Time & Patience: Napoleon’s (Hard) Lesson for Negotiators [Gaille Energy Blog Issue 67]

“The strongest of all warriors are these two — Time and Patience.” – Leo Tolstoy, War and Peace

Even if both parties must conclude a deal, we must consider the question of Time—by when does each need to reach agreement.  One party may absolutely need resolution by the end of the month; the other, within the year.  The causes for such Time asymmetries vary greatly.  For example, consider a company that owns a valuable asset but has run into financial problems.  It needs to sell the asset to stay afloat.  The faltering company’s timeline for a transaction is constrained.  It has no Time.  It must sell now.

On June 24, 1812, Napoleon marched on Russia with 680,000 soldiers, seeking to engage and decisively defeat the weaker Russian army.  The Russian’s tactic was to retreat, and as they did, scorch the earth.  Whole towns were burned in their wake, leaving little behind to supplement Napoleon’s supply lines.  The French did not catch up with the bulk of the Russian army until September 7—near Moscow at Borodino—where Napoleon won a narrow victory.

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 The Battle of Borodino by Louis Lejeune 

When their defeat was evident, the Russians abandoned and burned Moscow—heading even further east.  Napoleon walked into Moscow expecting a settlement offer from Tsar Alexander I.  Only none came.  Not until October 19 did Napoleon realize that he was out of time.  His army was short on food, and winter was coming. Napoleon’s retreat back to France left 380,000 of his soldiers dead and 100,000 captured.

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French Retreat by Illarion Pryanishnikov 

As observed by Tolstoy, Napoleon’s defeat was ultimately caused by his miscalculation of the Time asymmetry.  No matter how many soldiers Napoleon had, the Russians had an indefinite Time horizon.  They had thousands of miles of countryside to retreat across. Napoleon’s expectation of an attractive peace offer was unfounded—because the Russians knew that logistics and winter would eventually force Napoleon to leave.

Similar situations often play out in negotiations.  When I was the general counsel of a shale developer, my company had great oil and gas leases with three- or four-year terms—but lacked the money to drill wells needed to extend these leases.  Meanwhile, the clock was ticking day-by-day.  If wells were not drilled, the leases would expire and revert back to landowners.  In such a case, the company’s entire investment in them would be lost.  So along came multi-billion-dollar majors like Hess and EOG to jointly develop the leases—for a price.  But Time was not on our side.  The big companies knew this and extracted concessions.  As painful as those concessions may have been, they were the price of not ending up like Napoleon.

The lesson for negotiators is to always be aware of asymmetrical Time horizons.  If your counterparty in a deal or a dispute has a short Time runway—by which they need resolution—then you will be able to extract concessions.  The size of those concessions will only grow with Time, as your counterparty’s position becomes more desperate.

If you happen to be the Time-constrained party, then realism must prevail.  Do not fall into the so-called “Napoleon Complex,” which is “characterized by overly-aggressive or domineering” behavior (Wikipedia).  It will not fool your counterparty.  Your failure to shrewdly evaluate your shorter Time horizon only will result in your deal deteriorating—or worse.

Napoleon managed to have a second act, but no happy ending.  He was exiled to one of the most remote islands in the world, Saint Helena, where he died at 51.

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About the Gaille Energy Blog.  The Gaille Energy Blog (view counter = 64,950) discusses issues in the field of energy law, with periodic posts at  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development).

Images available on the Internet and included in accordance with Title 17 U.S.C. Section 107.



LNG vs. Pipeline Economics [Gaille Energy Blog Issue 66]

This is a guest blog authored by Ankur Shah, one of my students at Rice University’s Graduate School of Business.  

Royal Dutch Shell says the world could be grappling with a shortage of liquefied natural gas within a decade due to underinvestment in new projects. The Anglo-Dutch energy giant issued the warning in its second annual LNG outlook, which reports on developments in the booming market for natural gas cooled to liquid form for export. Shell says the market for LNG grew by 29 million tons last year, 30 percent more than previously expected. Trading in LNG reached 293 million tons in 2017, up from just 100 million tons at the turn of the century. At nearly 300 million tons, suppliers shipped enough LNG last year to power about 575 million homes, by Shell’s count.  Tom DiChristopher, Shell warns of liquefied natural gas shortage as LNG demand blows past expectations (CNBC Feb. 26, 2018)

While pipelines between nations and continents have traditionally dominated the international gas trade, they offer limited options for re­balancing dynamic markets.  If circumstances change, their owners can reverse directional flows or adjust capacity (by increasing or reducing compression).  In contrast, LNG can respond to market conditions by sending gas to entirely new markets or spreading deliveries across multiple buyers.

The significance of this flexibility is illustrated by the shale revolution’s impact on the United States LNG market.  The United States switched from importing to exporting LNG (Seeking Alpha, “Latest Trends In The Global LNG Market – A U.S. Perspective” (Apr. 23, 2018).

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Meanwhile, Latin American and African (planned) LNG exports to the United States were diverted to Europe and Asia (see below figure from bp).

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Notwithstanding this flexibility, LNG has faced challenges with respect to its cost profile.

The Cost of LNG

LNG consists of three stages, each of which incurs substantial cost:

  • Step One: Liquefaction Plant

The first step in the chain for transporting LNG is a liquefaction plant. This plant requires an investment of $1.6 to $2 billion dollars for a plant capable of handling 500 million cubic feet per day. Assuming a real rate between 10 to 12 percent, this implies a cost of $1 to $1.30 per thousand cubic feet. Most studies also report costs in that range.  Brito, D., & Sheshinski, E., Pipelines and the Exploitation of Gas Reserves in the Middle East (Baker Institute of Public Policy – Rice University 1997) (the “Rice Paper”).

  • Step Two: LNG Vessels

The second step in the chain is the tanker. LNG must be transported at a temperature of -162 degrees centigrade and requires specialized vessels. These vessels cost $230 million for a 135,000 ton tanker. This is to be compared with a cost $85 million for a 280,000 ton VLCC. The reported shipping rates are $.20 per thousand kilometers or $.32 per mile (Rice Paper).

