Ilargi: Drilling Our Way Into Oblivion

Lambert here: So the fracking companies have purchased “risk insurance.” I wonder what happens when they all file their claims at the same time. What could go wrong?

By Raúl Ilargi Meijer, editor-in-chief of The Automatic Earth. Originally published at Automatic Earth.

Oh, that sweet black gold won’t leave us alone, will it? West Texas Intermediate went through some speedbumps Friday, but ended over +5%, though still only at $57. Think them buyers know something we don’t? I don’t either. I see people covering lousy bets. And PPT (and that’s not the one we used to spray our crops with).

The damage done must be epic by now, throughout the financial system, but we’re not hearing much about that yet, are we? We will in time, not to worry. Everyone’s invested in oil, and big time too, and they’ve all just become party to a loss of about half of what both oil itself and oil stocks were worth just this summer.

There’s those who can ride it out and wait for sunnier days, but many funds don’t have that luxury. Who wants to be manager of Norway’s huge oil-based sovereign fund these days? With all these long-term obligations entered into when oil was selling for $110, no questions asked? The Vikings must be selling assets east, west, left and right. But they’re not going to tell us, not if they can help it.

Just like all the other money managers who pray every morning and night on their weak knees for this nightmare to pass. Your pension fund, your government, they’re all losing. BIG. They’ll try and hide those losses as long as they can. But trust me on this one: all major funds have oil in a prominent place in their portfolios. And there’s a Bloomberg index that says the average share values of 76 North American oil companies, i.e. not just the price of oil, have lost 49% of their value since June. There will be Blood with a capital B.

The discussions over the past few weeks have all been about OPEC, whether they would cut output or not. And I’m not really getting that. There are 3 major producers today, you might even label them swing producers: Saudi Arabia, Russia, and the US. But all the talk is always about OPEC cutting. What about Russia? Well, they can’t really, can they, with all the sanctions and the threat they are to the ruble. Russia must produce full tilt just to make up for those sanctions. The Saudis know that if they cut, other producers, OPEC or not, will fill in the gap they leave behind. At $55 a barrel, everyone’s desperate. Therefore, the Saudis are not cutting, because it would only cost them market share, and prices still wouldn’t rise.

So why does everyone in the western media keep talking about OPEC cutting output, and not the US, just as the same everyone is so proud of saying the US challenges the Saudis for biggest producer status?! Why doesn’t the US cut production? It’s almost as big as Saudi Arabia, after all. Why doesn’t Washington order the (shale) oil patch to tone it down, instead of having everyone talk about OPEC? I know, energy independence and all that, but it’s still a curious thing. Want to save the shale patch? Cut it down to size.

Anyway, this is what we have on offer: the oil industry faces a triple whammy. Oil prices are down 50%, oil company share valuations are also down 50%, and their production costs are rising, in quite a few cases exponentially so. That’s what they, and we, face while slip-sliding into the new year. Do I need to explain that that does not bode well? Let’s do a news round. Starting with Bloomberg on how the shale boys are stumbling over their hedges and other ‘insurance’ policies. All you really need to know is: “Producers are inherently bullish ..” And then you can take it from there.

Oil Crash Exposes New Risks for U.S. Shale Drillers

Tumbling oil prices have exposed a weakness in the insurance that some U.S. shale drillers bought to protect themselves against a crash. At least six companies, including Pioneer Natural Resources and Noble Energy, used a strategy known as a three-way collar that doesn’t guarantee a minimum price if crude falls below a certain level, according to company filings. While three-ways can be cheaper than other hedges, they can leave drillers exposed to steep declines.

“Producers are inherently bullish,” said Mike Corley, of Mercatus Energy Advisors. “It’s just the nature of the business. You’re not going to go drill holes in the ground if you think prices are going down.” [..] Shares of oil companies are also dropping, with a 49% decline in the 76-member Bloomberg Intelligence North America E&P Valuation Peers index from this year’s peak in June. The drilling had been driven by high oil prices and low-cost financing.

Companies spent $1.30 for every dollar earned selling oil and gas in the third quarter, according to data compiled by Bloomberg on 56 of the U.S.-listed companies in the E&P index. Financing costs are now rising as prices sink.

The average borrowing cost for energy companies in the U.S. high-yield debt market has almost doubled to 10.43% from an all-time low of 5.68% in June, Bank of America Merrill Lynch data show. [..]

