Jeremy Grantham is not a believer in the shale fracking boom.
Back in November, we highlighted Grantham’s full quarterly letter to GMO clients, in which he said, among other things, that the US shale boom had been “a very large red herring.”
“Its development has been remarkable,” Grantham writes.
“It will surely be seen in the future as a real testimonial to the sheer energy of American engineering at its best, employing rapid trials and errors — with all of the risk-taking that approach involves — that the rest of the world finds so hard to emulate. Similarly, it will always stand out as remarkable proof that, so late in the realisation of the risks of climate change and environmental damage, the US could expressly deregulate such a rapidly growing and potentially dangerous activity.”
The overall thrust of Grantham’s letter is that the world will soon be devoid of the resources it is going to need to sustain our current economic model, which over the past 150 or so years has been predicated on cheap energy, namely oil.
A concern Grantham has with fracking is that the boom hasn’t been accompanied by any real concern as to the environmental damage it may be inflicting. But Grantham is also hugely sceptical on the potency of the shale boom because it doesn’t address the problem of our need for cheap oil.
Grantham writes: Fracking “has not prevented the underlying costs of traditional oil from continuing to rise rapidly or the cash flow available to oil-producing countries like Saudi Arabia, Iran, and especially Venezuela from getting squeezed from both ends (rising costs and falling prices).”
And as we saw last week, OPEC announced that it would not impose production cuts despite the sharp decline in oil prices seen over the past few months, and it seems unlikely that Grantham would be surprised by this.
Because if your national economy is chiefly predicated on exporting oil, you have made your bed and therefore must lie in it as oil prices drop.
But the US boom, which as Grantham notes has accounted for almost all of the increase in global oil production over the past several years, has been undertaken by companies, not countries.
And so with an eye toward profit, Grantham writes, these companies “have drilled, as always, the best parts of the best fields first, and because the first two years of flow are basically all we get in fracking, we should have expected considerably better financial results by now. The aggregate financial results allow for the possibility that fracking costs have been underestimated by corporations and understated in the press.”
And with a decline in oil prices set off by too much supply, it will be these companies that are forced to pare production, which will reduce supply, which will create — once again — expensive oil.
“The current fall in price does nothing to offset the squeeze on the total economy from rising costs,” Grantham writes. “It merely transfers massive amounts of income from one subgroup (oil producers) to another (oil consumers), in a largely zero-sum game.
“Oil consumers tend to spend more and save less than oil companies so short-term impacts are favourable. But we should not be carried away with enthusiasm because the declining investment from the oil industry will lower future growth. When, as now, oil costs are still rising even as prices fall there is of course a particularly savage effect on the profits of oil companies, squeezed from both ends.
“They must and will rapidly adapt by reducing expenditures and therefore oil production with the fairly obvious result that prices will rise again. The only longer-term price relief and net benefit to the economy will come when either we reverse recent history and start to find more oil more cheaply, which will be like waiting for pigs to fly, or when cheaper sources of energy displace oil.”
And so for Jeremy Grantham, nothing fundamental has changed about our relationship with oil: pigs still don’t fly.