The below figure provides a further breakdown of vessel costs for various routes:

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  • Step Three: Regasification

The third step is regasification, which typically ranges between “$.35 to $.50 per thousand cubic feet” but can be  “as high as $1.00 per thousand cubic feet” in Japan “due to the high cost of land” (Rice Paper).

The below figure from the Rice Paper shows the variable impact of shipping (Step Two) on delivered price, as a function of distance:

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The Cost of Pipeline Transportation

The Rice Paper also examined the cost of transporting gas 1,000 miles through various sizes of onshore and offshore pipelines under assumes 15-year and 25-year project life, including the identification of the fixed cost as a percentage of the average cost (approximately half of onshore pipeline and three-quarters of offshore pipeline costs are fixed):

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The Rice Paper assumed $40,000 per mile inch for an onshore pipeline and $100,000 for an offshore pipeline (in 1997), but INGAA data indicates pipeline fixed costs are continuing to increase.

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Comparing the Cost of LNG to Pipeline Transportation

The Rice Paper plotted three curves for hypothetical pipeline cost profiles against LNG’s cost curve, revealing likely breakeven points:

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More recent studies show even earlier breakeven points (~700 miles and ~2200 miles for offshore and onshore pipelines, respectively):

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Technology Appears to Be Reducing LNG Costs

While LNG was initially used over very long distances (for which pipeline projects were not economically justified), technological advances appear to be shifting the breakeven toward shorter distances.  The below figure shows how the LNG cost profile declined somewhat from the 1990s to the 2000s:

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Additional technology driving further LNG cost reductions in the 2010s include:

  • More efficient ship designs

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  • Lower United States liquefaction plant costs

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  • Floating liquefaction

Floating liquefaction enables even more flexibility than traditional (onshore) liquefaction because the origination end of the LNG train also can be relocated in response to market or economic conditions.  With respect to offshore gas discoveries, it also may reduce costs by eliminating the need for pipelines to transport natural gas from offshore wells to the onshore liquefaction plant (the floating liquefaction unit can be positioned on top of the offshore reservoir).

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Such technological advances will only further serve to increase global demand for LNG.

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About the Gaille Energy Blog.  The Gaille Energy Blog (view counter = 64,098) discusses issues in the field of energy law, with periodic posts at  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development,and International Energy Development).

Images available on the Internet and included in accordance with Title 17 U.S.C. Section 107.


Does Your Negotiating Style Resemble a Fox or Hedgehog? [Gaille Energy Blog Issue 65]

“The fox knows many things, but the hedgehog knows one big thing.” – Archilochus of Paros, 7th Century, B.C.

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Courses at Yale, Oxford, and the United States Naval War College have used the aphorism of the fox versus the hedgehog to help leaders and negotiators understand various approaches to strategy:

  • The Hedgehog. The hedgehog is relentless in its direct and dogged pursuit of the goal, focusing on the big picture but possibly blowing through process and complexity.
  • The Fox. The fox’s style is collegial, creative, and accommodating, but may be unfocused.

The hedgehog has a “sense of direction” and the fox has a “sensitivity to surroundings,” explains John Lewis Gaddis in On Grand Strategy.

American negotiation styles tend toward the hedgehog.  We often want to cut to the chase, save time, and get to our bottom line.  As a young lawyer, I moved to the Middle East to negotiate deals for Occidental Petroleum.  My mentor broke me out of my hedgehog tendencies in the carpet souks of Oman and the Emirates.  There, I learned the slow dance of bringing the shop owner to his best price over many hours of tea drinking while comparing the quality of various carpets.  The more valuable the carpet, the more time it took to consummate the deal.  My best outcomes were the product of three or four afternoons, spread out over several weeks.

Assume that both a carpet seller and an American buyer have the same bottom line price of $7,000.  The seller is unwilling to accept less, and the buyer is unwilling to pay more.  If the seller opens the negotiation at $10,000, and the American then counters with a “best and final” offer of $7,000, what will happen?  The souk owner will reject the $7,000 and counter with, say, $9,000.  The seller does not find the American’s claim of a “best and final” offer to be a credible one because they have not yet fully discussed the details—where and by whom the carpet was made, the quality of its silk, the number of threads per square inch, and its age.  The seller believes that he will be able to move the buyer from her $7,000 position by delving into the details.  But the American responds, “I told you that $7,000 is my final offer.”  The seller becomes frustrated and disappointed.  He assumed he would do better than $7,000—now, $7,000 is not good enough for him.

I’ve seen the same thing happen in energy negotiations.  Someone tries to accelerate the process with a big move—the so-called “best and final” offer.  Then the offer is rejected and countered.  Even though the “best and final” offer might have been accepted later in the negotiation process, it came too early.  The recipient thinks it can do better.  As such, negotiators need to be sensitive to the timing of their proposals.  The probability of acceptance depends not only on what the proposal is, but when and how it is made.

Another example is the art of suggestion.  Japanese negotiators are masters of leading from behind.  There’s even a word for it: ringiseido.  I spent several months in Tokyo and Kyoto negotiating a series of transactions with a Japanese trading house.  My colleagues there taught me how to suggest proposals privately, allowing them to become the other’s “idea.”  If a hedgehog directly demands a concession in the midst of a Japanese negotiation, it’s less likely to be adopted.  The counter-party could lose face (mentsu).  Instead, the fox indirectly causes the counter-party to become the proponent of the fox’s compromise—so the counter-party gains face (kao o tateru).

The best negotiators are able to blend the resolve of the hedgehog with the adaptability of the fox.  In my courses at U. Chicago and Rice, I teach my students that negotiation expertise is a product of:

  • Inherent Skill. A hedgehog-like focus married to a fox-like ability to discern the other party’s needs and creatively meet them.
  • Experience. Knowledge of what has (and has not) worked before, gained through negotiating more and more deals.