Pioneer, one of the biggest U.S. shale oil producers, used three-ways to cover 85% of its projected 2015 output, the company’s December investor presentation shows. The strategy capped the upside price at $99.36 a barrel and guaranteed a minimum, or floor, of $87.98. By themselves, those positions would ensure almost $34 a barrel more than yesterday’s price.

However, Pioneer added a third element by selling a put option, sometimes called a subfloor, at $73.54. That gives the buyer the right to sell oil at that price by a specific date. Below that threshold, Pioneer is no longer entitled to the floor of $87.98, only the difference between the floor and the subfloor, or $14.44 on top of the market price. So at yesterday’s price of $54.11, Pioneer would realize $68.55 a barrel.

Where does this turn from insurance to casino, right? It’s a blurred line. Nobody worried about that as long as prices were NOT $55 a barrel. But now they have to. Pioneer gets $68.55 a barrel. Big deal. That’s still well over 30% less than in June.

In Europe, oil is a big issue too. They still have some of the stuff there after all. And that too has halved in value. North Sea oil is a large part of total UK tax revenues, but it’s also energy independence. And already there are people saying that the entire industry is dying.

North Sea Oil Industry ‘Close To Collapse’

The UK’s oil industry is in “crisis” as prices drop, a senior industry leader has told the BBC. Oil companies and service providers are cutting staff and investment to save money. Robin Allan, chairman of the independent explorers’ association Brindex, told the BBC that the industry was “close to collapse”. Almost no new projects in the North Sea are profitable with oil below $60 a barrel, he claims. “It’s almost impossible to make money at these oil prices”, Mr Allan, who is a director of Premier Oil in addition to chairing Brindex, told the BBC.

“It’s a huge crisis.” “This has happened before, and the industry adapts, but the adaptation is one of slashing people, slashing projects and reducing costs wherever possible, and that’s painful for our staff, painful for companies and painful for the country. “It’s close to collapse. In terms of new investments – there will be none, everyone is retreating, people are being laid off at most companies this week and in the coming weeks. Budgets for 2015 are being cut by everyone.”

His remarks echo comments made by the veteran oil man and government adviser Sir Ian Wood, who last week predicted a wave of job losses in the North Sea over the next 18 months. US-based oil giant ConocoPhillips is cutting 230 out of 1,650 jobs in the UK. This month it announced a 20% reduction in its worldwide capital expenditure budget, in response to falling oil prices.

Other big oil firms are expected to make similar cuts to their drilling and exploration budgets. Research from Goldman Sachs predicted that they would need to cut capital expenditure by 30% to restore their profitability at current prices. Service providers to the industry have also been hit. Texas-based oilfield services company Schlumberger cut back its UK-based fleet of geological survey ships in December, taking an $800m loss and cutting an unspecified number of jobs.

[..] .. as a lot of production ceases to make money below $80 barrel (it’s now in the region of $63), North Sea producers and those in their supply chain now face pressure to cut costs sharply. Those costs have been rising steeply in recent years. And measured per barrel of production, they’ve been rising at an alarming rate.

400,000 people work in the industry in the UK, plus at least twice as many in supporting fields, and most of those jobs are in Scotland. Not good.

And it’s not going to stop either, as the following Bloomberg piece makes crystal clear, and for obvious reasons. Once you’ve dug a well, you have to squeeze it for all you got. Makes perfect sense to me.

But… A 42-year record in US domestic production just as prices plummet by 50%, that has to be a game changer. And then you run into problems.

Exxon Mobil Shows Why US Oil Output Rises as Prices Plunge

Crude oil production from U.S. wells is poised to approach a 42-year record next year as drillers ignore the recent decline in price pointing them in the opposite direction. U.S. energy producers plan to pump more crude in 2015 as declining equipment costs and enhanced drilling techniques more than offset the collapse in oil markets, said Troy Eckard, whose Eckard Global owns stakes in more than 260 North Dakota shale wells.

Oil companies, while trimming 2015 budgets to cope with the lowest crude prices in five years, are also shifting their focus to their most-prolific, lowest-cost fields, which means extracting more oil with fewer drilling rigs, said Goldman Sachs. Global giant Exxon Mobil, the largest U.S. energy company, will increase oil production next year by the biggest margin since 2010. [..]

