After nearly two decades of horizontal drilling, fracking - as it is commonly known, has "turned the energy world upside down," according to Journalist Bethany McLean, a former Goldman Sachs analyst-turned-journalist.

And according to a new op-ed in the New York Times, McLean has a warning for anyone betting the farm on the shale industry; beware .

In a nutshell, the fracking industry - which "could not have taken off so dramatically were it not for record low interest rates after the 2008 financial crisis," is setting up for a spectacular fall without rising oil prices and global demand. Fracking companies have largely survived, according to McLean, because "plenty of people on Wall Street are willing to keep feeding them capital and taking their fees."

From 2001 to 2012, Chesapeake Energy, a pioneering fracking firm, sold $16.4 billion of stock and $15.5 billion of debt, and paid Wall Street more than $1.1 billion in fees, according to Thomson Reuters Deals Intelligence. That’s what was public. In less obvious ways, Chesapeake raised at least another $30 billion by selling assets and doing Enron-esque deals in which the company got what were, in effect, loans repaid with future sales of natural gas. But Chesapeake bled cash. From 2002 to the end of 2012, Chesapeake never managed to report positive free cash flow, before asset sales. -NYT

Columbia University Center on Global Energy Policy fellow, Amir Azar, calculates that the fracking industry's net debt in 2015 was $200 billion, a 300% increase from a decade earlier, however interest expense increased at half the rate debt did due to falling interest rates.

Dr. Azar recently called the post-2008 era of super-low interest rates the “real catalyst of the shale revolution.” -NYT

Another major concern is that fracking wells have a ridiculously steep decline rate: "The amount of oil they produce in the second year is drastically smaller than the amount produced in the first year," writes McLean, citing an economist at the Kansas City Federal Reserve, who noted that production at the average well in the North Dakota Bakken region, declines 69% in its first year and over 85% in its first three years. Conventional wells, meanwhile, may decline around 10% a year. For Frackers, this means constantly poking expensive holes in the ground to try and offset declines from previous years' wells.

Between the debt, decline rates and the exorbitant cost of maintaining a fracking operation, many on Wall Street have become skeptical that that the industry will ever be able to frack its way into the green amid relatively low oil prices compared to when much of the industry expansion took place.

Some of fracking’s biggest skeptics are on Wall Street. They argue that the industry’s financial foundation is unstable: Frackers haven’t proven that they can make money. “The industry has a very bad history of money going into it and never coming out,” says the hedge fund manager Jim Chanos, who founded one of the world’s largest short-selling hedge funds. The 60 biggest exploration and production firms are not generating enough cash from their operations to cover their operating and capital expenses. In aggregate, from mid-2012 to mid-2017, they had negative free cash flow of $9 billion per quarter. .. In early 2015, another famous hedge fund manager, David Einhorn, went public with his skepticism at an investment conference. He had looked at the financial statements of 16 publicly traded exploration and production companies and found that from 2006 to 2014, they had spent $80 billion more than they received from selling oil. -NYT

“It came back because Wall Street was there,” Chanos told McLean, who notes that in 2017, American frackers raised $60 billion in debt, a jump of nearly 30 percent since 2016, according to Dealogic.

Also eating into profits are hedges that many operators have taken out in search of stability after years of wild fluctuations in crude prices. Many frackers entered into derivatives contracts in late 2017 that ensured they could sell a portion of their 2018 output for $50 to $55 a barrel. At today's $70 oil, however, companies are failing to capture the rally. WPX Energy, for example, reported an adjusted net loss of $30 million in Q1 of this year because of $69 million in losses they say they took on hedges due to higher oil prices.

Technology to the rescue?

Fans of fracking maintain that technological innovations will continue to reduce the costs of fracking, "reshaping the financial firmament so that companies can make money, even with low oil prices."

According to a 2016 paper by the board of governors of the Federal Reserve, not only are rigs in the Bakken region drilling more wells, but each well is producing more. Extraction from new wells in the area in their first month of production has roughly tripled since 2008. The break-even cost, the estimate of what it costs to get a barrel of oil out of the ground, has plunged. The best-run companies, which often focus on the Permian, are now making some money. “Their rates of return are still below levels that will sustain the industry in the long run,” says Brian Horey, who runs Aurelian Management, but “they are trending in the right direction.” -NYT

Still, McLean notes, just five of the top 20 fracking companies managed to generate more cash than they spent in the first quarter of 2018. "If companies were forced to live within the cash flow they produce, American oil would not be a factor in the rest of the world, an investor told me."

Catstrophic potential

While interest rates have remained low, pension funds have turned to hedge funds to invest in high-yield debt - including that of fracking companies. Private equity firms have also poured money into shale companies, then played shell games with M&A or taking them public.

Private equity funds dedicated to natural resources raised nearly $70 billion of capital in 2015, according to SailingStone Capital Partners, an energy-focused investment firm, and over $100 billion in 2016. Today, 35 percent of all horizontal drilling (the industry’s preferred terminology) is done by privately backed companies. Private equity titans have made fortunes, but not necessarily because the companies they fund have produced profits. Private equity firms have generated some of their returns by selling one company to another, or taking a company they’ve funded public. -NYT

Meanwhile, frackers are valued "not based on a multiple of profits," but according to the acreage a company owns. As long as companies can sell stock or get eaten up by an already public company, "everyone in the chain, from the private equity funders to the executives, can continue making money."

This, says McLean (who wrote a book on Enron and Fracking), is all a bit reminiscent of the dot-com bubble of the late 1990s, "when internet companies were valued on the number of eyeballs they attracted, not on the profits they were likely to make."

And with higher interest rates on the horizon, it's going to be harder than ever to generate fracking profits unless the cost of oil - and demand - remains high.