The below quote from the movie Lincoln describes how President Lincoln combined styles to accomplish his goals:

“[A] compass . . . [will] point you true north from where you’re standing, but it’s got no advice about the swamps and deserts and chasms that you’ll encounter along the way.  If in pursuit of your destination, you plunge ahead, heedless of obstacles [like a hedgehog], and achieve nothing more than to sink in a swamp . . . , [then] what’s the use of knowing true north?”

To read more about fox and hedgehog strategies, John Lewis Gaddis’ book On Grand Strategy tracks their evolution across history, starting with the Persian invasion of Greece in 480 B.C.

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Bust of Archilochus

About the Gaille Energy Blog.  The Gaille Energy Blog (view counter = 62,787) discusses issues in the field of energy law, with periodic posts at  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development).

Images available on the Internet and included in accordance with Title 17 U.S.C. Section 107.

How Will Blockchain Technology Be Adopted by the Energy Industry? [Gaille Energy Blog Issue 64]

The headlines may be filled with stories about Bitcoin and other cryptocurrencies—but it’s the underlying innovation called Blockchain (rather than cryptocurrencies themselves) that is poised to impact the energy industry:

“Blockchain is a special technology for peer-to-peer transaction platforms that uses decentralised storage to record all transaction data. . . .  Essentially, a Blockchain is a digital contract permitting an individual party to conduct and bill a transaction . . . directly (peer-to-peer) with another party. The peer-to-peer concept means that all transactions are stored on a network of computers consisting of the computers of the provider and customer participating in a transaction, as well as of the computers of many other network participants. Traditional intermediaries, e.g. a bank, are no longer required under this model, as the other participants in the network act as witnesses to each transaction carried out between a provider and a customer, and as such can afterwards also provide confirmation of the details of a transaction, because all relevant information is distributed to the network and stored locally on the computers of all participants.”  PWC, Blockchain – an opportunity for energy producers and consumers? (2016).

The following PWC figure illustrates how a Blockchain eliminates the need for a central institution:

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By distributing identical copies of ownership records to many computers around the world, property owners no longer need institutions (such as banks, exchanges, or governments) to verify transfers of property.  The decentralized network itself performs this function by recording information “on a ledger that is distributed across every node (i.e., computer) in a network on the internet, and is structured and encrypted in such a way that it cannot be altered without agreement by a majority of the nodes in a network (which automatically and simultaneously check the change against the ledger)” Deloitte, Blockchain: Overview of the potential applications for the oil and gas market and the related taxation implications (April 2017).   The following figures from PWC illustrate the security feautures of Blockchain technology:

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While it is difficult to predict how new technologies will be adapted, possible impacts for the energy industry include the following:

(1) Petroleum Chain of Ownership

A few years ago, I had the opportunity to spend a day boating through the bayous of West Africa’s Niger Delta.  While doing so, I met a stream of rickety boats filled to the brim with barrels of stolen crude oil.  About 100,000 barrels a day of Nigerian production is stolen, with ~75,000 barrels being transferred to offshore tankers and sold on the global market.  When the Islamic State captured oilfields in Syria, it also found ways to export its illicit oil.  Blockchain technology could make such sales of stolen/sanctioned crude more difficult:

“Blockchain could provide a fully transparent and secure record of the entire supply chain.  Using a distributed ledger, digital tokens can be used to represent the asset being transacted. These tokens can be issued by a trusted authority for the needs of the companies or participating parties; for example, if oil and gas companies used a Blockchain ledger to buy and sell barrels of oil, transactions could include digital tokens named Brent or WTI. These tokens would represent the underlying asset of a barrel of oil and would remain digitally attached throughout its supply chain journey.”  Deloitte, Blockchain: Overview of the potential applications for the oil and gas market and the related taxation implications (April 2017).

(2) Decreased Political Risk

Weak property rights is a significant factor contributing to political instability in the developing world:

“The great economic divide in the world today is between the 2.5 billion people who can register property rights and the five billion who are impoverished, in part because they can’t. Consider what happens without a formal system of property rights: Values are reduced for privately owned assets; wages are devalued for workers using these assets; owners are denied the ability to use their assets as collateral to obtain credit or as a credential to claim public services; and society loses the benefits that accrue when assets are employed for their highest and best purpose.”  Phil Gramm and Hernando de Soto, How Blockchain Can End Poverty (Wall Street Journal, Jan. 25, 2018).

The more secure property rights are for all citizens, the less susceptible a nation is to socialism and other revolutionary movements.  When people have little or nothing to lose (because their property is insecure), political risk is higher.

“If Blockchain technology can empower public and private efforts to register property rights on a single computer platform, we can share the blessings of private-property registration with the whole world. Instead of destroying private property to promote a Marxist equality in poverty, perhaps we can bring property rights to all mankind. Where property rights are ensured, so are the prosperity, freedom and ownership of wealth that brings real stability and peace.”  Phil Gramm and Hernando de Soto, How Blockchain Can End Poverty (Wall Street Journal, Jan. 25, 2018).

Such an effort is already underway in the African nation of Rwanda, where “the first phase of the Rwanda Blockchain project will see the Rwanda Land Registry digitized to ensure control of authenticity. This will use WISeKey’s WiseID suite of mobile applications and digitally store necessary the necessary land registry data to enable authenticity of identification and the validation of assets”  Rwanda Government’s Blockchain Project Gains Momentum (Iafrikan News, Oct. 13, 2017).

(3) Title to Mineral Rights 

United States private mineral rights and leases can be challenging to verify, manage, and transfer.  For example, one Eagle Ford development in South Texas involved the acquisition of ~20,000 acres of mineral leases.  The leasing process required the execution of ~800 different leases, each of which required various documents to establish ownership:

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When all of the leases were signed, the energy company was left managing ~6,000 documents totaling more than 50,000 pages.  Before a well could even be drilled, lawyers then had to comb through the historical chain of title for each lease, ensuring that good title had been acquired.

