Some of you may know that I cut my teeth writing articles for the now archived site The Oil Drum. What you may not know is that I spent a lot of time arguing with people who were absolutely convinced that the global peak of oil production was taking place in 2005, and that by 2010 the production shortfall would be so great that modern civilization would begin to splinter. Investors were often advised to avoid shares in oil companies, which many argued would soon be worthless as their reserves were depleted.

In debating people with this mindset, I learned two things. One is that most of them suffer from serious confirmation bias, which means they preferentially believe information that confirms their beliefs. So, someone who believed peak oil was taking place in 2005 might have placed a lot of weight on a sharper than expected production decline in one country, while totally dismissing major oil discoveries in another.

The second thing I learned is that most of the people who argue these points don’t ever admit to being wrong. They simply rationalize away contradictory information. Instead of accepting that production in Saudi Arabia was actually increasing after they had believed that it was on the cusp of terminal decline (as argued by the late Matt Simmons in Twilight in the Desert), many simply argued that Saudi Arabia was lying about its increasing oil production. The phrase “I was wrong” just wasn’t in their vocabulary.

The rationalization has been in full force during the shale boom of the past six years. Many have dismissed the boom as a myth, a mirage or a flash in the pan. If a company had to write down reserves, confirmation bias kicked in. Production increases were met with silence or denial that they could be maintained for more than another year or so.

The recent news that the EIA is slashing its prior estimate of recoverable oil in California’s Monterey Shale by a whopping 96 percent has generated a number of gleeful articles from the same crowd that loudly argued that Saudi Arabian oil production would be down by 3 million barrels by 2010. (Instead Saudi oil production is a million barrels a day higher than it was in 2005.) I covered this in some detail in this week’s Energy Letter: Is Shale Drilling a Sham?

My friend Chris Martenson, writing for Seeking Alpha, wrote an article called The U.S. Shale Oil Miracle Disappears. He wrote:

The U.S. shale oil “miracle” has about as much believability left as Jimmy Swaggart. Just today, we learned that the EIA has placed a hefty downward revision on its estimate of the amount of recoverable oil in the #1 shale reserve in the U.S., the Monterey in California.

He further argued that this write-down was “a huge blow to Occidental Petroleum specifically.” Occidental Petroleum (NYSE: OXY) is of course one of our portfolio holdings, and it has actually risen 4 percent since Chris published his article.

Because of their confirmation bias, the people who are ready to dismiss the shale boom as a myth are not likely to note that in some places, recoverable estimates have actually been going up. Estimates are revised as wells are drilled and results are reported. In the Monterey Shale, this resulted in a massive downward revision. In the Williston Basin, where the Bakken Shale is located and where, in contrast to the Monterey production is soaring,  the opposite happened.

Last year the US Geological Survey (USGS) provided the first update of oil and gas resources in the Williston Basin since 2008. The new estimate included the Three Forks Formation (a layer underneath the Bakken) because of the rise in drilling and production in the formation. Inclusion of Three Forks added an estimated mean resource of 3.73 billion barrels of oil to the estimated 3.65 billion barrels of oil in the Bakken region for a total estimated resource of 7.4 billion barrels of undiscovered, technically recoverable oil in the two formations.

Those who are ready to dismiss the entire shale boom because of certain downward revisions, or because some companies are highly leveraged, are just flat wrong. They are scaring investors away from enormous opportunities. EOG Resources (NYSE: EOG) is not a myth. Continental Resources (NYSE: CLR) and Whiting Petroleum (NYSE:WLL) are not myths. These are real companies (all of which happen to be in our portfolios), generating cash flow and real returns for investors. Those who sat on the sidelines waiting for companies like these to fail have instead seen them make lots of their shareholders wealthy.

As I said in The Energy Letter this week, it’s not a myth that North Dakota has had a 10-fold increase in oil production in 10 years, or that Texas oil production has gone up by nearly 2 million bpd in four years. It’s not a myth that the shale boom has increased US oil production by 2.5 million barrels in the past five years, and increased natural gas production by a third in under a decade. Those who have been sitting on the sidelines listening to naysayers have lost out on huge opportunities.

Of course not all oil companies are created equally and, as we have seen in the Monterey Shale, neither are all shale plays. But one downward revision — as large as it was — has no bearing on the potential of the Bakken or the Eagle Ford. Yes, production in these plays will decline — that is inevitable. They will also create many more millionaires before their epitaphs are written. And you can count on us to steer you to the companies best positioned to benefit from the boom.

Understanding the Environmental Issues with Hydraulic Fracturing

The shale oil boom is sometimes also called the “fracking boom.” This week I want to help readers better understand what fracking actually is, why it enabled the shale oil and gas boom, and why it is controversial.

We have all been bombarded with mixed messages on the topic of fracking. One side of the debate would have you believe that this is the greatest development in the oil and gas industry in the past century, opening up enormous new oil and gas reserves and economic opportunities in the US. The possibility of energy independence is seriously discussed in the mainstream media. Fracking has increased the amount of oil and gas that can be recovered from a field, and it is credited with boosting recoverable US oil reserves by 30 percent and natural gas reserves by 90 percent.

On the other side are those who feel that fracking threatens our water supplies, causes earthquakes, and has the potential to derail a clean energy revolution. And, in general, neither side acknowledges the positions of the other side.

