Federal Reserve Policy Keeps Fracking Bubble Afloat and That May Change Soon

Yves here.  This post highlights an issue that has also been flagged by Wolf Richter, that fracking depends on junk bond financing that has been made unnaturally cheap by the machinations of the Fed. Steve Horn conflates QE with the Fed’s super-low interest rate policy known as ZIRP, when they are distinct, but they have been implemented with the same idea in mind, that of encouraging investors to make riskier investments, particularly riskier loans.

Horn cites sources that suggest that the Fed could start undoing its  rock-bottom rates in 2015. Bear in mind that that’s a minority view.

By Steve Horn, a freelance investigative journalist and past reporter and researcher at the Center for Media and Democracy. Originally published at DeSmogBlog

In August 2005, the U.S. Congress and then-President George W. Bush blessed the oil and gas industry with a game-changer: the Energy Policy Act of 2005. The Act exempted the industry from federal regulatory enforcement of the Safe Drinking Water Act, the Clean Water Act and the National Environmental Policy Act.

While the piece of omnibus legislation is well-known to close observers of the hydraulic fracturing (“fracking”) issue — especially the “Halliburton Loophole” — lesser known is another blessing bestowed upon shale gas and tight oil drillers: near zero-percent interest rates for debt accrued during the capital-intensive oil and gas production process.

Or put more bluntly, near-free money from the U.S. Federal Reserve Bank. That trend may soon come to a close, as the Federal Reserve recently announced an end to its controversial $3 trillion bond-buying program.

In response to the economic crisis and near collapse of the global economy, the Federal Reserve dropped interest rates to between 0 percent and .25 percent on December 16, 2008, a record low percentage. It also began its bond-buying program, described in a recent Washington Post article as implemented to provide a “booster shot” to the economy.

“The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability,” the Fed stated in a press release announcing the maneuver. “In particular, the [Federal Reserve] anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”

That free money, known by economics wonks as quantitative easing, helps drilling companies finance fracking an increasingly massive number of wells to keep production levels flat in shale fields nationwide.

But even with the generous cash flow facilitated by the Fed, annual productivity of many shale gas and tight oil fields have either peaked or are in terminal decline. This was revealed in Post Carbon Institute‘s recently-published report titled, “Drilling Deeper: A Reality Check on U.S. Government Forecasts for a Lasting Tight Oil & Shale Gas Boom.”

Were it not for the Federal Reserve’s policy, the ever-accelerating drilling treadmill would likely slow down, making shale oil and gas production a far less lucrative endeavor for oil and gas companies and the financiers bankrolling it.

Some articles in the business press, including in the Houston Chronicle and Bloomberg, speculate the Fed could lift interest rates on debt in 2015. That would sharply hinder many smaller and mid-level independent oil and gas companies.

Junk Debt Keeps Drillers on Treadmill

A June article published in the Houston Chronicle highlighted the heavy reliance drillers have on “junk debt” to stay on the drilling treadmill. That is, the ever-increasing number of wells drilled to keep production numbers flat on a field-by-field basis, measured monthly or annually.

“[T]he gatekeeper of the nation’s money supply already has signaled it is planning to end its multibillion-dollar bond-buying program by the end of the year, and then begin to raise short-term interest rates toward historically typical levels from the near-zero rates that helped jump-start the recovery,” wrote Chronicle energy reporter Collin Eaton.

That bond-buying program, Bloomberg pointed out, helps frackers to “stay on [the] treadmill.” The combination of the end of the bond-buying and raising of interest rates is no small matter for drillers. 

Higher interest rates might make risky new bond issues by shale producers less attractive, and a flight of investor capital could leave the producers short on a commodity even more precious than oil: Cash,” explained Eaton.

Junk debt earned the name for a reason: it means risky business for investors, but also a higher yield of the cut if the bet goes well. It also means the cash needed for frackers to do exploration and production and the drill baby, drill process.

According to Bloomberg Businessweek, the horizontal drilling process for a single well can cost between $3.5 million to $9 million per well.

“What that tells us is it’s an operation heavily dependent on debt,” Vivendra Chauhan, an analyst for Energy Aspects, told the Chronicle. “Any cash you’re bringing in is being consumed by capital expenditures. This becomes a 2015, 2016 story about what happens when interest rates do rise. If they stop lending, you’ll get a pullback in production growth.”

The accelerating treadmill comes at a steep ecological cost even if the cash has come free of charge via the Fed.

“We’re concerned about what riding out the accelerating treadmill means,” Hugh MacMillan, senior researcher for Food and Water Watch and author of the report “The Urgent Case for a Ban on Fracking,” told DeSmogBlog. 

