Julian Rodríguez-Drix presents our extended feature, “Frackonomics: Economic Strategy for Fractivists.” In this strategy-based piece, Julian provides an in-depth analysis of the oil and gas market in order to provide activists with a roadmap for economics-based strategies. In addition to clearly explaining the industry and its economic incentives, Julian’s work should prove useful for coalition-building between environmental and other activists, particularly students, land owners, and animal rights activists.

This issue marks a transition for Occupy America from a bi-monthly release schedule to a monthly release. It is our hope that this adjustment allows us to continue providing high-quality, in-depth coverage while reaching new writers.

As always, thank you for your time and I hope you enjoy.

Sincerely,

Bobo Bose-Kolanu

Lead image shows the Horai power station, Fukushima in 1975. Courtesy of National Land Image Information (Color Aerial Photographs), Ministry of Land, Infrastructure, Transport and Tourism, Japan.

Emissions trading was elevated as the international policymaking community’s preferred mitigation solution by the passage of the Kyoto Protocol in 1997, a multilateral agreement ratified by 156 sovereign states and infamously ignored by the United States, then the world’s largest emitter.^[2] Seeking to accommodate corporate firms’ capital accumulation strategies, emissions trading policies issue commoditized credits to pollute (one credit allowing one legal ton of CO₂ emissions) capped on a nation-by-nation basis toward the overall goal of reducing emissions through decentralized redistribution of credits among actors with different propensities to pollute. While proponents perceive the market as a neutral means for resolving the tension between climate change’s global reach and the divisive state of global politics, further investigation reveals this supposed neutrality to be a sham.

Dodging Historical Responsibility

As a complex phenomenon with an inexorable historical context, one might expect solutions to global warming to deal with history frankly. Cap-and-trade approaches, however, do exactly the opposite. The Kyoto Protocol’s allotment of credits on a historical basis is most gracious toward those countries with the most significant historical responsibility for emissions, the United States and the countries of the European Union, which in 2007 accounted for more than half of the world’s cumulative CO₂ emissions with less than a sixth of its population.^[3]The prevalent system of “grandfathering,” where countries allocate the largest portions of their credit quotas to their most polluting industries, similarly reinforces embedded inequality but on the scale of individual domestic economies.^[4] Nations and industries with the greatest historical responsibility for emissions are, with emissions credits, perversely given the most freedom to continue polluting.

An institutionalized moral hazard framework for allocating carbon credits cannot change long-standing behaviors responsible for creating the climate crisis in the first place.

The Market Cannot Fix The Planet

Despite the fact that the Kyoto Protocol’s recourse to the market evades historical justice, proponents of carbon trading schemes are slow to realize the deeper, structural problems with the cap-and-trade approach. From the perspective of the biosphere it is expansion of the traditional economy itself that is the problem. As John Bellamy Foster and Brett Clark note, “in a properly functioning capitalist economy savings are redirected into investment or new capital formation designed to expand the scale of the entire economy… it is such expansion that is the chief enemy of the environment.”^[5]

In other words, as firms save money (for example, by switching to greener technology that lowers fixed costs like electricity bills), they redirect that money into expanding the scale of their operations in order to make even more profit. Environmentalist Wes Jackson sums the point up sharply: “When the Wal-Marts of the world say they’re going to put in different lightbulbs… what are they going to do with savings? They’re going to open up another box store somewhere. It’s just nuts.”^[6] An economy based on carbon-intensive, production-based growth cannot cleanly transition away from this reliance by replicating its profit-maximizing market-based approach in carbon trading. Instead of addressing the core of the problem cap-and-trade schemes expand it.

Cap-And-Trade Is The New Bubble Economy

Industrial capitalism is not the only capitalism at play in cap-and-trade. In today’s heavily finance-based market systems, risky trading schemes analogous to those responsible for the global recession and subprime mortgage crisis are beginning to appear in carbon trading markets as well.^[7] Understanding how carbon credits are calculated is necessary to understanding how these markets evolved.

In theory cap-and-trade enables markets to efficiently allocate plots of land to their most economically productive uses, while building in the risk associated with greenhouse gas pollution. For example, a polluting firm might purchase a carbon credit to offset its emissions, and the credit may represent a tract of land in the Amazon to be kept clear of development in order to act as a carbon sink.