As is usually the case with controversial issues like this, the truth is more complicated. There are elements of truth in both narratives, so my goal here is to help you determine which elements are more soundly rooted in the realm of reality, and which are based on fantasy and wishful thinking.

Fracking 101

The technique of hydraulic fracturing, or “fracking” had been around since the late 1940s and has been used extensively to promote higher production rates from oil and gas wells across traditional production regions like Texas and Oklahoma. Fracking involves pumping water, chemicals and a proppant down an oil or gas well under high pressure to break open channels (fractures) in the reservoir rock trapping the deposit. Oil and gas do not travel easily through these shale formations, which is why they need to be fractured. The proppant is a granular material designed to hold those channels open, allowing the oil (or natural gas) to flow to the well bore. Some common proppants include sand, ceramics, glass beads — even walnut shells have been utilized.

While fracking has been around for decades, two developments in recent years are responsible for thrusting the technique into the public eye.

The first is the fairly recent development in which fracking was combined with another common technique used in the oil and gas industry — horizontal drilling. Like fracking, horizontal drilling was invented decades ago, having been widely used in the oil and gas industry since the 1980s. As its name implies, horizontal drilling involves drilling down to an oil or gas deposit and then turning the drill horizontal to the formation to access a greater fraction of the deposit. These horizontal “laterals” can be 5,000 to 10,000 feet in length:


Source: ProPublica

The second development is that fracking started to move into populated areas unaccustomed to oil and gas development. I have long believed that if fracking were still relegated to the traditional oil and gas producing states, much of the public would have still never heard of the technique. But these populated areas weren’t used to having energy development in their backyard, and as it began to happen many people rebelled against this intrusion into their lives. As someone who believes that fracking is generally safe, I can nevertheless understand the desire by locals to keep it out of their neighborhood.

But anti-fracking sentiments have unfortunately fed into a great deal of misinformation around the technique. The movie Gasland is largely based on misinformation and appeals to emotion instead of deploying scientific data, but it was embraced by anti-fracking activists. When Gasland director Josh Fox lights someone’s tap water on fire in the movie, it makes for a great anti-fracking sound bite, even though the Colorado Oil & Gas Conservation Commission determined that the methane was naturally occurring and unrelated to any gas development.

Fox did take a lot of criticism for some of his claims in the movie, and so in Gasland 2 he shifted focus and emphasized the fact that wells, once fracked, could possibly leak into surrounding aquifers. This was an important pivot, as there was no evidence that a fracked oil and gas deposit could migrate through miles of solid rock into an aquifer far above the deposit. But the well bore sometimes has to pass right through aquifers, and there does exist the potential for a cement job around the well to fail and leak fluids into an aquifer.

While there are no documented cases in which a properly fracked well has leaked fluids from the fracking zone into an aquifer, there was a very well-documented case of an improperly cemented well contaminating water in Dimock, Pennsylvania. In 2010, gas driller Cabot Oil & Gas (NYSE: COG) was cited by the Pennsylvania Department of Environmental Protection for contaminating 14 water wells with its Marcellus Shale drilling operations.

The Cabot case provides a perfect example of why fracking has become controversial in the area. The reason the water wells were contaminated was determined to be the result not of fracking fluids migrating from the fracking zone, but rather of the improper cementing of the gas wells. But for opponents of fracking, this distinction was irrelevant: It was fracking that contaminated the wells.

So Josh Fox pivoted in Gasland 2 to argue that these wells are always going to fail sooner or later, and that therefore all of our water supplies in fracking areas will be contaminated. This ignores that fact that there have been over a million fracked wells in the US with data going back to the 1940s, and if the failure rate on these wells were high then there would be numerous instances of water contamination across the country.

One issue that does appear to have merit, however, is fracking’s link to earthquakes. As in the case of the water contamination case involving Cabot, it isn’t the act of fracking that is the suspected cause, but rather the associated process of disposing the fracking wastewater down disposal wells. It is believed that this in some cases injection of the wastewater decreases the friction along a fault and enables an earthquake to take place. A number of studies have linked these earthquakes to drilling activity in Texas.

Conclusions

While a lot of what you hear about fracking’s threat to water supplies is grossly exaggerated, I also sympathize with those who don’t want to see fracking taking place in their neighborhood. It’s not just the act of fracking; it’s the level of change – traffic, noise, population increases – that accompanies development. People living in a quiet location in Pennsylvania aren’t going to necessarily embrace this sort of development — especially if they do not own mineral rights and thus don’t stand to benefit financially.

It’s not just fracking — people don’t like any energy development in their backyard. No clearer example of this can be given than the recent news that ExxonMobil (NYSE: XOM) CEO Rex Tillerson sued to block a fracking development near his Dallas home. On the one hand, he argues that fracking is safe, but on the other he says “just not too close to me.” (Note that this isn’t limited to fracking; the late US Senator Ted Kennedy was a supporter of wind power but staunchly opposed a wind power project in his backyard.)

But, as I always say, there’s no free lunch in energy. There are downsides to fracking as there are to any energy technology. Many people benefit through lower prices, higher tax revenues, and jobs — but some are going to be inconvenienced (or worse). By better understanding both sides of the issue, we can hopefully arrive at better compromises than if each side merely attempts to shout the other down.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)