The bottom falls out of BC's overhyped LNG gamble

How lucky do you feel?

by Mitchell Beer

Slot machines, Las Vegas | Photo (CC BY 2.0) by Paul Hudson

This is an adapted excerpt from All Fracked Up! The costs of LNG to British Columbia, out October 2020 from Watershed Sentinel Books. (order here)

I’ve had a few friends over the years who insisted their favourite pastime was to visit their friendly neighbourhood casino. They swore it was fun, even relaxing, to set aside a chunk of cash for a few hours at a roulette wheel or slot machine (aptly nicknamed “one-armed bandits” by my parents’ generation), then pour those dollars into an organized, well-oiled system where the game is fixed and the house rarely loses.

If they could save up enough of those dollars to blow the rest of them in a gambling mecca like Las Vegas, they said, so much the better. If you’re going to spend $40, $80, $100 or more on a night out for two, they asked, what’s the difference between dinner and a movie, an outdoor concert, or a casino trip?

And always, the amped-up hope in the background: once in a while, y’know, you just might win. (But not if you just go to a movie.)

A couple of those friends were convincing enough that I stopped second-guessing their choices, though I haven’t stopped judging the purpose-built gambling joints where every design feature – from the bright, flashing marquees and low ambient lighting, to the confusing aisles and hard-to-find exits – is meant to pull you in and keep you there.

But most of us would draw a big, bright line if we thought our governments were gambling our tax dollars and pension funds on “sure” bets about as reliable as a craps table or a one-armed bandit. Particularly if they were placing bets in the billions of dollars, rather than tens or hundreds, on our behalf.

And even more so in a moment when we thought we’d agreed that all our personal and government resources would be focused on recovering and “building back better” from a devastating global pandemic.

Understanding how those bets work, and why they’re so risky, brings us into the high-stakes, jargon-filled world of commodity futures and energy price hedging. It’s not for the inexperienced or the faint-hearted – when you try to dig in and start learning how personal investing works, you’re quickly told to stay clear of futures contracts and leave them to the “pros.”

When fossil companies tap out their wells faster than expected, they cover their losses by raising more money to drill more wells… which then fall short of expectation, so that the cycle repeats and amplifies.

Those are some of the same investment professionals, of course, who brought us the crash of Enron in 2001, the collapse of the US mortgage bubble in 2008, and the waves of investment that brought climate change to crisis proportions. But the grain of truth is that betting it all on the success of a decades-long project, when it’s utterly impossible to predict the stable supplies, prices, demand, or geopolitics on which it depends, is unwise for any government that sees itself as a responsible steward of public tax dollars. It becomes downright dangerous when the tax revenues that fund public services in a province like British Columbia depend to any degree on a collection of projects as risky as fracking and liquefied natural gas (LNG).

The fall of a “frack master”

For several years, a steady drumbeat of critical analysis has raised serious concern that many of North America’s shale oil and gas deposits have been overhyped, or at the very least, overestimated. There’ve been persistent reports of fossil companies tapping out their wells faster than expected, too quickly to recover the dollars that were invested to get them into production. Their short-term solution: Cover their losses by raising more money to drill more wells… which then fall short of expectation, so that the cycle repeats and amplifies.

As one online investment guide explains it: “Investors contribute money to the ‘portfolio manager’ who promises them a high return, and then when those investors want their money back, they are paid out with the incoming funds contributed by later investors.” The company orchestrating the deals can “merely transfer funds from one client to another” as the process rolls on from one investment to the next.

The problem is that that wasn’t meant to be a snapshot of a legitimate business operation. It’s the Investopedia definition of an illegal Ponzi scheme.

With the shale rush in the northeastern part of the province, British Columbia is getting its own first-hand look at the industry. But shale gas has made much of its reputation in the United States, and not all of that reputation is stellar.

In 2018, business operator and self-proclaimed “frack master” Chris Faulkner, former CEO of Dallas-based Breitling Energy, faced up to 12 years in prison after admitting to securities fraud, tax evasion, and money laundering. “With fake college degrees and the business experience of starting a web-hosting firm,” the Dallas Morning News reported, “Faulkner convinced the Dallas business elite and Texas political elite that he was an oil and gas expert. Officials at federal investigating agencies say Faulkner used the expert persona he faked to defraud investors out of $80 million.”

Even if the producers are as shocked and dismayed at the wells’ poor performance as their investors presumably are, the history shows that relying on a shale play to pay off is extremely risky.

