opposite, increasingย production to record levels along with the rest of the shale industry. Continental recently reported plans to drill 350 new wells at an estimated cost of $11.7 million per well, which adds up to over $4ย billion in total costs on those wells. The companyย currently holds more than $6 billion in debt and less than $100 millionย cash.

How will Continental fund those new wells? Hamm has promised that going forward, there would be โ€œabsolutely no new debt.โ€ Perhaps Continental will fund it by selling assets because without more debt, Continental does not have the money to fund those new wells. However, if past is prelude, then Wall Street will happily lend Continental as much money as itย wants.

Why would Hamm say one thing and do another? Well, he personally has accruedย billions of dollars while his company has burned throughย billions.

Despite leading Continental to another money-losing year in 2017, Hammย took homeย a fat raise.

Correction: This article initially estimated the cost for 350 new wells at $400 million. The correct number is $4ย billion.ย 

Follow the DeSmog investigative series:ย Finances of Fracking: Shale Industry Drills More Debtย Thanย Profit

Main image: Wall Streetย sign in New York. Credit: publicย domain

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Justin Mikulka is a research fellow at New Consensus. Prior to joining New Consensus in October 2021, Justin reported for DeSmog, where he began in 2014. Justin has a degree in Civil and Environmental Engineering from Cornell University.

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