“Saudi America” by Bethany McLean

oil

The Book

I recently finished “Saudi America” by Bethany McLean. The book was excellent, timely, and aligns with my interest in the subject of energy. The book tells the story of the renaissance of American energy production that occurred in the last 10 years as a result of fracking.

The book is exceptionally current and fresh. Bethany talks in depth about very recent events, such as the rise to power of MBS in Saudi Arabia and the Trump administration’s odd obsession with coal.

The book doesn’t take sides and presents all sides of the argument. Bethany shows the side of the fracking optimists: those who think that the United States has a vast energy supply that we’ve barely scratched the surface of. The energy supply could end our connection with the Middle East and lead to American dominance of global energy production.

There is the other side of the argument: the environmentalists and short-sellers like David Einhorn who don’t believe that fracking can generate enough free cash flow to be sustainable, and she also shows that a world of destabilized oil powers isn’t necessarily a good thing for the United States. Saudi Arabia, for instance, uses their oil wealth to supply their population with bread and circuses. If the Saudis went bust, do we really want the country to become unstable and slip the region into more chaos than it already is?

The book doesn’t come to firm conclusions and presents all sides of the argument. This is chiefly because the story isn’t over yet. We don’t know how all of this will shake out and this is a new, revolutionary development.

For all of the books written about social media and the growth of the internet in the last decade, I’m shocked that more people haven’t tackled the incredible phenomenon of the U.S. energy boom. While the media is obsessed with our smartphones and Facebook, this energy renaissance is the most important economic and geopolitical story of the last 10 years. The impact is more far-reaching and significant than the phenomenon soaking up all of the media attention lately: crypto, social media, and the 24/7 cable news cycle focused almost exclusively on unimportant shenanigans in Washington.

Peak Oil Worries

I was attracted to this book due to my fascination with the concept of peak oil. I first encountered the idea of peak oil in high school in the late ’90s and have been obsessed with it ever since.

The idea of peak oil is simple. There is a fixed amount of oil on the planet. When it peaks, we inevitably need to reduce our use of it. This is problematic because nearly all of the improvement in human living standards over the last 200 years was caused by capitalism combined with human beings figuring out how to harness fossil fuels.

Per capita GDP was flat for more of human history. Then, in 1800, it began increasing exponentially. For most of human history, people were really just expensive livestock. Every person was another mouth to feed, and most of our ancestors lived lives that were miserable, poverty-stricken, and short. We take our standards of living for granted today. It’s truly staggering to imagine that most of the human race for most of history lived in a state of extreme, grinding poverty.

The growing and widespread use of fossil fuels changed the dynamic.

Everything we enjoy about the modern world is made possible because we can harness fossil fuels. This makes the inevitable reality horrifying: at some point, we will run out of them. Estimates vary, but the Earth only has so many hydrocarbons in it. At some point, our use of fossil fuels will peak. This is what is the theory behind peak oil: at some point, our extraction of it will be peak and with it, our civilization.

This is the future pictured in the Mad Max films. A brutal, post-apocalyptic world where we’ve burned all the fossil fuels and the return of the scarcity the characterized most of human history. It’s also the future depicted in Ready Player One, which described a decades-long Depression caused by the exhausting of our energy reserves.

The chief proponent of peak oil was M. King Hubbert. He theorized in the 1950s that the U.S. would peak in oil production around 1970 and it would decline from there. It turned out that he was correct. Conventional U.S. oil production peaked around 1970 and then entered a steady rate of decline.

The U.S. itself did not reign in its thirst for oil. We sought more oil from the world, chiefly Saudi Arabia. The Saudis had an ocean of oil which we increased our dependence upon. The biggest field in Saudi Arabia is the Ghawar oil field, which pumps out 5 million barrels of oil a day.

Since U.S. oil production began declining in the 1970s, President after President paid lip service to “energy independence” and did little about it. In practical terms, the only real legislation passed to encourage U.S. energy independence was a ban on U.S. energy exports in 1975.

While U.S. production peaked in 1970, there were many competing theories for when world energy production would peak. I worried in the mid-2000s that peak oil was upon us and the peak of our civilization had been reached.