Fraud is a problem, too.  Brokers have exploited the complexity of the title process to embezzle funds that were supposed to have been paid to the mineral rights owners.  Signatures have been forged, with leases being “sold” without their rightful owners’ knowledge.  Blockchain technology could be used to improve the efficiency and security of mineral leasing.

(4) Peer-to-Peer Energy Transactions 

“Blockchain technology appears capable of enabling a decentralised energy supply system. It may be possible to radically simplify today’s multi-tiered system, in which power producers, transmission system operators, distribution system operators and suppliers transact on various levels, by directly linking producers with consumers.”  PWC, Blockchain – an opportunity for energy producers and consumers? (2016).

The following PWC figure illustrates how Blockchain could disrupt the traditional model:

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PWC’s further figure below provides a helpful overview of possible Blockchain applications in the energy industry:

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Nobel Prize-winning economist Milton Friedman actually predicted the rise of cryptocurrencies before his death:

“I think the internet is going to be one of the major forces for reducing the role of government. The one thing that’s missing but that will soon be developed, is a reliable e-cash.”


The anonymous creator of Blockchain realized Friedman’s vision:

“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.”

Perhaps it’s not so much any specific application of Blockchain that will transform the energy industry, but its broader impact on the regulatory state.  Energy companies are both shackled and protected by governments in many ways.  As technology enables individuals to increasingly bypass governments, the status quo that many in our industry take for granted will be disrupted.

About the Gaille Energy Blog.  The Gaille Energy Blog (view counter = 53,849) discusses issues in the field of energy law, with periodic posts at  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development).

Images available on the Internet and included in accordance with Title 17 U.S.C. Section 107.



Venezuela’s Oil Production Crash: Another Sad Chapter of Socialism [Gaille Energy Blog Issue 63]

When I last visited the Venezuelan cities of Caracas and Puerto La Cruz in 2007, Hugo Chavez was sowing the seeds of the nation’s economic destruction: “Venezuela demanded changes to the agreements made by international oil companies that would give PDVSA [Venezuela’s national oil company] majority control of the projects.  Total, Chevron, Statoil and BP agreed and retained minority interests in their Venezuelan projects.  ExxonMobil and ConocoPhillips refused, and as a result, their assets were expropriated.”  Robert Rapier, How Venezuela Ruined Its Oil Industry (Forbes, May 7, 2017).  Whether they stayed or left mattered little to future investment.  The international oil industry had lost faith in Venezuela, and its capital and expertise would be reallocated to projects in other nations.

The results of such policies are exemplified by Venezuela’s oil production.  The year that Hugo Chavez took power, Venezuela’s oil production stood at ~3.5 million barrels per day.  By the end of 2017, the nation could only manage ~1.7 million barrels per day, and the slope of the decline was steepening:

“Over all of 2017, [Venezuela’s] output was down 29%, among the steepest national declines in recent history, driven by mismanagement and under investment at the state oil company . . . . Generals with no industry experience have been named to run the [state oil company].”  Anatoly Kurmanaev and Kejal Vyas, Venezuela’s Oil Production Is Collapsing (Wall Street Journal, Jan. 19, 2018).

Venezuela’s 2017 production collapse is shown in the following figure from the Wall Street Journal:

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Interviews with Venezuelan oilfield workers on Lake Maracaibo illustrate the extent to which the industry has been plundered:

“[State oil company] workers sat in empty air-conditioned offices adorned with Socialist Party posters.  Roberto, a foreman, said his oil barge had been waiting for three months to sail. Each day something was missing: food, motor oil, a tugboat. His team of a dozen people comes back each day and waits—until it is time to go home.  After two decades in [the state oil company], Roberto earns an equivalent of $8 a month. This Christmas, for the first time, he had no presents to give his seven children. . . . Of [the state oil company’s] 560 speed boats in the lake, only six are operational . . . . Supplies sent by the company to his offshore rig in the lake usually run out days before the end of the shift, he said. To cope, workers ration lunches of boiled plantain or spaghetti with mayonnaise. . . . . In November, [a] rig was attacked at night by nine pirates in balaclavas armed with machine guns. They knocked out two workers with pistol butts, took a female worker hostage and went cabin to cabin, collecting each worker’s valuables, including loaves of bread, before releasing the hostage and leaving.”  Anatoly Kurmanaev and Sheyla Urdaneta, In Venezuela’s Oil Hub, Prosperity Turns to Crime, Hunger (Wall Street Journal, Jan. 19, 2018).

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The rest of the nation’s economy has collapsed alongside the oil industry:

“Venezuela, by the numbers, resembles a country hit by civil war. Its economy, once Latin America’s richest, is estimated to have shrunk by 10 per cent last year – worse even than Syria’s. GDP shrank by 19 per cent. The South American country also has the world’s worst inflation at more than 700 per cent (nearly double that of second-ranked South Sudan), rendering its currency almost worthless. In a country with the world’s largest proven oil reserves, food has grown so scarce that three in four citizens report involuntary weight loss, averaging 19 pounds in a year.”  Max Fisher and Amanda Taub, How Did Venezuela Went from the Richest Economy in South America to the Brink of Financial ruin?  (The Independent, May 21, 2017).

“Parents . . . go days without eating, shriveling to the weight of children themselves. Women line up at sterilization clinics to avoid having children they can’t feed. Young boys leave home and join street gangs to scavenge for scraps, their bodies bearing the scars of knife fights with competitors. Crowds of adults storm dumpsters after restaurants close. Babies die because it is hard to find or afford infant formula, even in emergency rooms.”  Meredith Kohut and Isayen Herrera, As Venezuela Collapses, Children Are Dying of Hunger (New York Times, Dec. 17, 2017).