In order for these calculations to take place cap-and-trade first requires establishing baselines. The baseline process is essentially arbitrary. Setting a baseline requires measuring the projected change in emissions a climate-friendly project might accrue against the amount of emissions happening would the project not be implemented. While at first glance this process seems logical, the blind spots are significant. Since greenhouse gasses are a function of human activity, the baseline requires deciding on quantity and quality of human activity over time. Furthermore, since accurate measurements of carbon sequestration — a natural process for trees, akin to breathing — are difficult to produce, it is easy to be seduced by the market incentive to overvalue the amount of sequestration taking place. Since valuation schemes are not rigorously regulated, traders are free to manipulate conditions as they see fit, allowing polluters to continue emitting greenhouse gasses while doing little to abate global warming overall.^[8]

The picture gets more complicated with the introduction of the negative futures contract, where sellers of credits promise not to emit. In exchange for no effective change in behavior, a firm is able to offset its carbon emission on paper while not performing or causing any real offsets ecologically.

Like the relationship between collateralized debt obligations (CDOs) and home mortgages, emissions credit prices are not aligned with any real underlying asset such as the health of the environment. Instead their prices are determined by market demand. Since the debt obligations are bundled in tranches to offset risk and regulatory oversight is absent, no real assets guarantee the debt. As both a trade in debt and a negative futures contract, the buyer-seller relationship of emissions trading is cemented by the seller’s appearance of not having emitted a set amount of carbon, which is then borrowed by the buyer to emit the same amount. In a vein similar to the collateralized debt obligation market preceding the 2008 financial crisis, this sweet but unsustainable arrangement foreshadows a massive risk of default, namely that the parameter of the emissions trading game, the health of the atmosphere, is not improving but instead deteriorating at a rapid pace. Emissions credits, while meant to insure buyers against overall rises in emissions, thus aggravate the destruction of the environment.

The cap-and-trade market is not a solution to the greenhouse gas problem. In fact, it is a Trojan horse, a magnification of the problem masquerading as a solution. Not only does it ignore the historical responsibility of the United States and Europe in creating the climate scenario we are now embroiled in, it also actively rewards and incentivizes increased pollution with risky trading structures that proved their volatility in the subprime mortgage crisis. Effective environmental solutions will need to look elsewhere.

The Economic Lay of the Land

Finding weak points in the industry’s business models requires an understanding of its economics. Fortunately for environmental and social justice activists, the natural gas industry faces a number of structural constraints. First, the extremely low price of gas keeps profits tight. Gas is currently around $3.5 per mmBtu^[3] and analysts expect gas to remain low for some time (in 2012 the low was only $1.9 compared to the 2005 high of $15). ⁴  The minimum price for ‘unconventional’ gas  to be profitable is $3 – $6, depending on the gas formation.^[5]

Second, the price of oil is relatively high and analysts predict it will stay high.^[6] The difference between oil and gas prices has pushed companies to shift focus to shale that produces oil or  “liquids” instead of just “dry” gas like methane.^[7]  Natural gas liquids (NGL) include ethane, propane, and butane, which are derived from “wet” gas and can substitute for some uses of petroleum, such as producing plastics.^[8] Companies are being forced to switch to drilling for oil and NGLs, which fetch higher prices, in order to survive.^[9]

Third, the gas industry is stuck in a vicious cycle of falling profits and overproduction. They produced record supply levels of gas which drove the price so low they were losing money to produce it.  However, they keep drilling and producing more gas because of requirements in investors’ contracts, leases that expire, and significant initial investments they don’t want to lose.^[10] There are over 1000 drilled Marcellus wells waiting to be connected to pipelines, guaranteeing additional supply and keeping prices low.^[11]  Companies’ value is based on their reserves and low prices mean those reserves are worth much less, which deeply cuts their profits and worth.^[12]

Finally, fracking is expensive and produces a diminishing rate of return. Drilling and fracking a single Marcellus shale gas well costs an average $3-$4 million dollars^[13] and as much as $7.6 million.[14] While fracking initially produces a large amount of gas production levels drop within months,^[15] requiring another round of fracking. All these factors conspire to make the economic outlook of the oil and gas industry tenuous at best.

The Natural Gas Players

In the face of these challenges the natural gas industry has developed survival strategies, but with careful analysis we can uncover vulnerabilities. Each type of gas industry player has different incentives and weak points, and the misalignment of these incentives presents opportunities for fractivists to intervene. Let’s take a closer look at how the types of businesses involved make a profit.