“Companies that are already producing oil will continue to operate those wells because the cost of drilling them is already sunk into the ground,” said Timothy Rudderow, who manages $1.5 billion as chief investment officer at Mount Lucas Management. “But I wouldn’t want to have to be making long-term production decisions with this kind of volatility.”[..] U.S. oil production is set to reach 9.42 million barrels a day in May, which would be the highest monthly average since November 1972, according to the Energy Department..

Existing wells remain profitable even as benchmark crude futures hover near the $55-a-barrel mark because operating costs going forward are usually $25 or less, Tom Petrie, chairman of Petrie Partners said. That’s why prices that have tumbled 47% from this year’s peak on June 20 haven’t prompted any American oil producers to shut down wells, said Petrie. The average cost to operate an existing well in most parts of the U.S. “is about $20 a barrel,” Petrie said. [..] Until you dip into that and start losing money on a cash basis day in, day out, you don’t think about shutting in” wells.

Once oil companies sink cash into drilling wells, lining them with steel pipes and concrete, blasting the surrounding rocks into rubble with hydraulic fracturing, and linking them to pipeline systems, they have no incentive to scale back production, said Andrew Cosgrove, an analyst at Bloomberg. Those investments, which represent “sunk costs,” are no longer a drain on cash flow, Cosgrove said. Instead, they generate capital companies use to repay debt, fund additional drilling, pay out dividends and buy back shares, he said.

Exxon Chairman and CEO Rex Tillerson pledged in March to raise output by an annual average of 2% to 3% during the 2015-2017 period.

Things run fine at existing wells. Prices get governments in Russia and other producers into trouble, but most can catch that fall up to a point. In the US shale patch, it’s a different story, because there it’s not like once you’ve drilled a well, you can move for years to come. Saudi’s famed Ghawar field has been gushing for 60 years. Shale wells deplete 80-90% in just two years.

It’s like comparing a business that can keep durable goods in stock for years, with one that has only perishables and needs to move them ASAP. A whole different business model, but operating in the same market, and competing for the same customers.

The shale patch can exist in its present form only if it has access to nigh limitless credit, and only if prices are in the $100 or up range. Wells in the patch deplete faster than you can say POOF, and drilling new wells costs $10 million or more a piece. Without access to credit, that’s simply not going to happen.

Don’t forget, shale companies came into the ‘new lower price era’ with big debt issues already in place – borrowing well over $100 billion more annually than they earned, for at least 3 years running, and then in Q3 2014 they spent ‘$1.30 for every dollar earned selling oil and gas’ according to Bloomberg’s E&P index.

Q3 is July, August and September. On July 1, WTI traded at $106. On September 30, it still did $91. And in those days, at those prices, the industry bled $1.30 for every dollar earned. What is that ratio today? $2 spent for every $1 earned? $2.50? More? That is not a different business model, that is not a business model at all.

Existing wells, those already drilled, will be allowed to be emptied, but then it’s over. Who’s going to continue to pump millions upon millions into something that’s a guaranteed loss? Nobody. And not only that, but lenders will start calling in their loans, and issue margin calls. “The average borrowing cost for energy companies in the U.S. high-yield debt market has almost doubled to 10.43% from an all-time low of 5.68% in June”, says BoAML.

That’s about all we need to know. Shale was never a viable industry, it was all about gambling on land prices from the start. And now that wager is over, even if the players don’t get it yet. So strictly speaking my title is a tad off: we’re not drilling our way into oblivion, the drilling is about to grind to a halt. But it will still end in oblivion.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.

63 comments

  1. abynormal

    “The average borrowing cost for energy companies in the U.S. high-yield debt market has almost doubled to 10.43% from an all-time low of 5.68% in June”, says BoAML.” you bet they knew something!

    how does one believe a finite commodity offers independence?
    when your livelihood relies on it…that’s how.

    “Returns on oil and natural gas assets in the top two state funds in 17 states, which include almost half of all the people covered by state and local pension plans in the U.S., averaged 42 cents for each dollar invested compared to just 6 cents for other assets in these funds from 2005 through 2009. http://www.whoownsbigoil.org/#/?section=whoowns-the-oil-companies.”

    we’re going to bail out big oil with less than we’ve ever had…

  2. Carolinian

    Speaking as a heartlander I say pass the popcorn. I realize many in this space and on the Left applaud high gas prices as a brake to global warming. But in a capitalist world they are also a huge rent, to use Michael Hudson’s phrase, on ordinary people who often have little choice but to drive long distances to work, school, etc. Shoveling hard earned cash from working people’s pockets to sharks and speculators and decadent oil sheiks is not a just way to deal with an environmental problem (if fuel prices must be high then it should be governments that are doing it–the taxes returned to the public in, say, health care).