Venezuela’s outcome is similar to that of other nations that have embraced forms of socialism—only faster.  Over the last century, “the effort to eliminate markets and private property has brought about the deaths of an astounding number of people. Since 1917—in the Soviet Union, China, Mongolia, Eastern Europe, Indochina, Africa, Afghanistan and parts of Latin America—communism has claimed at least 65 million lives.” Stephen Kotkin, Communisms Bloody Century (Wall Street Journal, Nov. 3, 2017).  The difference between the 20th century and now is that technology has made capital and people much more mobile.  Even the poorest residents of Venezuela can access the Internet and compare their plight to others around the world.  Consequently, more than two million Venezuelans have fled the nation (along with their talent and money), and those who remain have found ways to bypass the Venezuelan economy using technologies such as cryptocurrency.

Yet many young Americans still romanticize socialism.  The image below is from a Young Marxist club at an Oklahoma high school.

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And the Communist Manifesto is the most frequently assigned college textbook in six American states.

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What about Adam Smith’s Wealth of Nations?  Just one quote from Wealth of Nations sums up why capitalism works and socialism fails:

“[B]y directing [one’s effort] in such a manner as its produce may be of the greatest value, [each person] intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. . . . By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.”

This is how the spread of capitalism around the world has lifted billions of people out of poverty.

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Capitalism is why we have abundant food, medical care, technology, and transportation—and a plethora of comforts and entertainments. Notwithstanding this, “[n]early 45 percent of [American] millennials polled said that they would prefer to live in a socialist country compared to the 42 percent who said they preferred a capitalist one.”  Perry Chiaramonte, Millennials Think Socialism Would Create a Great Safe Space, Study Finds (Fox News, Nov. 3, 2017).  For every young American who pines for socialism, there’s a Venezuelan who would gladly trade places to escape it.


Adam Smith (1723-1790)

About the Gaille Energy Blog.  The Gaille Energy Blog (view counter = 53,386) discusses issues in the field of energy law, with periodic posts at  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development).

Images available on the Internet and included in accordance with Title 17 U.S.C. Section 107.


Shale vs. Deepwater Exploration Part II: The Risks [Gaille Energy Blog Issue 62]

Last week’s issue on Shale vs. Deepwater Returns [Issue 61] featured the below figure from Hess Corporation:

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Several readers questioned to what extent the figure’s economics reflected different risks, including the chance of success (during exploration) and political risk.  This week’s issue elaborates on such risks based on my own experiences.  At Oxy and several private equity-backed companies, I worked on deepwater projects in Africa and South America—including ventures with ExxonMobil, Chevron, Shell, and BHP Billiton—and as the General Counsel of a shale developer, I participated in several Eagle Ford shale joint ventures—including with EOG and Hess.  This gives me some perspective on the principal risks of deepwater versus shale opportunities.

(1) Exploration Risk.  Deepwater wells can cost more than $100 million each, but the chance of commercial success may only be 1-in-5, or less.  The key to managing exploration risk is portfolio economics—participating in enough wells that the odds should pay off.  For example, by drilling ten wells (each 1-in-5 chance of success), the probability of at least one successful well improves from 20% to ~90%.  My exploration models at Oxy and elsewhere assumed sunk costs of several dry holes in the early years, and the economics of the assumed successful ones had to be robust enough to absorb those early losses.  Practically speaking, this meant that each and every prospect being drilled had to be large enough that it could carry the costs of several failed wells and still achieve the investor’s return thresholds.  The below slide from Kosmos’ investor deck shows varying rates of commercial success in frontier plays (from 0% to about 33%) for companies such as Anadarko, BP, ExxonMobil, Petrobras, Repsol, Shell, Statoil, Total, and Tullow:

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American shale exploration is less risky because the wells are cheaper and the results less binary.  Shale exploration wells typically cost 5-15% of deepwater wells, mitigating losses.  Even a bad shale well usually produces some hydrocarbons, and that oil and gas can readily be sold on the American market.  In contrast, a marginal discovery in deepwater is no better than a dry hole because the capital required to produce it would exceed the value of its production.  Thus, shale investors can be confident that they will at least get some of their money back.

Even so, greenfield shale developments are still exploration.  Just because one method of hydraulic fracturing worked in one part of the Eagle Ford does not mean it will work a few miles away.  What I witnessed in new Eagle Ford developments was a process of trial-and-error.  The operator might drill a vertical well and test the same completion technique at different depths, trying to identify the most productive location to land horizontal wells.  Or a horizontal well might receive three different types of hydraulic fracturing (one in the toe, one in the middle, and one in the heel of the lateral), with each being flowed back independently.

The characteristics of the shale encountered in a well also are compared against a growing database of thousands of samples extracted from other shale wells.  This enables the operator (by analogy) to deploy those completion techniques most likely to be successful—and avoid those that previously yielded poor results in similar shale.  Thus, operators can reduce shale exploration risk using a variety of approaches that are not available in deepwater wells.

(2) Production Profile Risk.  Another challenge of deepwater exploration is the lag time between the drilling of a discovery well and the time when first production is achieved.  The below figure from Kosmos shows how deepwater oil averages 8 years to first production:

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In contrast, shale wells (at least in the United States) can be brought to sales within a matter of weeks.  Shale developers also can optimize the timing of future wells, drilling in periods of high prices, and pausing when prices drop.  The Hess figure below illustrates how companies can time certain wells based on oil price:

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Deepwater projects (subject to some opportunities for phasing) tend to come online all at once and continue to produce over decades—irrespective of price environment.

(3) Concentration/Magnitude Risk.   A deepwater development relies on a few wells (the Hess Guyana development has eight)—whereas a comparable shale development has hundreds.  This creates a concentration risk with deepwater wells.  When one well has an issue, the economic consequences are much higher in deepwater than in shale.  Deepwater wells also can be more challenging to control when something goes wrong, and the human and environmental toll can be much greater.

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(4) Political Risk.  Energy companies also worry about political risk—typically that a government will do something to impair the value of their assets.  Deepwater exploration often takes place in the developing world, where government institutions may be unstable and vulnerable to conflict.  Nonetheless, the perception of political risk for deepwater may be greater than the reality.  Even if the government changes, the new administration may be dependent on the international oil companies to operate the offshore facility and keep the revenues flowing to its treasury.  Deepwater platforms also are usually far from the shoreline.  Militants are less likely to sail 60 or more miles into the ocean searching for a deepwater platform when there are plenty of softer targets on land.