• Investors supply financing to all parts of the supply chain, but can shift their investments in order to reap the biggest profits.  Overall industry health is inconsequential to investors so long as they extract profit somewhere. Examples: Goldman Sachs, Jefferies[16]
• Operators^[17] contract and coordinate all production activities, buying leases to get acreage in target areas.  Operators use investment capital to find and produce gas and earn profit from selling it. Examples: Chesapeake, ExxonMobil, Anadarko, BP
• Drilling companies^[18] own fleets of drilling rigs and are contracted by Operators to drill wells.  Some are independent companies, others are subsidiaries of Operators or Service companies.  Examples: Helmerich & Payne (independent), Patterson-UTI (subsidiary of Universal Well Services, fracking service company), Nomac (subsidiary of Chesapeake)
• Service and Supply companies^[19] are contracted for fracking or other specialized operations, which are the most expensive part of production.  The price of gas or which Operator contracts them is irrelevant as long as there is demand for their specialized techniques.  Examples: Halliburton, Schlumberger, Baker Hughes
• Midstream companies^[20] own and operate infrastructure (pipelines, compressors, storage facilities, processing plants) to transport gas/NGLs to market. They buy gas/NGLs at low prices from Operators and sell at higher prices to Consumers, charging for transport and storage. Operators and Utilities can have divisions that are Midstream companies. Examples: Williams, Enterprise Products, Dominion, TransCanada (owner of Keystone XL)
• Consumers are major buyers of natural gas and NGLs, including Utilities (gas and electric) and other industries including Chemical, Steel, and Fertilizer.  They want the price of gas to be low in order to keep their costs down and profits up.

How To Hit Them Where It Hurts

How can we use this knowledge of the natural gas industry to devise economically effective fractivism? Overall our strategy follows a simple guiding principle: shrink profit margins by increasing the costs of production and keeping demand low.

In response to the structural pressures of their industry and the sector-specific interests above, each class of the natural gas players has created business strategies to turn a profit. Each of these profit models presents an attack opportunity for fractivists.

They: Decrease Production To Maximize Cashflow and Increase Gas Prices

We: Increase Cost Of Production to Cut Into Profits, Cause Cashflow Problems

Operators that have sufficient cashflow, such as ExxonMobil, Chesapeake, and EQT, are pulling back on production with the hopes of causing gas prices to rise to more profitable levels.^[21] They either sit on existing leases waiting for market conditions to improve, sell leases to smaller operators, or let some leases expire rather than produce gas at a loss. Overall, the number of rigs in operation has dropped dramatically.^[22]

The industry has dug itself into a hole, and fractivists can help keep them there.  With current low prices, any increase in the cost of production cuts into the industry’s profits and pushes them further into unprofitability. There are a diversity of tactics that can be used to increase costs. Fracking is the most expensive part of production^[23] and requires timed deliveries of supplies (water, sand, chemicals) and equipment (pressure pumping).  Any disruption or increased expense in these long supply chains, whether from sabotage, civil disobedience, or additional regulations, will increase the cost of the service companies and impact multiple wells and companies. Passing legislation or local ordinances that require new environmental or economic impact assessments, fees or taxes, worker safety evaluations, or transportation/storage safety evaluations can disrupt operators’ cashflow. To maximize frustration, requirements should be passed at all levels of government: federal, state, municipal, and county. Contradictory or conflicting guidelines with different filing requirements can further increase the legal costs of doing business.

They: Shift To Natural Gas Liquids (NGL) To Increase Profit

We: Target New NGL Infrastructure

Operators have shifted focus to NGLs (derivatives of wet gas such as ethane, propane, and butane) in order to make profit from NGLs higher prices.  This has caused high production levels of NGLs and a similar round of oversupply and dropping prices.^[24]  Midstream companies are working to build new NGL infrastructure to handle this extra supply and deliver it to petrochemical consumers.  This requires new NGL pipelines such as the 1,230 mile ATEX (Appalachia-to-Texas) Express,^[25] new NGL storage facilities such as Inergy’s proposed LPG storage in New York,^[26] and the construction of specialized “ethane crackers” that turn ethane into ethylene, a petrochemical feedstock.^[27]  Shell is planning to build a $2 billion ethane cracker petrochemical facility in Pennsylvania,^[28] though the plans are not yet finalized.^[29]

New infrastructure offers opportunities for fractivists to disrupt industry plans and build alliances with other activists, such as those concerned with public health and toxins, economic justice activists, or landowners concerned about use of eminent domain. Fractivists can learn from the resistance of Texan land owners in the Tar Sands Blockade against Keystone XL^[30] who are upset about the use of eminent domain to enable foreign companies to seize Americans’ land for their own profit.^[31] In Canada, the indigenous Idle No More movement has had success in blockading rail lines and stopping transportation of propane.^[32]  In British Columbia, the Unist’ot’en Clan of the Wet’suwet’en Nation has blocked several proposed tar sands oil and fracked gas pipelines from crossing their unceded sovereign territory.^[33]

They: Develop New Markets to Increase Demand

We: Expose Their Greenwashing And Block Access to New Markets

The industry’s main strategy to deal with oversupply is to increase the demand to match. Overall the industry seeks to bolster demand by replacing coal with gas for electrical production, promoting compressed natural gas (CNG) vehicles as environmentally friendly, exporting gas as liquefied natural gas (LNG),^[34] and selling NGL for plastic production and other petrochemical uses.  Blocking access to these markets with a broad diversity of tactics is a key priority for fractivist strategy.

