A Paradox of Gluttony

September 7, 2012

Even the cursorily familiar with economics will have heard of the Paradox of Thrift; when people, worried about the future of the economy, save rather than spend, and in doing so ensure that the economy takes a downturn.

The current shale gas boom in the US is an example of a different kind of paradox: a paradox of gluttony, of excessive greed leading to failure. Shale gas has been held up as the saviour of our economy; a new resource we can exploit in order to deliver cheaper energy and hence growth. However, unlike normal booms, no-one whose core business is extracting shale gas is actually making any money.

The reasons for this are pretty clear:

Henry Hub Natural Gas Spot Price Chart

Henry Hub Natural Gas Spot Price data by YCharts

Following the economic crisis, gas prices collapsed due to falling demand. The advent of shale gas has served to keep prices low, to the point where profitability of the sector is collapsing.

Why is this the case? Markets should respond to a price signal like this by decreasing production. Instead, gas production in the US has actually risen over the period.

The reason behind is an astonishing case of induced greed; an example of talking one’s book on an epic scale. The initial flood of investment into shale gas came from several ‘pioneer’ companies such as Chesapeake massively overleveraging themselves in order to snap up shale plays cheaply before the rest of the market caught on to the potential of fracking. Of course, once they’d done so, they had to ensure that the market, in fact, caught on. And so, they engaged in an enormous publicity campaign about the potential of fracking, placing articles in the media, engaging the investment community and generally putting themselves around quite a bit*.

It had an impact. Money flooded into shale exploitation, in the main by buying plays at extortionate rates from ‘pioneer’ companies, who proceeded to make a great deal of money. These plays have now been written down in large part. Nonetheless, the gas continues to flow, as the once greedy  and now worried investors lose money on their assets and demand production continues to extract any possible value, assuming that at some point other people will blink and the price will rise. Of course, if everyone does this, then the price will continue to stay too low for anyone to make any money. This is a paradox of gluttony.

It is difficult to say how long this particular ‘boom’ will last, estimates ranging from six months to several years. Nonetheless, it will eventually end in a squabble of recrimination, litigation and spiking gas prices. The environmentalists will blame the greed of the frackers, the libertarians will blame a quirk of SEC regulations that allowed the likes of Chesapeake to claim that a play is profitable without factoring in the actual cost of drilling, and the Austrians will blame the cheap credit that allowed the initial land grabs in the first place. In the interim before we decide who we’re going to blame, it’d probably be best if people stopped assuming shale gas will be a silver bullet.

*It is interesting to note that Cuadrilla, the company looking to exploit the UK’s Bowland Shale, has recruited Nick Grearly to go round the country extolling the potential of shale gas.

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