Shale developments, even in the United States, actually may be more vulnerable to political risk.  Shale imposes considerable inconveniences on local populations, with upwards of 100 trucks per hour descending on a single well location.  Drilling density is high, which can fundamentally change the rural landscape and lead to not-in-my-backyard opposition from local residents.

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Environmental activists have targeted shale, most notoriously with the movie Gasland, which showed natural gas leaking into residents’ tap water.

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Such issues have led states such as New York and nations such as France to ban shale development altogether.

Political risk can be tough to predict, though.  Venezuela was the pillar of stability and prosperity in South America before Hugo Chavez took power.  In the United States, oil and gas production is regulated mostly at the state level—thus, political risk varies according to which political party controls which states.  Republican or “red” states tend to support the oil and gas industry while Democratic or “blue” states can be hostile (e.g. the 2016 Democratic Party Platform states: “We believe America must be running entirely on clean energy by mid-century”).  Texas seems to be among the lowest risk states, but even it has been trending blue over the last two decades (particularly in its largest cities):

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Deepwater projects are exposed to political risk in another way—up-front sunk costs.  Deepwater capital costs are front-loaded whereas shale capital costs occur over a period of many years, as additional wells are drilled.  Should political risk increase, shale developers can cut their losses and redeploy capital elsewhere.

While deepwater and shale have different risk profiles, it’s hard to generalize and conclude that one or the other is less risky.  Many risks are project-specific or site-dependent.  What are the exploration risks for a particular set of wells?  Where is the project located?  As Mark Twain once quipped:

All generalizations are false, including this one!

About the Gaille Energy Blog.  The Gaille Energy Blog (view counter = 52,682) discusses issues in the field of energy law, with periodic posts at  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development).

Images available on the Internet and included in accordance with Title 17 U.S.C. Section 107.



Shale vs. Deepwater Exploration Rates of Return [Gaille Energy Blog Issue 61]

Last week, the Trump Administration announced that it would open new areas of the United States coast to deepwater exploration:

In a striking about-face, the Interior Department announced yesterday that it wants to allow drilling in nearly all U.S. waters, the single largest expansion of offshore oil and gas leasing ever proposed by the federal government.  The agency said it will hold 47 lease sales in every region of the outer continental shelf but one between 2019 and 2024. The updated five-year plan, required by President Trump in an executive order in April, puts regions that were long off-limits to oil and gas development back in play.  Planning areas in the Pacific Ocean and the eastern Gulf of Mexico are included in the new plan, as well as more than 100 million acres in the Arctic and along much of the Eastern Seaboard. Brittany Patterson and Zack Colman, Trump Opens Vast Waters to Offshore Drilling (Scientific American, Jan. 5, 2018).

While oil and gas investors have been focused on investing in onshore shale developments, there is renewed and growing interest in offshore exploration and development.  This has been driven in part by investors being disappointed in shale returns:

Fed-up investors are demanding that U.S. shale-oil producers make money for a change, write The Wall Street Journal’s Bradley Olson and Lynn Cook.  In the past decade, the shale-fracking revolution has made the U.S. the world’s largest oil-and-gas producer and upended global markets.  Nevertheless, shale has been a lousy bet for most investors. Since 2007 energy companies have spent $280 billion more than they generated from operations on shale investments.  Neanda Salvaterra, Wall Street to Shale: Show Me the Money—Energy Journal (Wall Street Journal, Dec. 7, 2017).

The below chart compares shale with conventional development returns:


The numbers get even more interesting when one looks at a specific deepwater project.  Guyana’s Stabroek Block on the northern coast of South America is estimated to have total recoverable resources of more than 3.2 billion barrels of oil equivalent.  On January 5, 2018, Hess announced another discovery there:

[Hess] and ExxonMobil affiliate Esso Exploration and Production Guyana Ltd. began drilling the Ranger-1 well on Nov. 5, 2017 and encountered approximately 230 feet (70 meters) of high-quality, oil-bearing carbonate reservoir. The well was safely drilled to 21,161 feet (6,450 meters) depth in 8,973 feet (2,735 meters) of water.

Hess’ September 7, 2017 presentation at the Barclays CEO Energy-Power Conference included the following comparison between the economics of its Guyana deepwater discoveries and shale:

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When I was Director—Business Development at Oxy from 2004-7 and President of private equity-backed West & East Africa Oil from 2007-9, my geological teams identified dozens of 200 million-plus barrel deepwater prospects on both sides of the Atlantic.  Among these were the Stabroek Block and the adjacent waters in Suriname.  Most of our prospects are still waiting to be drilled.

About the Gaille Energy Blog.  The Gaille Energy Blog (view counter = 48,566) discusses issues in the field of energy law, with periodic posts at  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development).

Images available on the Internet and included in accordance with Title 17 U.S.C. Section 107.


Gaddafi’s Violent Legacy Continues to Haunt Libya’s Energy Industry [Gaille Energy Blog Issue 60]

More than six years after Muammar Gaddafi’s death, the violence in Libya continues.

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Attackers bombed a major Libyan pipeline, reducing the nation’s production by ~100,000 barrels per day:

“Libya is rife with rival militias and armed groups, some in competition with the internationally backed government.  Oil was trading at more than $65 (€55) a barrel after the incident, close to its highest price since mid-2015. . . . The pipeline is operated by a subsidiary of the National Oil Corporation (NOC) and a joint venture with Hess Corp, Marathon Oil Corp and ConocoPhillips. . . . Libya produces about 1 million barrels of per day, but production is often cut due to sabotage, politics and instability.”  Explosion at Major Oil Pipeline in Libya, (Dec. 26, 2017).

The impact of such attacks is evident in the nation’s recent production history:

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All of this started in 1969, when Colonel Gaddafi (then 28 years old) deposed King Idris and took over Libya.