In March 2020, DeSmog told the story of Alta Mesa Resources, a company formed in November 2016 by influential industry veteran Jim Hackett, a former fracking CEO and executive committee member of the American Petroleum Institute. A highlight of the case: Just one year after claiming in 2018 that an average well at its core acreage in Northeast Kingfisher County, Oklahoma would produce 250,000 barrels of oil, Alta Mesa cut its estimate to 120,000 barrels. By May 2019, DeSmog said, the company’s practices had prompted a number of lawsuits.

But the record for overstated shale resources must surely have been set in May 2014, when the US Energy Information Administration reported that the volume of oil in the Monterey shale, then considered the country’s biggest formation, had been overestimated by 96%.

In March 2015, analyst Deborah Lawrence, Executive Director of the Fort Worth, Texas-based Energy Policy Forum, reported that investors in the US shale revolution were receiving only mediocre to poor returns, despite the “extreme hype” that had drawn them in. Of the top five producers in the Marcellus shale in the northeastern US, the bottom three lost 1% to 89% of their value over five years, “all during the height of the shale gas revolution,” she stated. In late June 2020, Chesapeake Energy, the Oklahoma City-based fossil widely seen as a pioneer in the US shale boom, declared its US$9-billion debt load unmanageable and filed for bankruptcy.

DeSmog’s story on Alta Mesa Resources ends with an account of a Wall Street Journal reporter attending an industry seminar and learning that there are much more accurate methods for predicting oil production – and that those methods often produce considerably lower estimates for shale reserves. “There are a number of practices that are almost inevitably going to lead to overestimates,” said Texas A&M professor John Lee – yet those are the practices the industry uses.

Citing the WSJ story, DeSmog said a workshop participant “stood up and challenged the engineers in attendance,” asking why the forecasters weren’t using the accurate models Lee had described. “Because we own stock,” another engineer replied.

And then participants laughed.

A house of cards

This is not to suggest that all shale projects are fraudulent. If companies and their investors missed the memo about Lee’s seminar and bought a set of numbers based on a fatally flawed methodology, it may not have been wise, but that doesn’t mean it was deliberate.

But even if the producers are as shocked and dismayed at the wells’ poor performance as their investors presumably are, the history shows that relying on a shale play to pay off is extremely risky. Certainly much riskier than, say, signing a 20-year Power Purchase Agreement for a solar or wind farm, or investing in dozens or hundreds of deep energy retrofits that will reliably deliver energy and cost savings, year after year.

Unless you’ve already made the commitment.

As any casino operator will tell you, it’s tough to break an addiction once you’re hooked. After a multi-year oil price slump began in 2014, US shale producers had no choice but to keep pushing product out into a saturated market.

“The shale revolution has always been funded by massive debt,” Lawrence wrote in March 2015. “Operators who were drilling for gas back in 2009-2011 used debt extensively.” So when they produced more gas than the market could absorb and prices tanked, “many couldn’t afford to pull back production to help stabilize prices. Had they done so, they would not have been able to meet their debt payments. So they kept pumping… and pumping… and pumping.”

It took a global pandemic and an unprecedented price crash to begin to shift that picture, even though there’s been no shortage of critical analysis:

In October 2018, the Sightline Institute and the highly-regarded Institute for Energy Economics and Financial Analysis detailed the “alarming volumes of red ink” in the US shale industry, with combined losses of $3.9 billion over six months. As pointed out at the time, it was a particularly bad look for the industry, following the International Energy Agency’s projection that US shale would finally break even in 2018 after blowing through $200 billion in cash flow between 2010 and 2014.

In the second half of June, in what was widely seen as a bombshell for the global industry, BP and Shell each acknowledged that some of their oil and gas holdings will never be developed, producing “stranded assets” worth up to US$39.5 billion.

In an analysis for the Post Carbon Institute, Canadian earth scientist and shale analyst J. David Hughes chronicled the industry’s failures and critiqued US government projections for shale oil and gas production through 2050. “Ultimately, technology can’t overcome core characteristics of shale,” he wrote, including well decline rates of 75-90% in the first three years, field declines of 25-50% per year without new drilling, and variable quality within reservoirs, with high-quality “sweet spots” accounting for no more than 20% of a given field.

How lucky do you feel?

Asia – the region that accounts for more than half of global demand – is where successive British Columbian governments have always been intent on selling their product.

It isn’t that Premier John Horgan or his apparently like-minded predecessor, Christy Clark, would never have been able to find a projection of future LNG demand that matched up with their overheated export ambitions. It’s more that the numbers range widely enough to support almost any set of conclusions. Which means that, by cherry-picking the analysis, it would be easy for any government of any stripe to make a deep, long-term commitment based on data that is wafer-thin.