“It means tens of thousands of new wells each year, for decades, playing out as waves of systematic, widespread and intensive targeting of communities as years go by and as local economies go boom and bust. It means far more climate pollution than we can afford, and it means a legacy of risk to vital sources of drinking water for generations.”

“Melting Ice Cube Business”

According to Eaton, U.S. independent oil and gas producers sold $2.3 billion worth of bonds in the first quarter of 2014 alone. And Bloomberg reported that the number of bonds issued by oil and gas companies has grown by a factor of nine since 2004.

Critics within the world of finance say some investors have erred when it comes to shale, falsely assuming production levels would stay high despite the contrary facts on the ground.

“There’s a lot of Kool-Aid that’s being drunk now by investors,” Tim Gramatovich, chief investment officer and founder of Peritus Asset Management LLC, told Bloomberg in an April article.

“People lose their discipline. They stop doing the math. They stop doing the accounting,” he continued. “They’re just dreaming the dream, and that’s what’s happening with the shale boom.”

If production levels do not stay high and if the price of oil continues to drop, it could mean a real financial squeeze for investors, as well as the demise of smaller, independent oil and gas companies.

This is a melting ice cube business,” Mike Kelly, an energy analyst at Global Hunter Securities, explained to Bloomberg back in April. “If you’re not growing production, you’re dying.”

0% Interest Rates: Not for Average People

While U.S. oil and gas companies have benefitted from near zero percent interest rates for loans, average people have not been so lucky.

A case in point: federal student loans for university students have interest rates ranging from 3.4 percent to 8.5 percent. Another example: credit cards in the U.S. generally have interest rates ranging from 7 percent to 36 percent.

Indeed, an entire activist movement offshoot of Occupy Wall Street started because of the debt crisis faced by average people. That movement coined itself Strike Debt.

Carl Gibson, founder of the anti-austerity group US Uncut, believes it is a trend emblematic of a greater whole.

“The benefits these drilling companies get are the result of a quid-pro-quo system of government. The more they put in, the more the U.S. government puts out,” Gibson said. “When you don’t have the means to shower Congress with millions in campaign donations or hire armies of lobbyists to rig the rules in your favor, the system will always be stacked against you.”

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  1. zapster

    If their free money is mandated in the energy bill, how will ending QE have any effect on it? They’ll still be entitled to it by act of congress.

    1. John Zelnicker

      I didn’t read it quite that way, although looking at it again, it is a bit confusing. The zero interest rates were not a part of the legislation even though he used the word “blessing” in both cases. The text doesn’t say that the “blessing” of the zero interest came from the legislation. It doesn’t specify how this blessing was bestowed, just that it was. In the next paragraph he connects it to the Fed.

    2. goingnowhereslowly

      The Halliburton loophole in the Energy Policy Act said that fracking operations did not need injection well permits under the Safe Drinking Water Act unless they injected diesel with the fracking fluid. Nothing in EPACT addressed monetary policy.

  2. Code Name D

    It’s like dayjavo all over again. Tight oil is looking more and more like the housing market bubble.

    I remember as far back as 2005 observing chatter predicting the housing boom would go bust. And by traditional models, it should have but didn’t. There was one gall who went by the name “Smithy” (this was back in the dial up days, she only did audio files) who correctly identified how securitization could artificially stabilize the bubble – long past the bursting point. Allowing it to grow in orders of magnitude and do far more damage.

    I find myself asking the same question here. What is keeping the oil boom bubble from popping? The jig is not up, production numbers are starting to become harder to hide, prices are dropping and they still can’t seem to build storage tanks fast enough to store the excess inventory.

    And yet some how this thing remains standing. Or will the bottom fall out of the market on November 5th?

  3. Paul Tioxon

    Okay money people, is this doomed to failure or what? Gas fired power plants located practically on top of the gas wells. No pipeline to big buck payoff, so cheap gas burned into electricity fed directly into PJM Power Grid. Coal killer prices with no dirty coal image problems. Natgas continues to displace coal for electricity production with help of EPA anti-coal regs. So, is EPA helping prop up natgas by killing off coal, the way one drug cartel gets help from the Policia to do in their rivals, if yo catch my drift? Looks that way to me.


    ” The flurry of power-plant projects in the Marcellus is aimed at taking advantage of the region’s natural-gas price, discounted since so much gas cannot reach distant markets because of pipeline constraints. Merchant power producers can convert that gas to electricity and sell the power into the regional grid operated by PJM Interconnection Inc.