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Most American oil companies—Conoco, Marathon, Amerada Hess, and Occidental Petroleum—managed to coexist and work with Gaddafi’s regime, but Exxon and Mobil eventually abandoned their Libyan assets in 1981 and 1982, respectively.

Things turned worse in 1986, when two American servicemen were killed and 79 were injured when a disco was bombed in West Berlin.  The United States blamed Libya for the attack, and President Reagan retaliated with air strikes and sanctions. The other American companies had to walk away from billion-dollar oilfields in the Libyan desert.  The best these companies could do was enter into Suspension Agreements—whereby Libya’s national oil company assumed all of the American companies’ Libyan obligations (e.g., operating the oil fields) in exchange for receiving all of their oil revenues.  When the Americans left, Libya got to keep all of the Americans’ oil for itself, which only further enriched Libya’s dictator. Eighteen years would pass before anything changed.

In 2004, Colonel Gaddafi finally reached a deal with the Americans.  He agreed to rid Libya of weapons of mass destruction and cooperate in America’s war against terror.  In exchange, the United States lifted its sanctions.

In the last three years of Libyan sanctions, I was responsible for looking after Occidental Petroleum’s dormant Libyan contracts, and then afterwards, with transitioning them back into operations.  I spent much of 2004 shuttling back and forth between Libya and Malta.  In the process of working with the Libyans, I heard many stories of Gaddafi’s decadent lifestyle and brutality.

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Gaddafi Palace Indoor Pool

A journalist I knew went to interview Gaddafi just after the sanctions were lifted. She was escorted to a private room and left there alone, waiting for him.  Then the Colonel entered, wearing a green velour leisure suit unzipped to his bellybutton.  He was smiling broadly and holding two martinis.  Gaddafi offered her one, which she accepted but only pretended to sip–fearing it might be drugged.  My friend tried in vain to interview the Colonel, while he pursued her around the room, repeatedly groping her.

The journalist was lucky to have escaped:

[I]n April 2004, Gaddafi was visiting a school in his home town of Sirte, on the Mediterranean coast 350 miles east of Tripoli.  She had no idea that the pat on the head, seemingly so paternal, actually signified something far more sinister. The car arrived the next afternoon. The girl was working at her mother’s hairdressing salon when in walked three women, one of whom was dressed in a military uniform. The women told the girl’s mother that her daughter was needed to present another bouquet to ‘Papa Muammar’ because she had conducted herself so ‘beautifully’ the previous day. Despite the mother’s protestations, the girl was driven away at high speed to an encampment in the desert. There she was once more introduced to Gaddafi, who was sitting in a red chair holding a TV remote control. He looked her up and down and barked to one of the women: ‘Get her ready!’ Now terrified, the girl was taken away and undressed. . . . Guy Walters, The Terrible Truth about Gaddafi’s Harem: How Libyan Dictator Kidnapped and Raped Dozens of Women to Fulfil His Perverted Desires, Daily Mail (October 23, 2013).

In another gruesome story, the husband of one of Gaddafi’s victims complained.  Gaddafi had him executed by tying each of his arms to cars and sending them in opposite directions.  He literally ripped the poor man apart.

The end of Gaddafi’s life was similarly violent.  The Colonel’s last moments were spent hiding in a drainage pipe, before he was pulled out, tortured, and summarily executed.

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What’s in store for Libya in 2018?  Rising from the ashes of Gaddafi’s fallen regime is Khalifa Haftar.

Screen Shot 2018-01-01 at 12.36.43 PMHaftar participated in the 1969 coup and led numerous military campaigns for Gaddafi before turning on him:

In March 1996, Haftar took part in a failed uprising against Gaddafi in the mountains of eastern Libya. . . .  Haftar moved to suburban Virginia outside Washington, D.C., living in Falls Church until 2007. He then moved to Vienna, Virginia. From there, and mostly through his close contacts within the American intelligence community, he consistently supported several attempts to topple and assassinate Gaddafi.  Wikipedia.

Two days ago, General Haftar threatened to seize power in Libya:

Libyan strongman Khalifa Haftar has said he will support 2018 elections in the war-torn country but also implied he would seize power if the polls did not occur.  Late on Thursday, Haftar said presidential and parliamentary elections were ‘a fundamental solution’ to Libya’s crisis and should be held ‘without delay or fraud’.  Oil-rich Libya has been wracked by chaos since a 2011 uprising that toppled longtime dictator Moammar Gaddafi.  A UN-backed unity government in Tripoli has failed to impose its authority nationwide, and has been rejected by a rival administration backed by Haftar in the east of the country.  This month, Haftar said the unity government had definitively lost all legitimacy after the expiry of the December 2015 UN-brokered agreement that gave rise to it.  ‘But the accord is one thing and the UN mission’s work (towards holding elections) is another,’ he told the Al-Hadath television channel on Thursday. Haftar’s opponents accuse him of wanting to seize power and establish a military dictatorship, while his supporters have called for him to take control by ‘popular mandate’.  Haftar said this ‘mandate’ could be a possibility ‘if all classic mechanisms allowing a peaceful power transition via free and democratic elections were exhausted’.  Libya Strongman Says Backs 2018 Elections, AFP (Dec. 30, 2017).

But Khalifa Haftar is not a young man.  At 75 years of age, his reign is unlikely to be a long one.

About the Gaille Energy Blog.  The Gaille Energy Blog (view counter = 48,566) discusses issues in the field of energy law, with periodic posts at  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development).

Images available on the Internet and included in accordance with Title 17 U.S.C. Section 107.


France Passes Law Banning Fossil Fuels [Gaille Energy Blog Issue 59]

Toreador Resources Corporation was one of the first companies to exploit international shale in the late 2000s.  Hydraulic fracturing was working in the United States, and similar shale formations exist around the world.  One of the largest sits in the middle of France, just east of Paris.  The EIA estimates that France has among the largest natural gas reserves in Europe:

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France also is a large importer of natural gas, burning more than 1 tcf of gas produced elsewhere.

