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Wonking Out: To Shale and Back, Redux

The price of oil, which was extremely low during the worst of the pandemic — it actually went below $0 for a brief, weird period — has spiked as a result of Russia’s invasion of Ukraine:

The crude realities of war.Credit…FRED

This price spike is adding to already high inflation, and it is inhibiting the Western response to Vladimir Putin’s aggression — governments are reluctant to tighten sanctions against Russian energy exports, lest rising prices anger their voters.

But shouldn’t we expect the market to help reduce this problem? Don’t higher prices provide an incentive to increase oil production outside Russia? Yes, they do, and there are in fact signs of at least some supply response to high prices. So far, however, most media accounts suggest that this response is limited, and that the U.S. oil industry — which is where most of the extra production would probably have to come from — is reluctant to expand.

OK, obligatory reminder that higher oil production would not necessarily be a good thing. The dangers of climate change just keep getting even more terrifying, and the world needs to wean itself from fossil fuels, not produce more. At best, you can make a St. Augustine argument — “Make me chaste and celibate, but not yet” — for higher oil production during the Ukraine war. But even that’s dubious.

Still, the tepid response of oil producers to very high prices needs explaining. Why aren’t they rushing in to take advantage of the Putin premium?

Of course, the usual suspects blame President Biden, who is responsible for everything bad — hey, I blame him for the fact that my first cup of coffee this morning was a bit weak. Or they denounce environmentalists and government regulation — remember the rush to blame the 2021 electricity crisis in Texas on renewable energy, when disrupted supplies of natural gas were actually the main factor?

But the Federal Reserve Bank of Dallas recently carried out a survey of oil producers, asking them what was inhibiting their expansion, and for the most part they didn’t blame either regulators or environmentalists. Instead, they blamed their bankers:

Bankers put the brakes on oil.Credit…Federal Reserve Bank of Dallas

What’s that about? The answer is, we’re looking at the aftermath of the debt-financed shale bubble of the 2010s.

The introduction of fracking — using high-pressure water jets to fracture shale containing trapped natural gas and oil — was, without question, a big deal. But many people in the business world (and, for what it’s worth, the national security community) treated it as a bigger deal than it was. I don’t know how to quantify this, but my sense all through the 2010s was that Very Serious People were far more enthusiastic about fracking than they were about the truly revolutionary advances in renewable energy. After all, extracting oil and gas sounded hardheaded and realistic, while a surprising number of influential people still associate solar and wind power with hippie fantasies.

And this Serious Person enthusiasm for hydrocarbons translated into a willingness to throw money at the fracking industry, which bled cash year after year but kept going by running up hundreds of billions in debt.

Eventually, however, this debt-financed boom hit a wall. The death of the former chief executive of Chesapeake Energy in 2016 seemed to mark the end of the industry. Chesapeake eventually became one of more than 230 oil and gas companies to declare bankruptcy since 2015.

But the financial implosion of fracking didn’t provoke a broader financial crisis, as some observers worried. The bad news is that the aftermath of that implosion is, as I said, inhibiting the West’s response to Putin’s aggression today: Having been burned in the past, the energy sector’s bankers are keeping a tight leash on spending despite the surge in oil prices.

They may be overdoing it: Whatever happens in the war, it’s hard to see Russia fully rejoining the world economy for a long time, so oil prices are likely to stay high for a while. Still, the caution of fracking creditors is understandable. And to be fair, the really important energy adjustments will have to come from Europe, which needs to end its dependence on Russian natural gas.

There are, I think, two broader lessons here.

First, bubbles don’t necessarily involve obviously flaky ideas. We can and should make fun of investors taken in by Silicon Valley technobabble, but it’s perfectly possible to lose hundreds of billions on ventures that seem perfectly solid, except for the fact that their math doesn’t add up.

Second, burst bubbles can have long lasting effects. One reason rents are surging right now, adding to inflation, is the long drought in home building that followed the housing bubble — a bubble that burst 15 years ago:

Housing, still weak after all these years.Credit…FRED

I just hope that fossil fuel advocates don’t manage to use the current oil shock to bash climate activists, who bear no responsibility for the mess we’re in.


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