    The new generation of gas plants also is displacing dirtier coal-fired power stations, cutting the output of carbon dioxide, nitrogen oxides, and sulfur dioxide emitted from coal.

    IMG, formerly known as Iron Mountain Generation, is backed by New York-based private equity firm Bregal Energy.

    Bregal is also an investor in Atlantic Wind Connection, a proposed transmission project off the Jersey Shore, and Inflection Energy, a Colorado oil and gas producer active in the Marcellus.”

  4. Chris

    This assumes that QE ending will automatically drive interest rates higher, but the change in the available portfolio is what drove rates lower, not the act of buying by the Fed. The stock of treasuries and MBS available has changed, just because the flow of money from the Fed has ended doesn’t mean rates go up anytime soon, especially with the economy the way it is.

    Lack of refinancings for marginal homebuyers is what drove the first subprime lenders under I presume. What drives the marginal driller out of business? As rates stay low, most can still refinance, extend amort period and continue CapEx. The bigger impact will be oil prices on borrowing base collateral I believe.

    1. Yves Smith Post author

      You are straw manning the post. The more hawkish regional Fed presidents have been calling for rate increases in 2015. Most market pundits don’t see it as likely but it is possible. Rate increases always his the weakest credits first. That is why the post talks about possible trouble in 2015.

      What drove the first subprime lenders under was that their loans were so bad (many borrowers didn’t even make a single payment) that their putback rates were so high that they went under. That took place even with some of the parties providing warehouse lines NOT being able to put enough loans back (as in they were securitizing terrible garbage) because if they did put the loans back to the originator, they knew it would fail, and they couldn’t take the losses on their warehouse lines.

      1. Chris D

        What am I straw manning? The real problem is comparing a driller that could potentially sell a commodity with a student loan borrower in an environment where there is no job opportunity. I agree that fracking companies have benefited from lower rates, I disagree with the assumption that this will magically change because QE has ended.

        1. Aaron

          Couldn’t agree with you more Chris. The lower price of crude (dropping again this morning) I believe, will be the overriding problem for marginal projects. There was a good article on FuelFix yesterday on this subject.


          I don’t buy the argument that the Fed is going to raise rates in 2015, but if they are stupid enough to believe the “recovery” is organic and sustainable, it will be entertaining to watch them try.

          1. McMike

            The economy as it is structured cannot tolerate higher rates =
            The elite will not permit higher rates =
            The Fed cannot raise rates =
            The Fed will not raise rates.

            No idea how they will finesse it, or if they will even bother to finesse it, but they will not raise rates on net.

        2. Yves Smith Post author

          You are straw manning the post AGAIN as well as ignoring my reply.

          I said QE is not raising short term rates, which the Fed calls tightening. The post conflates the two a bit but it never tied the risk to junk bonds to the end of QE. It clearly states 2015 as the window when risk begins, which is when the Fed might start tightening.

  5. Chris D

    Smaller pool of MBS and treasuries drove rates down, not the actual purchases. The composition won’t change unless the Fed starts selling some of their assets off. Hard to see rates increasing much without significant improvement in the labor market or the economy, either.

    The canary in the coal mine for subprime was when refinancers couldn’t close deals and subprime lenders went under. I think a lot marginal drillers can still refinance and extend amort for now. The change in oil prices may have an impact, but it could take a while.

    1. Yves Smith Post author

      Huh? Don’t you get that QE was about trying to compress the spread between MBS and risk free rates to encourage refis (an indirect form of stimulus) and make housing more “affordable”? And that buying Treasuries in the belly of the curve was to lower long term rates? But QE was a stupid way to go about it. If you target quantities, you can’t target yields. They should have targeted rates (as the Fed did in WWII, very successfully) and done whatever quantity of QE that was necessary to achieve that end.

      The Fed has made it clear that it is not selling assets. In fact, it is committed to keeping its MBS levels constant for now by replacing runoffs due to normal runoff due to sales of houses, which lead to the disappearance of the related loan.

      You keep fixating on QE and that is not where the action will be. The traditional mechanism for Fed tightening is to raise policy rates, as in the Fed fund rate. It has new tools to play with short-term rates via its reverse repo facility. You keep insisting in looking in the wrong place where the Fed will start tightening.

      1. Chris D

        I requested this comment to be deleted as it says the same thing I said earlier (I thought I closed the tab before it was submitted). To me, it seems you chose not to delete it so you could make another point that I am not making.

        I am not making any point about tightening or where that will occur. Just disagreeing with the idea that the lack of QE is going to drive rates higher.

