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Sovereign Risk

Pro-industry sources suggest that fracking bans are a sovereign risk. A ban on fracking may be a business risk for fracking companies, but it's not a sovereign risk.

A ban unequivocally provides certainty for all stakeholders. Submissions to the fracking review from the TFGA and WineTasmania, amongst others, made this very case. An environment that provides certainty for the unconventional gas industry removes certainty from existing industries. Other sectors of the Tasmanian economy can't plan and invest for growth when they operate under a moratorium that can be withdrawn at any time.

Conventional wisdom says that money runs away from uncertainty. The behaviour of investors in stock markets across the globe proves this to be true. The truism is no less valid for Tasmania's agricultural and tourism industries, which also require certainty in their economic environment in order to make long-term strategic planning and investments decisions.

Company Expertise

The Australian Council of Learned Academies (ACOLA) reports that "Most governments have only limited experience in regulating shale gas (or tight gas) production. Government and industry need to jointly address this issue, particularly to ensure that new companies with only limited experience of shale gas are effectively regulated as these companies gain experience".

A well's susceptibility to functional failure relates to the experience level, standards, regulations and oversight used to design, build, operate and plug the well. The experience level of the contractors, adherence to best management practices, sophistication of the regulatory agencies and the degree of oversight are key, according to a 2014 study published by the US Proceedings of the National Academy of Science.

Petratherm, the parent company of Petragas, which holds the exploration licence in Southern Tasmania, has experience in drilling projects relating to geothermal energy, but not hydraulic fracturing for shale and tight gas extraction.

Big moneyRisk Management

The potential lack of insurability of unconventional mining companies is a monumental risk for the people of Tasmania, who risk being left with the devastating public health and environmental costs of fracking - with no way to obtain compensation from the companies that caused the damage.

Exploration licences, particularly licences for fracking operations, should be automatically refused if companies can't get insurance cover commensurate with the risk they obtain.

In 2010, investment bank JPMorgan said Queensland's $50 billion CSG industry posed significant water depletion risks and a potential risk to public safety. The bank identified major risks including:

  • it put towns and landowners at risk of reduced water supplies and reduced water quality and the risk of gas migrating to existing bores
  • the dangers of a gas build-up in water bores could result in large, uncontrolled gas releases and pose a risk to public health and safety
  • the saline water extracted in the CSG mining process will have to be treated, stored and disposed of

Managing riskIn 2012 US insurer Nationwide Mutual announced it would decline to insure fracking companies because it wasn't comfortable with the unique risks associated with fracking. Nationwide's press has been seen a direct rejection of fracking companies' insistence that the procedure is perfectly safe.

In 2013 agricultural lender, Rabobank, said it was no longer in the business of making loans for unconventional fossil fuel projects - shale gas and tar sands - because of the environmental and social implications. Rabobank is also declining loans to farmers who lease their land to shale gas extraction companies.

Earlier that year, Storebrand, a major Scandinavian insurance and pension fund, said it was divesting from more than 20 fossil fuel companies. Storebrand said it was a financially responsible decision because the need to avert climate change meant these stocks would soon be 'financially worthless'.

In 2014 Michael Diggin, Vice President of Swiss Re, said that because oil and gas companies had large amounts of capital invested in fracking, insurers should be alert to the likelihood that those companies would fiercely defend any lawsuit that questioned the environmental safety of their business model. Insurance companies could incur significant defence costs if fracking companies tried to aggressively litigate fracking claims.

Gas well decline rates

Bad Economics

The basic economics of fracking - what it costs to drill versus what gas sells for - should be ringing alarm bells for shale gas investors. Frack gas production is totally unlike drilling in any other part of the global market. Conventional oil and gas wells operate on extremely long cycles. Production in conventional wells typically declines at a rate of around 2 to 5 percent a year. But that's not the case for fracking. Unlike conventional wells, shale wells have an extremely short life. The average productive life of a well in the Barnett Shale is 7.5 years.

Wells in the Bakken shale fields pump out about 1,000 barrels a day in the first year, but this dwindles to just 280 barrels by the start of year 2, a shrinkage of 72 percent. By year 3, more than half the reserves of a well are depleted and annual production falls to a trickle. Fracking companies are then trapped by what the industry calls the Red Queen Effect - the need to constantly drill new wells to stay in the same (revenue) place.

A group called Marcellus-shale tracked 190 wells drilled in almost 40 locations on the Marcellus shale fields. The production results point to a similarly short lifespan. The gas wells showed a 65 percent drop in production over the first 3 years, with further declines of 8 percent per year after that, meaning that a Marcellus well's average productive life is around 8 years.

