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Frack On

Irwin M. Stelzer

There is something about the energy business that is conducive to the creation of myths. So Roger Sant, a long-time and highly respected participant in the energy policy game and in the industries that energy legislation and regulation affect, told a group of Houston oil men recently. Energy myths do die, but only to be replaced by new ones. For decades the myth that drove policy and the energy companies’ investment policies was scarcity. Now the myth is perpetual abundance.

Old Myth: The world, and especially America is running out of oil. New Reality: Thanks to fracking, which extracts oil and gas from shale, we have larger reserves of oil than we did years ago, despite rising consumption. The new worry is an impending oil glut.

Old Myth: Natural gas is too precious and scarce a resource to waste as fuel in electric generating stations, so government should force a switch to coal. New Reality: Natural gas is being discovered in such abundance that except when the weather turns bitter cold prices are so low that gas is displacing coal as a fuel for electric generation here in America.

Old Myth: Electricity from nuclear power will be too cheap to meter. New Reality: Electricity from nuclear plants is uneconomically expensive as construction costs continue to run out of control and governments have to offer huge subsidies to get nukes built.

Old Myth: Consumers will never use less electricity or petrol merely because their prices go up. New Reality: Higher electricity prices cause customers to adjust thermostats and lighting, and high gasoline prices spur sales of more fuel-efficient vehicles.

As these scarcity myths meet their justly deserved fate, a powerful new one emerges. New discoveries of oil and gas reserves uncovered by fracking make America “energy independent.” That myth is leading to dangerous policies. Because domestic oil production is booming, and we are on the way to becoming perhaps the world’s largest producer of oil, we are told we can ignore the Saudis when devising policy towards Iran, and refuse to build a pipeline that would bring more crude oil from Canada. Moreover, new discoveries of natural gas mean we can dispense with the domestic coal industry, a one this administration is pledged to destroying, surrendering an important source of fuel diversity.

That confidence in abundance is, at minimum, premature, at maximum dangerous. For one thing, some engineers worry that the rate of production of fracking wells will fall off sharply after the early years, and the U.S. Energy Information Service is warning that shale oil development “is still at an early stage, and the outcome is highly uncertain.” For another, many of our refineries are not equipped to process domestic crude — they are built to use heavier, more sulphurous Middle East and African crudes. So we and the rest of the world still depend on crude oil from unstable places such as Libya, Nigeria, and South Sudan.

Finally, oil prices are made in world markets, still subject to supply interruptions and with the lowest-cost producer the key price-setter. That low-cost producer, Saudi Arabia, can, if it chooses, drive prices below the level our fracking industry needs to survive. Leonardo Maugeri, who has been a manager at Eni, the Italian oil giant, and is now an associate at the Harvard University’s Belfer Center for Science and International Affairs, estimates that 80 percent of projects now planned could be profitable with oil prices at $70 per barrel. Harold Hamm, CEO of the largest shale producer in the prolific Bakken of North Dakota, disagrees. He thinks a $70 price would hurt the industry, and is hoping for a price closer to $100 per barrel. Averages are often deceiving: some companies can make do at $40, others need Hamm’s $100 price. No matter: in the end the Saudis will be the price makers.

Also, the huge supplies of shale gas extracted by fracking are no substitute for gasoline, which will remain the principal fuel for transportation no matter how rapidly other fuels penetrate the market for new vehicles. Cheap natural gas will not necessarily mean cheap crude oil and cheap gasoline.

These uncertainties notwithstanding, even a sober view of fracking is that it will provide the world with plenty of energy in years to come. For now, one thing is certain. Rising oil and natural gas production in the United States is laying the basis for more rapid economic growth as we compete for investment with countries with sky-high energy costs. The EU bureaucracy last week affirmed its love of costly wind machines and solar panels, but industry loves low-cost energy. Energy-intensive industries are moving to America to get access to it, especially since it is found in states with laws unfavorable to trade union organization. Low energy costs and the possibility of a work force responsive to management rather than union organizers is a combination difficult to beat.

It is too early to shout “manufacturing Renaissance” in the U.S., although the National Association of Manufacturers is predicting that low-cost natural gas — about one-fourth of the cost in Europe — will result in one million new manufacturing jobs in the U.S. by 2025. Many will be filched from anti-fracking Europe. Austrian steel maker Voestalpine is spending over $700 million to build a new plant in Texas; German chemicals giant BASF is spending $5.7 billion on plants that in prior years would likely have been built in Europe. South America, too, will feel the competitive pressure: Canada’s Methanex Corp. is laying out $425 million to dismantle a methanol plant in Chile and move it to the U.S.

The danger here is that politics might trump economics. Yoko Ono, Lady Gaga, and Sir Paul McCartney are leading a thus-far successful lobbying effort to stop fracking in long-depressed upstate New York, where several celebrities have homes and most inhabitants need jobs. They argue that fracking threatens the area’s water supply. Governor Andrew Cuomo is stalling on granting drilling permits lest he antagonize the stars and their publicity machine. Other threats to fracking include the anti-fossil-fuel crowd that fears an increase in carbon emissions, never mind that fracked natural gas is displacing much more carbon-intensive coal, driving U.S. emissions steadily down.

In the end, policy and prices will determine the extent of the fracking revolution. So far, if I might be permitted a pun, the industry has a green light to proceed with drilling.

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