        1. Yves Smith Post author

          Your words are crystal clear so you can hardly complain about what you wrote. And I can’t delete them without breaking the thread. Moreover, as matter of site policy I don’t delete comment unless they are duplicates (specific duplicates, not generally redundant), from someone who was blacklisted but got around it (banned is banned) or so insanely abusive as to merit expungement. You don’t have the right to sanitize your own record, particularly when you willfully persist in arguing a point in error.

      2. Aaron


        That may have been the stated intention, but as we’ve learned there were other, less philanthropic intentions. The Fed is first and foremost about keeping the banking “system” intact and keeping the wealth-skimming mechanisms in place. Once you understand that, everything else is just lip gloss.

  6. McMike

    Increased gas pipelines and more gas power generation, and most importantly, gas export terminals going on line will lead to a renewed boom on the shale gas fracking side.

    Industry is biding its time for that. NY and CO are paving the way to clear regulatory hurdles, TX and ND are ready and waiting.

    1. ambrit

      My problem with that is energy price in general. Every extra step of the gas production and transmission system adds extra costs to the endeavour. With the Saudis able to drive down hydrocarbon prices almost at will, where is the superiority of the American gas production regime? It is still captive to the global hydrocarbon price. “Festung America” is all well and good for the Police State, but when it comes to messing with international capital, think again. Another leg of this infernal tripod is the cost of renewable energy sources. When global hydrocarbon prices reset, I would cynically suggest after the U.S. fracking bubble has been well and truly popped, the hydrocarbon price per watt will sooner or later cross the renewable watt level and ‘level the playing field.’ The other avernal appendage to this procrustean stool is efficiency. This may well come due to public demands for improvement in devices and dwellings as prices for energy grow steadily as a percentage of median incomes. Price per watt for hydrocarbons is the Canary in this Gas Well.

      1. McMike

        Yes, the cost curves will eventually pass each other by.

        But the shale industry’s anticipation of exporting gas to Asia is very real. And will certainly lead to a resurgence of the gas bubble, at least for a while. Exporting gas from the US on a large scale is essentially a disrupting “new technology” in effect, in term of opening the spigot to a previously blocked supply vector.

        1. ambrit

          Apropos of the LNG phenomenon would be if the major producers figured out a way to economically liquefy all that gas they presently flare off at the well head. Now there’s a cost efficiency crying out for implementation. Again, once the costs cross the threshold, it all becomes ‘inevitable.’ (Economic Evitability, now there’s a measure worthy of a genius level Doctoral Thesis.)

  7. dee prestom

    Isn’t tje real issue that the fracters don’t have to comply w/clean water act?? The loophole needs to be closed before its too late! Whoever allowed THATt loophole should be held accountable! That is the whole problem as I see it. Halliburton is a criminal enterprise. They are criminals and ruining the water and the whole environment. That is INSANE!!

  8. susan the other

    This post just confounds me. Unless I see QE and zirp as emergency measures that must be taken in order to keep what is left of the old dead system functioning, I can’t explain it to myself at all. Why interest rates would go up because the fake shale boom collapses doesn’t make much sense. Why interest rates would go up at all doesn’t make any sense either. The system collapsed because finance tried to fake it with MBS and failed, but the real problem is that the economy failed long before that. And oil is at the heart of the insanity. We are in a global war over oil; the Europeans are even pitching in. But catch-22 says even when/if we get control of Middle East oil it will not resuscitate the world we knew as recently as the 90s. Interest rates seem almost meaningless at this point because the idea of money is changing. I’m more curious about what Obama and Yellen are really discussing today.

  9. afisher

    Many here has been hating the current administration – and if you get your way, there will be a different congress in 15 – but the RW / Libertarians can’t be calling for more QE – as it is government inserting itself in the market – which they have been screaming against for years.

    GOP want a free-market….so what about free-handouts to Big Oil? It will be interesting to see how these companies that have been screaming against handouts to mere individuals will now have to turn on a dime and plea for a bigger handout for them. An interesting Catch 22 scenario – should make for interesting reading .

    As is my wont, I often look to what other information is on a site and at Desmogblog – the Banking Industry is also the biggest player in Coal – to the tune of $80B in loans. So ZIRP is ending as QE ends wouldn’t that indicate that the cheap banking of coal may be dying with it. If OIL is no longer refi at ZIRP or near ZIRP, the energy sector may be in for a really big “POP”. Of course, I am not an economist / banker, etc.

  10. kevinearick

    Inflation Rotation: Getting Nowhere Faster

    Business Card. God helps those who help themselves, and so does labor.