Game Over

There is no doubt about it, the price fall of the last several months has deterred investors away from expensive oil including US shale...

If oil and gas prices are low, the return on investment is low and capital swiftly moves to more profitable ventures. Unconventional gas extraction is expensive, and only viable when the oil price is high.

The decision by the wealthier OPEC countries to skewer oil prices is almost certainly to make fracking unprofitable and drive US producers out of business. OPEC's actions, to maintain their dominance of the world energy market (at least the fossil fuelled energy market), is causing investors and analysts to ask if the plummeting oil price means that it's game over for the fracking industry.

The International Energy Agency's (IEA) annual gas market report, released in June 2015, slashed its forecast for gas demand. The IEA report notes that, after last year's halving in the crude oil price:

  • returns on capital have been dramatically impacted as a result of the direct link between the oil price and LNG contract sales prices
  • revenue from Australia's 7 new LNG projects is projected to be 'well below target' resulting in a $US20 billion ($25.7 billion) loss
  • in view of the current environment, new projects will struggle to be built at all

Investor Activism

Even before the OPEC shock of 2014, the writing might have been on the wall for the fracking industry. Royal Dutch Shell slashed its production targets and announced large scale write-downs in its US shale beds. BHP said it was offloading half of its oil and gas acreage in Texas and New Mexico. Many CEOs of smaller shale gas firms are losing their jobs as the industries' troubles have made them the targets of activist investors.

Divestment

The global divestment movement to divert investment dollars from fossil fuels to ethical investments is gaining momentum, as are campaigns like The Guardian's Keep it in The Ground.

In the largest single fossil fuel divestment to date, in May 2015 Norway announced plans to offload billions of dollars of coal investments. The divestment will affect 122 companies around the world, and is regarded as an enormous success for the UN-backed global climate change campaign.

Large institutional divestments are vital to avoid catastrophic climate change, but the collective impact of millions of individual investors divesting from the fossil fuel industry is equally significant. Market Forces and 350.org have partnered to inform individual investors – people with bank accounts, home loans, super funds or share portfolios, about the steps they can take to switch to fossil fuel free finance options. A report a report produced by The Australia Institute discusses the financial implications of climate proofing investments. The report also notes that:

At present, fossil fuel reserves are counted as assets in a company's share evaluations, but in future it is likely that these listed companies will have to write down, or leave 'stranded', a substantial portion of their reserves. This would have a big impact on the value of those companies.

Stranded Assets

The perfect storm of an OPEC driven low oil price environment, increasing investor activism and divestment, and the terminally short production life of fracking gasfields add up to stranded assets. Banks, pension funds, sovereign wealth funds, investment houses and other capital lending and financial investment institutions who are moving to disassociate their brand from a toxic and environmentally damaging industry may also be having an effect.

Stranded assets mean potentially bankrupt companies. Bankrupt oil and gas companies, or at least fracking companies whose financial obligations outstrip the worth of their assets, have a high probability of leading to a landscape pockmarked with abandoned wells. And abandoned wells can pose significant environmental, financial and public health costs to communities.

Abandoned Wells

The state of Wyoming in the US is a case study in abandoned wells. In that state, shale gas drillers have abandoned more than 1,200 wells. The wells are being abandoned because gas prices are lower than production costs, and because shale gas production is inherently unprofitable, given the extremely rapid decline in production in a very short period time.

The Wyoming state government estimates that plugging the 1,200 abandoned wells will cost around US $8 million. But several thousand more could soon be orphaned as more oil and gas companies file for bankruptcy on the back of the oil price plunge.

The state fund for plugging abandoned wells and reclaiming land - the bonds, or security deposits, paid by the companies that were licenced to drill and frack for gas - are often insufficient for the scope of the work required. According to the experts, given enough time, all gas wells leak. After all the expense, all the risk is transferred to the landholder and the community.

Abandoned well not producing, not plugged, just forgotten and rusting

Make Good

The Queensland Government's make good requirements include requiring CSG operators to provide water to other users whose water supplies are reduced, or more expensive, because of their extraction of water for fracking. While the intention looks good on the surface, the practical difficulties mean the make good provisions aren't really workable. For example:

  • how would the cause-and-effect relationship with fracking be established, and who has the onus of proof?
  • how feasible are make good provisions, given the widespread impact from an increasing number of wells?
  • how effective are make good provisions when the long-term impacts on aquifers are likely to play out over a time-scale of decades or centuries, long after fracking has disappeared?

Genuinely workable solutions to these real, long-term, costly issues ought to be settled long before mining approvals are granted.

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