    Of course the sharks and speculators are threatening to take us down with them unless they get a bailout. But perhaps those around here better versed in economics than yours truly could explain how that’s going to happen. Weren’t all the magic bullets used up in the last crisis? Perhaps it’s time to put the risk back in risk premium. Meanwhile in my neck of the woods there are some happy drivers. In low gas tax SC some stations are now down to $1.99.

    1. Llewelyn Moss

      Did you know bottled water is more expensive per gallon than gasoline?

      Please report back after the Frackers have poisened the aquifers under your entire state, and you can no longer drink or bath in what comes out of your tap. I really want to know what’s in those millions of gallons on chemical slury that they pump into the ground. I must be nice to own congress and get your own personal exemption from the Clean Water Act. I would watch the movie Gasland II before you offer drilling rights in your backyard.

      1. Carolinian

        Yes I do know all that. Did you know that low oil prices are putting a stymie, at least for awhile, on this evil fracking nonsense? Perhaps you should read the above NC article.You might also re-read my comment which says nothing in favor of fracking (luckily for SC, we have no oil).

        My point is simply that it is our economic system which is both incapable of managing a rational oil market or dealing with environmental problems such as AGW. The wheelhouse for that economic system, btw, is in deep blue NYC–not anywhere around here. For awhile at least people between the coasts will get to enjoy this latest manifestation of economic dysfunction. I’m sure it won’t last that long.

        1. John Calhoun

          Never underestimate Senator Toby’s push to drill off the coast of South Carolina. The locals talk pretty bout da marshes, farms, dem oysters and da plantation land, but in a heartbeat, they’ll put grandma on the mahogany table and yank her kidney out with the family silver for a dollar if the could sell it on the open market.

        2. Llewelyn Moss

          Ok, I guess I got a bit preachy, sorry. I was just venting frustration with the energy industry. Fracking is used in many shale extraction wells including oil, not just natural gas. I’m really tired of energy companies getting billions in tax breaks even as they are some of the most profitable companies in the US — read that as Corporate Welfare Queens. Then they turn around and use billions to lobby the govt to further rig the system in their favor and against taxpayers and consumers.

          I wonder what would have happened if the US had taken the $5-6 Trillion it has spend on the Pointless War on Terror(WOT) and spent the money instead on building a Govt controlled renewables industry selling the energy back to taxpayers AT COST. Hint: The WOT has been money down the drain from a taxpayer viewpoint — literally nothing of value has been accomplished.

          1. different clue

            Oh, but something HAS been accomplished. Those several trillion dollars spent on the GWOT have been rendered safely unavailable for spending on renewable energy. The renewable energy threat having thus been neutralized, oil is rendered safely crucial to the economy for several petroprofitable decades to come. That is really quite and accomplishment. Or “decomplishment” , as John Stewart might say.

    2. James

      Low prices now = reduced or non-existent exploration and new production later. And while a prospective bailout might make current losses whole, it likely won’t stimulate any new exploration afterward, barring the few that might count on yet another bailout further down the road. Another step on the road to the end of oil, although it will likely lead to the further ‘militarization’ of the remaining reserves, as there’s crucial limits below which our modern society cannot fall without melting down altogether. Something tells me we’re dangerously close to testing those limits now, especially in light of recent and ongoing American military misadventures, which make no rational sense whatsoever on any other basis.

      1. Brooklin Bridge

        All good points! The military industrial complex alone is being run be people that are certifiably bat-sh*t crazy. We are headed toward war with Russia as if it were an afternoon sail. It’s beyond belief.

    3. financial matters

      It’s a matter of priorities and it’s becoming very clear who’s calling the priorities:

      http://neweconomicperspectives.org/2014/12/technology-solution-democracy-crisis.html

      By Joe Firestone

      ‘The spectacular intrusion of special interests into the passage of the $1.1 trillion government spending bill on December 13, 2014 was breathtaking as bankers and lobbyists whipped the vote by calling Congressional representatives directly to demand a host of special interest provisions, including the following:

      Repealing the Dodd-Frank prohibition on locating derivatives trading activities in the same bank subsidiary company as their depositories containing checking, savings, and other accounts insured by the FDIC.