    Question: Which individual do you choose to pull out of the rip current?

    Back of an Envelope. Gather some envelopes. Draw a hysteresis loop on each. Suspend them in a manner that creates supply and return.

    Question: Where is the gravitational field, magnetic field, double-sided mirror, and how is gravity adjusted?

    If you look in small community newspapers, you will see critters waking up, but still incapable of accepting responsibility, because their own participation has been normalized to seek a scapegoat first, with early childhood education, superstition and propaganda.

    America has been propping up European banks since its inception, addressing the symptoms of natural resource exploitation, with natural resource exploitation. The one and only change is global communication, which is rapidly becoming fascist itself.

    Big city critters run away from the outcomes of their habits, returning to the small community, only to seek answers from the big city, and the system discharges, as you should expect, but that energy doesn’t disappear.

    The big city cannot feed itself, and so pits small communities against each other, with BigAg. Trading surplus for a toilet paper intermediate is one thing; impoverishing your community with RE inflation is another.

    America is better at exploiting nature with derivative science than any other nation in History, which is self-adjusting if you move forward.

    Big city voters don’t blaze a trail to the future. They show up when all the work is done, impatient, looking for entertainment, which attracts the loan sharks who buy their votes with growing access to credit of increasing maturity, squaring the circle with diminishing returns on evacuating labor hunted accordingly.

    Financial control increases with leverage, and the system chokes itself.

    The more time you spend in the loop, the more your future will be controlled by the past, debating until it’s far too late, when someone has to be thrown under the bus, repeating the process. Critters with falling standards for self crave to belong, so the odd one out is obvious.

    The problemsolution of a dc economy is that everything must be working to identify what is not working, when it stops working, and the monkeys are always throwing wrenches into the equipment, based upon future probability extrapolated from the past. And the apes are more than happy to inflate money on the resulting economic activity of creating artificial scarcity, until all the monkeys have bankrupted themselves.

    The critters jump the safeties and blow out their own processor, because they do not understand the closed system in which they dwell, shrinking it to avoid reality beyond themselves. That is History of, by and for passive aggressives, agreeing to hide from themselves, assuming that everyone else is likewise blinded.

    Everyone makes mistakes, but not everyone repeats the process expecting a different outcome. Drive up the price of gold, copper, whatever, for banksters owning all the mines, all the paper, and most of the physical, as you like. Empire always begins by cornering itself, hoping you will follow, and tl:dr does, every time, attempting to short the short.

    You want to be at the implicit multiplexer hub, where you have many good options, which means that you want to be building a gate, instead of traveling in a hysteresis loop looking for the best of bad options, spending your time at an increasing purchasing power loss, buying the time of others at an arbitrage disadvantage.

    You want a closet full of solutions, skill, instead of a closet full of secrets, anxiety, or be born well in a game of last to lose, in which the only secret is that everyone loses, sooner or later, one way or the other.

    Labor loses the empire game every time, from beginning to end. Inflation in the global city you can have, but inflating rents in the small community is self-destructive. Allowing critters in London to manage the small community with remote control is pretty stupid, but that is empire, where nothing is an emergency and everyone is a firefighter.

    Why can’t a peer pressure group, whether Church, State, University or Bank, tell you whether the furnace it is trying to control is on?

    Public education doesn’t produce juvenile behavior by accident. You can only rent what appears to be a life in a wage and price control empire, which can wipe you out for non-compliance at will. Houses, cars, furniture, equipment and tools are a dime a dozen, if you see the empire for what it is.

    The ‘Market’ is a rigged lottery, and only your own can throw you under the bus. Who competes to pretend to be in control of an automated machine producing debt with arbitrary technology is irrelevant. Turn the needle into a circuit, for economic mobility, and everything else will take care of itself.

    1. kevinearick

      So, the central banks don’t think money laundering to drive up global city real estate prices is the problem, but rather that it’s the solution, which is why they are bankrolling slumlords in small communities. The critters are always surprised to find out that their Federal Land Bank is the slumlord of slumlords. All is well; just ask Bank of England.

  11. vegeholic

    The one fact that I hoped to learn by reading this article was missing. What is the rate that drilling/fracking companies pay on their bonds. We are told that student loans are 3.5%-8.5% and that credit cards are 7%-36%. So what do these companies have to pay and who buys their bonds? How exactly does the Fed arrange for investors to ignore the risk and settle for a low interest rate? These supporting facts would certainly help to justify the headline about the Fed keeping the fracking bubble afloat.

    1. ambrit

      A more useful measure would be the rate of revolution of functionaries between Government and Business in this sector.

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