The environmental costs of natural gas production have already been detailed as hugely detrimental elsewhere,^[35] but the industry is attempting to sell their technology as an environmentally friendly replacement for coal and gasoline, a technique known as “greenwashing.”^[36]  Exposing the industry’s greenwashing is important to win the PR war. Fractivists have already scored a major victory with “fracking” becoming a household word with negative connotations^[37] and the industry is explicitly trying to avoid the “F” word.^[38]  Fractivists need to use the word “frack” to expose the industry, set the framework, and develop strong partnerships with anti-coal, anti-diesel, and climate change activists to make sure that they don’t advocate natural gas as a “solution.”

They: Use Mergers, Partnerships, and Foreign Investment^[39] To Manage Cashflow

We: Target Investors With Public Pressure And Support Divestment

Smaller operators without large cash reserves are feeling the squeeze of market conditions. Even Chesapeake, one of the biggest producers, had to sell off $6.9 billion of pipeline and gas field assets to focus on oil and liquids.^[40] Domestic gas producers formed joint ventures with or were bought out by foreign companies such as StatOilHydro^[41] (Norway), Total^[42] (France), Sinopec^[43] (China), BHP Billiton^[44] (Australia), and others.  A total of $51 billion from overseas was invested in US oil and gas fields in 2011.^[45]  Investment firms like Jefferies, Barclays, and Goldman Sachs are essential to this reshuffling, not only providing financing but structuring the deals and creating requirements for production levels, which incidentally are what led to current levels of oversupply.^[46]

Targeting investors can take many forms.  Concern is growing that shale gas investment is the next bubble, with companies purposefully overstating the size of their reserves and productivity of their wells.^[47]  Fractivists have used the economic analysis of former investment banker turned public servant Deborah Rogers and others to expose this concern,^[48] which could be used to scare off risk-averse investors.  Public pressure campaigns against firms financing mountaintop removal^[49] have proven successful and provide an example for fractivists to learn from. Finally, divestment is a tactic successfully used in support of the South African anti-apartheid movement^[50] and the Palestinian Solidarity Movement,^[51] and is proposed as a tactic against fossil fuel companies.^[52]

Conclusion

The goal of the ideas presented here is to help create unity and focus to make our movement more successful: not by searching for a magic bullet but by weaving together many local struggles within a general strategic framework.  An overall framework that encompass a wide range of tactics, targets, and efforts is more likely to be successful than strategies that call for everyone to do one single thing. Like a healthy ecosystem, the more diverse and interconnected our movement is the stronger it will be.

This is not the first or last word on this subject, but an addition to ongoing conversations.  As market conditions change and as the industry tries to respond to the ongoing success of our global movement, we will have to adjust our efforts accordingly.  By maintaining an economic analysis of the industry and continuing strategies that target their weaknesses, I believe we have the power to go on the offensive and win. Together, we’ll protect the land, water, local economies, and communities that we love.

Resources: Industry documents

• Oil and Gas Investment Environment (Ralph Eads, Vice Chairman, Jefferies & Co)

http://www.jefferies.com/CMSFiles/Jefferies.com/files/Conferences/112812/Presentations/Ralph%20Eads%20-%20Oil%20%26%20Gas%20Investment%20Environment.pdf

• The US Energy Revolution: How Shale Energy Could Ignite the US Growth Engine (Goldman Sachs, Asset Management – Insight on Today’s Investment Issues, September 2012)

http://www.goldmansachs.com/gsam/docs/fundsgeneral/general_education/economic_and_market_perspectives/ps_us-energy-revolution-tpd.pdf

• Shale Fueling Chemicals Boom (Zacks Equity Research, January 2013)

http://www.zacks.com/stock/news/90793/shale-fueling-chemicals-boom

• Task Force on Ensuring Stable Natural Gas Markets (American Clean Skies Foundation)  Note: see last pages of report for list of industry participants and list of commissioned papers on the subject

http://www.cleanskies.org/wp-content/uploads/2011/05/63704_BPC_web.pdf

• Oil & Gas Financial Journal – Unconventional Resources

http://www.ogfj.com/unconventional.html

Resources: Activist Economics

• (Event) FRACKONOMICS – Debunking the financial myths of shale gas and embracing a green energy future.  Video of talks available at http://shaleshockmedia.org/2012/05/08/frackonomics/

• Energy Policy Forum – Deborah Rogers Shale Gas Economic Presentation (video)

http://energypolicyforum.org/2011/12/01/deborah-rogers-shale-gas-economic-presentation/

Julian Rodríguez-Drix

I am a fractivist from New York’s Marcellus Shale gasfields.  I am not an economist, but have spent years studying gas industry business news looking for strategic insight.  This article’s goal is to summarize some strategy ideas for fellow fractivists.