Here’s how that’s been turning out for them so far:

In mid-December 2018, analysts at consultancy group Wood Mackenzie confidently predicted that uncontracted LNG demand in Northeast Asia could quadruple, to 80 million tonnes per year, by 2030. reported that WoodMac foresaw decisions in 2019 to proceed with LNG megaprojects in Russia, Mozambique, and the US, as well as smaller “backfill projects” in Australia and Papua New Guinea.

Just nine and a half months later, the picture was much less certain. “The next wave of LNG demand growth expected from Asia’s emerging economies is far from assured, raising questions over how fast supply from new projects can be absorbed by the market in the coming decade,” S&P Global Platts advised in October 2019. While “some industry proponents have argued that supply will create its own demand,” the release added, “looming risks of a recession mean expensive LNG could be the first fuel countries axe from their energy mix when demand slows.”

By late January 2020 – a moment when the coronavirus outbreak had hit hard in China, but still weeks before the World Health Organization declared a global pandemic – the prognosis for LNG was downright morose. With Asian economies signalling slower economic growth, the market was “still small enough that it takes considerable time for LNG demand growth to catch up with new LNG supply,” Petroleum Economist reported, and creating demand would hinge on “downstream investment that is equal to or greater than the cheque being written for new liquefaction.”

By mid-March, with crude oil prices collapsing, more than a dozen LNG projects had been scrapped. “Even before crude’s drop, developers were under pressure from a slump in global gas prices, milder winter temperatures, and demand restraints from the coronavirus,” Bloomberg wrote. In late April, the Institute for Energy Economics and Financial Analysis weighed in with a list of cancelled or deferred investments that included BC’s Woodfibre LNG project, as well as the proposed Goldboro LNG project in Nova Scotia.

In late April, columnist Nick Cunningham reported that at least 20 LNG cargoes from the US had been cancelled by customers in Asia and Europe. “The price for LNG in Asia was already crashing before the pandemic,” he wrote.

In early May, both the International Energy Agency and Royal Dutch Shell predicted permanent reductions in fossil energy demand, as the changes wrought by the coronavirus pandemic changed the oil and gas industry forever. “The plunge in demand for nearly all major fuels is staggering, especially for coal, oil, and gas,” said IEA Executive Director Fatih Birol. “Only renewables are holding up during the previously unheard-of slump in electricity use.”

In the second half of June, in what was widely seen as a bombshell for the global industry, colossal fossils BP and Shell each acknowledged that some of their oil and gas holdings will never be developed, producing “stranded assets” worth up to US$39.5 billion. Analysts confidently predicted the two industry giants would be the first, but not the last, to acknowledge a permanent shift in global energy markets.

By then, Nikkei Asian Review had reported that growth in China’s LNG imports was set to fall from 12.1% in 2019 to just 1.8% in 2020. Japan’s imports were on track to fall by 1.2%, South Korea’s by 0.5%. “The weak demand in Asia will influence investment in LNG projects involving contracts in the region,” the Review stated, and “the recent crash in the oil market will have a negative impact on LNG investment” since “plummeting revenues have forced oil super majors to slash investment in LNG.”

Pop quiz: If John Horgan were the provincial opposition leader, what would he say about a sitting premier betting it all on that kind of risk?

It’s a baked-in feature of oil and gas markets that prices and demand are constantly shifting. That’s why Alberta will be doomed to a boom-and-bust economy until it can diversify its economy beyond petroleum and its various spin-off products. It also means BC’s gamble on LNG depends on a long list of rosy assumptions – from economic growth in Asian countries driving ever-higher demand for gas, to limited competition from sources of supply that are closer by or more convenient, to investors willing to tune out their mounting concerns about the risks of climate disruption and stranded assets. All of those unpredictable, uncontrollable assumptions have to go close enough to plan, often enough, for the bet to pay off.

(Pop quiz: If John Horgan were the provincial opposition leader, what would he say about a sitting premier betting it all on that kind of risk?)

But here’s a question you rarely see LNG boosters ask: If experience in North America shows increasingly that natural gas costs less than coal in a head-to-head comparison, but solar and wind (with or without battery storage) are cheaper still, and energy efficiency is often the most affordable choice of all… if other regions of the world are reorienting their energy and climate strategies along those lines, why would anyone tacitly assume that planners in Asia would weigh the same options and come to a different conclusion?