Toreador’s CEO was American Craig McKenzie, a graduate of Northwestern’s Kellogg School of Business.  He was among the first to see the Paris Basin shale opportunity.

Picture mc

I like to understand people’s life stories.  What events have shaped them?  What did they have to overcome?

“[One study] found that less than 15% of their famous men and women had been raised in supportive, untroubled homes, with another 10% in a mixed setting. Of the 400, a full 75%—some 300 individuals—had grown up in a family burdened by a severe problem: poverty, abuse, absent parents, alcoholism, serious illness or some other misfortune. ‘The ‘normal man,’’ the [study] wrote, ‘is not a likely candidate for the Hall of Fame.’”  Meg Jay, The Secrets of Resilience, Wall Street Journal (Nov. 10, 2017).

Craig McKenzie lost his father at 13.  William W. McKenzie was a pilot for Southern Airways. Captain McKenzie’s plane encountered a terrible storm, and hail stones broke the cockpit windows and destroyed the plane’s engines:

“At 4:18 P.M. on April 4, 1977, a powerless DC-9 . . . on its way to Atlanta, made an emergency landing on a rural two-lane highway in this small community, about 30 miles northwest of Atlanta. The pilot brought the plane down right on the yellow line. But the plane clipped roadside power poles and trees with the tips of its wings . . . . Twenty-two survived, including the two flight attendants.”  Kevin Sack, Memories and Healing Two Decades After Crash, New York Times (Apr. 14, 1997).

While Captain McKenzie perished, his miraculous landing on the road saved the lives of 22 passengers.  Twenty years later, the New York Times reported how Craig and his mother attended a reunion of these survivors and their descendants.  Such experiences do shape people.

Craig McKenzie saw the untapped supply in the Paris Basin shale, and the growing energy demand in Europe.  He pounced, betting the company on French shale.  McKenzie led the acquisition of nearly a million acres there.

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He then partnered with Hess Corporation to develop them.  Just when it looked like Craig’s vision would be realized, disaster struck.  In 2011, France banned the use of hydraulic fracturing.  Without hydraulic fracturing, Toreador’s 780,000 acres of shale concessions were worthless—because the natural gas could not be produced.  About $350 million of Toreador’s stock value evaporated.

France offered no compensation to Toreador’s shareholders, and McKenzie had no choice but to sell Toreador for the value of its existing wells.  Texas’ ZaZa Energy Corporation entered into an agreement to acquire Toreador in mid-2011.  The new ZaZa Board of Directors elected McKenzie as the combined companies’ initial CEO.  That same Board also appointed me as ZaZa’s Chief Compliance Officer & General Counsel.

As General Counsel, my responsibilities included trying to realize value from the distressed Toreador assets.  I hired experts on French politics, who helped me understand the behind-the-scenes maneuvers leading to the shale ban.  I also traveled to Paris and met with the French ministers responsible for energy and the environment.  What I learned in 2012 and 2013 was that it was unlikely the shale ban would be reversed.  One minister candidly told me:

“The ban on fracking is merely the start.  We will ban fossil fuels in all forms.  We will ban production.  We will ban importation.  We will ban motor vehicles.  One day, France will be green.”

Words like these made it clear there was no future in France for my client.  The Toreador assets were eventually broken-up and divested to others with rosier views of France’s future.

But had Toreador been sold prematurely?  Five years later, my assessment of the French political situation was proven correct.  The 2011 ban on hydraulic fracturing was just the first step toward ending fossil fuels in France.  As the minister had predicted, a new law was passed, paving France’s path to zero fossil fuels:

“No new permits will be granted to extract fossil fuels and no existing licenses will be renewed beyond 2040, when all production in mainland France and its overseas territories will stop.  France bans fracking and oil extraction in all of its territories.  . . . [The French] government plans to stop the sale of diesel and petrol engine cars by 2040 as well.”  The Guardian (Dec. 20, 2017).

It looks like France’s 100+ TCF of natural gas will remain forever locked in the planet’s crust. So, too, will France’s law affect the economic prospects of its distant dependencies in South America and Africa:

  • French South America. South America’s Guyana basin is estimated to have as much as 13 billion barrels of oil—spread across the two nations of Guyana and Suriname and France’s overseas territory, French Guiana.  Explorers have been excited about the Guyana basin for more than a decade.  I first traveled there in 2005 to negotiate a series of farm-ins and production sharing agreements to lock-up acreage in Guyana, Suriname, and French Guiana.  While the big discoveries have been outside of French waters, the Zaedyus well in French Guiana intersected 236 ft of oil pay (although subsequent appraisal wells failed to extend the reservoir), and there are numerous other undrilled prospects in French waters there:


  • French Africa. Other territories within French control that could harbor petroleum reserves include the Indian Ocean islands of Mayotte and Juan de Nova. These islands sit between petroleum discoveries in Mozambique and Madagascar:


The French President tweeted jubilantly about the ban:

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But does #keepitintheground actually help #makeourplanetgreatagain?  If France’s goal is to reduce carbon emissions, the surest way to accomplish that goal is by substituting natural gas for coal.  Burning natural gas—instead of coal—would reduce carbon emissions by ~50%.  French gas could be used elsewhere in Europe, perhaps enabling Russian gas to be sold to China (the world’s number one carbon polluter due to its reliance on coal).

greenhouse map

Yet France apparently believes that a 50% reduction in carbon emission is not enough.  They are purists.  They want zero emissions.

Unfortunately, purists often end up with nothing.  Twenty-two years from now, how will France’s quest for environmental perfection be viewed?  Will France have successfully led the world to ban fossil fuels?  Or, will President Macron have squandered an opportunity to curb carbon emissions by developing its shale gas?  As another French citizen, Voltaire, once warned:

“Le mieux est l’ennemi du bien. (The perfect is the enemy of the good.)”


About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with periodic posts at  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of three books on energy law (Construction Energy Development, Shale Energy Development, and International Energy Development).

Images available on the Internet and included in accordance with Title 17 U.S.C. Section 107.

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