In the summer of 2008, I was cash-strapped and paying $4 a gallon for gas. I watched the money drain away, and I thought to myself: this is it. This is peak oil.

Not the peak, after all

I was wrong. Oil production did not peak in 2008. In fact, the U.S. was about to undergo an energy renaissance that would wind up reshaping the world.

The oil production that was long on the wane in the United States wound up turning around. At this point, U.S. oil production now exceeds the 1970 peak.

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Catalysts of the Revolution

What caused the fracking revolution? This is a question that Bethany answers in depth in the book. The answer is two-fold: cheap capital made available from Wall Street combined with technological ingenuity.

The first catalyst was technology. The technique of fracking involves breaking apart rocks underground and unleashing natural gas and oil trapped within the rocks. The rocks are “fracked” and broken open and the gas/oil is unleashed. The tech and engineering behind it are over my head, but the fracking technology which existed since the 1940s had advanced in the 2000s to the point where it was economical to pursue in the United States. Oil prices also increased to a level where the technology was worth the investment.

The second catalyst was cash.

After the financial crisis, with interest rates at historic lows, Wall Street wanted to lend money. They wound up lending a large amount of high yield debt to the frackers. The money flowed into fracking ventures of various kinds, from the semi-respectable to the dubious.

Critics like David Einhorn believe that fracking will never generate sufficient free cash flow to be sustainable. In other words, the frackers will be destroyed by the high capital expenditures involved in successfully pursuing fracking.

When oil prices collapsed in 2015, it appeared that the shorts may have been correct. Many frackers went bankrupt. Others used it as an opportunity to restructure their loans.

The pessimists were disappointed, though. Fracking wound up surviving, but it’s unclear if this is a testament to the fiscal soundness of their operations or the willingness of Wall Street to throw cheap money around for the purpose of minting fees.

The new era was solidified in December 2015 when the 1975 ban on drilling was lifted. This was a momentous decision that was barely covered in the press. The era of declining U.S. energy production which began in the 1970s was over.

The Future

The future for fracking is uncertain. No one is sure how much oil exists within our shale deposits. Estimates vary wildly. The optimistic projections estimate that the U.S. contains trillions of barrels of oil. To put this in perspective, the Saudis produce about 10 million barrels of oil per day.

Skeptics believe that these estimates are too optimistic. They also think that fracking still hasn’t demonstrated its ability to generate cash flows that exceed the cost of capital.

Another concern is that regardless of the estimate, the supply of oil is finite and we will run out of it. At the end of the book, Bethany cites Charlie Munger, who advises prudence. He makes a good point that oil is used heavily in our farming industry and, because of this, it is one of the most precious resources that we should use prudently. Munger explains:

“Every barrel that you use up that comes from somebody else is a barrel of your precious oil which you’re going to need to feed your people and maintain your civilization. You want to produce just enough so that you keep up on all of the technology. And you shouldn’t mind at all paying prices that look high for foreign oil. You will be better off because you delayed gratification, instead of grabbing for it like a child.”

There are also environmental concerns. The burning of fossil fuels makes modern life possible, but it is also contributing to climate change and threatens our long-term survival as a species.

The story of the American energy revolution isn’t over, which is why the book doesn’t try to moralize and clearly define who is right and who is wrong. It tells the story. It also contains fascinating portrayals of the characters involved: from the risk-taking fracking executives to the skeptical short sellers.

From my point of view, I think Munger (as usual) is right. We should exercise prudence even if our newfound energy supply is abundant.

Oil is a critical, precious, non-renewable resource. We shouldn’t waste it. As a nation, we need a coherent energy policy that seeks to produce as much energy as possible without the use of fossil fuels. We need to plan for the reality that, eventually, we’re going to run out of it. It might be 50 years from now. It might be 200. Regardless of when it happens, the end is coming and, for the sake of our children, we should develop a coherent plan to deal with that future. When we run out of oil, it could potentially have far-reaching economic implications. Let’s mitigate those consequences. Let’s plan for the future.

Prudence will likely lead to a better world. We don’t want to live in the world of Max Rockatansky.

Whether you agree with me or not, I recommend Bethany’s book. It will give you perspective on the most important economic event of the last decade and help you come to your own conclusions.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.