How competitive is the market for fracking, and how has that changed since the shale boom began? There are many competitors across the supply and production chain of oil & gas drilling, but a new class action lawsuit that began earlier this month unveiled the attempts of some companies to increase their own wherewithal in the fracking services industry and weed out competition.
Fracking services monopoly?
A trio of co-conspiring fracking corporations, which happen to be the three most dominant and longstanding companies in the industry, are being sued for anti-competitive practices, namely price fixing. If the claims hold up in court, this would make Halliburton, Schlumberger, and Baker Hughes the OPEC of the U.S shale gas/oil industry. Okay, not exactly. They are being sued not for colluding to fix the price of oil & gas, but for fixing the price of the machinery required for fracking. These companies don’t perform fracking operations; they’re actually the biggest providers of the fracking services bought by companies that do.
Collusion between companies that sell the same good or service was made illegal over a century ago under the Sherman Antitrust Act of 1890 & the Clayton Antitrust Act of 1914. “Antitrust” really refers to anti-competition. If companies are found to engage in prolonged behavior that limits competition in a market and gives them an unnatural monopoly, it is unlawful. These acts allow the government to step in to limit cartels & monopolies, thus preserving the idea of a free, competitive market with many buyers and sellers of the same good. If Halliburton, Schlumberger, and Baker Hughes are collectively manipulating the fracking services market, they are also illegally increasing their profits and market share at the expense of both customers and competitors. And to monopolize a pressure pumping industry worth well over $31 billion would not go unnoticed. It didn’t.
Quick economics lesson: when only three companies control over 60% of the market share for pumping equipment and services for fracking, they wield considerable control over how much they supply to the companies doing the fracking. Restricting the supply of pumping services increases the price fracking companies are willing to pay for limited equipment while also increasing the market share of those three companies. Why would they restrict supply, save for the lure of windfall profits? What happened in the shale gas market between 2011 and 2013 is illuminating. In 2011, an onslaught of independent competitors jumped into the market for the operating machinery, too. There was a huge push to add capacity & pressure pumping equipment as fracking increased dramatically across the country. 2011 was the biggest year in terms of the sheer volume of frack jobs performed; enormous demand for more machinery lured other providers into the market. Besides, this is a market that rose sharply from $31 billion to $46.6 billion annually, a long shot from being worth under $8 billion in 2002. So the 2011 supply chain constraints made it extremely lucrative to make & sell pumping machinery.
But 2013 was a turn for the worse. Because so much gas was being extracted and overshot U.S consumer demand, there was suddenly both a slowdown in drilling and an excess of pumping equipment. For big players like Halliburton, Baker Hughes, and Schlumberger, suddenly their equipment wasn’t selling: prices for natural gas were low, less fracking meant less equipment sales, and the new 50-60 competitors also providing pressure-pumping equipment made it difficult for any one company to turn a profit. Prior to the escalation of the shale boom in 2011, the three big companies controlled over 70% of the market share. Suddenly, their market share dropped nearly 10%.
How to curb competition
If the allegations made against them are true, what the three companies likely did to crush other service competitors was agreeing to collaborate, or collectively undercut the smaller companies and sell equipment at lower prices. Selling equipment at lower prices encouraged more fracking companies to buy only from Halliburton, et. al for pumping equipment. As the other service companies suffered losses or dropped out, the big 3 began to get their market share back. Then they proceeded to restrict how much equipment they sold, which drove prices well above competitive levels, thus forcing fracking companies to buy equipment at abnormally high prices. How could they do this? Because after their competitors dropped out, fracking companies had no one else to go to to buy equipment.
Consequent to changes in the fracking services market, a lawsuit was filed by a smaller company that bought machinery from Halliburton, Schlumberger, or Baker Hughes. Cherry Canyon Resources LP claims to speak and act on behalf of many smaller companies that allegedly paid higher fees for equipment than they would have in a truly competitive market. The pressure pumping equipment is expensive enough already due to the elaborate technology involved and because it must be powered by expensive diesel fuel. With higher overhead costs, companies paying thousands or millions more may suffer losses – instead of profiting – from their fracking operations.
Some speculate that the allegations are untrue and that what happened was simply an unfortunate business cycle:
“There may very well be a couple of abuses, but widespread and consistent abuse seems very unlikely given the structural nature of the market.” (Alexander Robart, analyst with PacWest Consulting)
Regardless, the Department of Justice will now investigate the case and likely access records, crucial documents, and even e-mails in an “antitrust probe” to determine whether or not the three companies did indeed collude to manipulate the fracking services market. Cherry Canyon Resources claims that meetings and direct communication were part of the companies’ tri-partite effort to increase their influence in the fracking services market to pre-boom levels. In response to too much competition, what behavior is acceptable for companies who want to maintain their status in the market? How does that behavior then affect other companies in the market, companies who rely on that market, and consumers? And if the allegations are true, will the disciplinary action taken against Halliburton, Baker Hughes, and Schlumberger be sufficient to prevent future predatory behavior?