The increasingly likely answer is that they won’t. For years, a top decarbonization priority in Asia has been to challenge coal plant construction and financing, and that battle hasn’t yet been won. But the Institute for Energy Economics and Financial Analysis says the region is now beginning its renewable energy transition. China has been the world’s leading renewable energy investor for a decade, IEEFA Director of Energy Finance Studies Tim Buckley wrote in mid-May. And “while South and Southeast Asia have been renewables laggards, Asia is nevertheless on the cusp of a dramatic pivot. Recent developments across India, China, Japan, South Korea, Vietnam, and Taiwan highlight the potential for change.”

Until now, LNG proponents have counted on energy demand in Asia continuing to grow, quickly and more or less reliably, as the region develops. But that picture keeps getting more complicated. Now, to justify a multi-decade, multi-billion-dollar provincial commitment with many thousands of jobs in the balance, British Columbia has to hope or assume:

  • That faltering gas demand will recover,
  • And that demand for coal-fired electricity will switch to gas,
  • And that gas prices will recover to a point where producers can break even, but somehow avoid being undercut by renewables,
  • And that in embracing gas, countries will choose to pay more than they have to for their heating, cooling, lighting, and connectivity,
  • And that BC can meet a large enough share of that demand to justify a big LNG buildout,
  • And that a region facing immediate, acute climate vulnerabilities will continue to accept an energy source whose greenhouse gas emissions are 84 times more potent than carbon dioxide over the crucial 20-year span when humanity will be scrambling to get the climate crisis under control.

In the aftermath of the COVID-19 pandemic, those assumptions don’t appear too sound. Not with the European Union, Canada, and New Zealand all looking at grounding their post-coronavirus economic stimulus in green recovery packages. Not with India increasingly favouring renewables in its exit from coal, the newly-elected majority government in South Korea beginning to confront the deep complexities of implementing its promised Green New Deal, and the consistently mainstream International Monetary Fund pledging $1 trillion for pandemic emergency loans that also address the climate crisis.

It isn’t impossible, and it may even be likely, that some of those funds will be directed to shale gas and LNG projects. But with the technology, economics, and climate impact analyses all pointing in another direction, how likely is BC to see any return on the billions in taxpayer subsidies and the years of policy support it has lavished on the industry? Particularly when public opinion is quickly turning against gas, and major investors may not be far behind?

The grown-ups in the room

None of this means LNG demand will evaporate tomorrow, nor even that any and all LNG exports from BC to Asia are doomed to fail. But with every economic setback, every cost reduction for renewables and storage, every new methane study, every fracking ban, every anti-pipeline campaign, every lawsuit and regulatory decision, the prospects for a continuing LNG boom become more tenuous – as some gas analysts are now acknowledging. And “tenuous” is not the adjective you want your government to lead with when it’s investing billions of dollars in an industrial strategy on your behalf.

In a democracy, we elect governments to take care of the issues that are too big to handle on our own, to be that grown-up in the room when we need someone looking out for our interests.

Whether the gamble is on an LNG pipe dream or a Las Vegas casino, the enticing draw for would-be winners is that the house doesn’t always win. One very close friend of our family beat the Las Vegas house (and lived to tell the tale) by changing up his assumptions: along with a co-worker, his goal wasn’t to win at penny slots, but to figure out how little they could get away with paying for bargain-basement beer and wine if they played slowly, drank quickly, and tipped the server lavishly. (By their own standard, they won big.)

There are two crucial differences between John Horgan’s big LNG gamble and our friend’s deliberately offbeat experience: The stakes for BC are so much higher than penny slots. And all the unconventional influences – the shady numbers behind shale gas production, the impact of energy efficiency and cheap renewables on future demand, and the emerging role of the coronavirus pandemic in reshaping energy use patterns – will make it far more difficult to bring home a win.

And that means the likely outcome for BC is much closer to the wrenching fate of the gambling addicts who file into those friendly neighbourhood casinos every day. In a democracy, we elect governments to take care of the issues that are too big to handle on our own, to be that grown-up in the room when we need someone looking out for our interests. The surest way to do that is to follow the evidence – on energy futures, carbon reductions, local economic development, Indigenous rights and title, farmland and biodiversity protection, and all the other issues the LNG file brings into play – rather than hanging on for dear life until the gamble goes up in smoke.

All Fracked Up! The costs of LNG to British Columbia | Watershed Sentinel BooksThis is an adapted excerpt from All Fracked Up! The costs of LNG to British Columbia – a new collection featuring graphic storytelling and articles from Maude Barlow, David Hughes, Christopher Pollon, Ben Parfitt and more on the costs and risks of fracking and LNG in BC. Out October 2020 from Watershed Sentinel Books (more details & pre-order here).

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