      Raising individual campaign contribution limits by roughly 10 times the present limit.

      Allowing businesses to default by as much as 1/3 of their private pension obligations.

      Preventing the EPA from introducing new climate protections.

      So it is now abundantly clear that what we have is government by minority rule in which special interests reign supreme. Clearly, this cannot continue. It is for this reason that we are sharing the post below describing the only solution to the democracy crisis of which we are aware that can be implemented in the near future.’

      1. John Zelnicker

        The technological solution that Joe speaks about can be found at:

        http://reinventdemocracy.net/

        Everyone here at NC who has been promoting their concept of how we can or should change, e.g., the economy, the culture, the politics…whichever part of our world you want to change, should check out this site and the group promoting it as a consensus building platform that can be used to foster and build any kind of political effort that a group of people want to focus on; local, state, national, narrow issue, broad issue, whatever motivates you. It’s a way to gather like-minded people to build coalitions that could, perhaps, achieve political change.

        Read Joe’s full post at NEP (it’s a bit long) and then check out http://reinventdemocracy.net/. It will be worth your time.

        1. Code Name D

          And it’s a bad idea.

          I only skimmed through it, but it sounds like just a re-branding of grass-roots organizing with a technical twist added in.

          However, the “science” to which it refers to (all though I haven’t actually found any so far) sounds to be extremely dubious and doesn’t agree with the state of social sciences as I understand them.

          The problem with grass roots is something I have heard coined as social tyranny or social veto, and is one of the problems associated with direct democracy. Imagine you have a thousand people in a conference, and all have to agree with an action before it is take. There is always one or two people who will refuse to agree with the action, no mater how practical it may appear.

          In order to get any thing done, the group will actually tend to become more authoritarian. Leaders will immerge and start to enforce group think onto the members. The only difference is that these leaders are not given formal powers within the group, but only take on informally powers through normal human networking. This can make these leaders harder to spot – even though they wield substantial power within the group.

          Those who wish to “respect” true equality within the group find that they can no longer compete with the new enforced order or the more aggressive group. They are ether forced to conform themselves, or forced out of the group.

          This is the core problem with grass roots organizing. It either fails to do any thing productive, or eventually falls into this group-think pattern which is required to be productive.

          This has happened over and over again, with Move on, DFA, the Occupy Movement, Atheism Plus, even the NAZI party. And it will happen to the Inner Active Voter Choice System as well.

          The problem is that you can not create a system that forces total equality on agents/citizens in the group for the obvious reason that all persons are not equal. Consider this, in our 1000 strong group, your bound to have a handful of persons who are intellectually challenged. They could be from a religious world view or some political ideology. You will also have a few persons who are full time academics and have dedicated their loves to researching and studying said issue, and are held accountable by his academic peers to insure his opinion confirms with established research.

          Clearly the opinion of the ideologue and of the academic is not equal. The opinion of the ideologue is detrimental to the group while the academic’s opinion will be of grater value to the group. But the group has no way of knowing this if both are forced into an artificial state of equality within the group. By definition, both must be treated as equal.

          This gives the ideologue an advantage over the academic when it comes to shaping the opinion of the group. Academic knowledge is seldom simple and requires time to convey accurately, and may include concepts that are counter intuitive or even unpopular. The ideologue’s narrative is simple in comparison and exploits common intuition and existing biases.

          You can also think of an ideology like a mental pathogen, one that is capable of mutating and evolving within the group. When a new group is formed, there could be many primitive ideologies that sprout in the population. But the one that exploits human nature better will have a selective advantage over the ideologies. The ideology that propagates through the population the fastest will eventually come to dominate the group, and ideologies that tend to be more authoritarian tend to have advantage over those that are more egalitarian.

          In contrast the academic is constrained by reality and is not flexible. An unpopular conclusions can not be modified because the crowd will’s it to.

          In my opinion, this is one of the differences between Liberalism and Progressive.

          Liberalism tends to favor the idea of total equality among all agents within the group. One voice is no less than or greater than a second voice. The argument is that if all voices can be made equal, than all concerns will be address in the collective, and the world will finally become a utopia.

          Progressivism places less emphases on the collective will, and more on comparing idea based on the merits of the ideas themselves, not on the people presenting said ideas. If an idea is better than what we have now – even if only marginally so, then it is to be adopted. All ideas are worthy of consideration, even if they only benefit a minority group. To a progressive, a utopia is unobtainable, but that we only need to leave things better then when we found it. But a Progressive is not obligated to treat all voices/agents as equals within the group.

          In this light, Obama is Progressive. He is enacting policies that he argues are better than what currently exists. His defense of Obamacare is very progressive in nature, even if its argued to be minimally better than what existed before, then its considered a win.

          But I am starting to see a new political philosophy taking shape that I call “Political Skepticism” which seeks to integrate academic freedom into the political space. Ideas that withstand academic rigger are promoted, while ideas that do not are penalized. Voice that practice academic rigger are promoted, while voices that do not are penalized within the group.

  3. Moneta

    Who’s going to continue to pump millions upon millions into something that’s a guaranteed loss? Nobody. And not only that, but lenders will start calling in their loans, and issue margin calls. “The average borrowing cost for energy companies in the U.S. high-yield debt market has almost doubled to 10.43% from an all-time low of 5.68% in June”, says BoAML.
    ———-
    Bailouts and QE has morphed the US into some strange form of centrally unplanned economy. We know that centrally planned ones can last 65 years. It will be interesting to see how long it lasts when decisions are made by putting on a blindfold and throwing darts.

      1. abynormal

        from which a New World Order will appear?…certifiably batsh!t crazy!

        THE EDGE, there is no honest way to explain it because the only people who really know where it is are the ones who have gone over.
        Hunter S. Thompson

        1. susan the other

          yes. language lags the action it laments by lifetimes… we’re caught between electronic delivery of a vaguely accurate description of what is happening and an 18th century emotional response.

  4. Billy

    Is everyone sure that the drastic drop in oil price isn’t an act of economic warfare against Mr. Putin ?

    After all this was successfully done before.

  5. Paul Niemi

    I would guess there is a Pulitzer Prize waiting for the journalist who documents the who, what, where and how of the post-2008 inflation of the oil bubble, and the aftermath of its destruction. In the worldwide recession environment, who colluded to bid up the price of oil, leading to creation of the enormous debt to finance all schemes for higher production? This cost consumers untold billions in higher gas prices at the pump, and ultimately created financial havoc when the bubble finally deflated.

    Did the same primary dealers who bid up the price of oil using free money from ZIRP and quantitative easing also profit from writing loans used to finance higher production worldwide? How about the junk bonds, did they provide a market for them? And now who holds the bag for all the bad debt? And who has profited as the price of oil has crashed? Remember the housing bubble? The scams seem similar, explain that, but this was done with zero-interest money, and the effects are bringing down governments in oil producing countries. So whither the oiligopoly?

    1. McMike

      The oil story is not an independent tale, its merely another chapter in story of the banks’ complete and utter pilfering of the global economy.

      At some point, it will dawn on people that no matter what happens, good times or bad, up or down, boom or collapse, peace or war, no matter what the story of greed or fraud or gambling, corruption or campaigns, bankruptcies, deaths and criminal scandals… the banks and the elite come out of each phase richer and bolder than before.

      There will be always and every time Goldman Sachs’ disembodied cheshire grin floating in the background. A real life Keyser Soze that is always leaving the scene of the crimes just ahead of the cops.

      1. Paul Niemi

        There is a principle which stands opposed to the banks eventually owning everything. Endlessly stimulated, with zero-interest money, they may buy up whole countries. But experience shows that properties and businesses owned by banks are neglected. Walk through a bank-owned house and see the broken locks, toilet that doesn’t work because the pipes were stolen, the holes in freshly finished walls. They take over businesses and sell the assets needed to earn income, firing the most experienced employees. Banks are ill-suited to managing assets or employing people in other businesses, and it doesn’t matter how large they are.

    2. John Zelnicker

      Paul – I think a big part of the answer is to look to the Saudi’s. According to Warren Mosler, they are the only true swing producer and are the price-setter (and have been for many years). If I understand him correctly, he explains that the Saudi’s don’t actually participate in the spot or futures markets; rather, they post the price at which they are willing to sell today and allow refiners to buy as much as they want.

    3. Rosario

      You don’t need the same culprits when it is an economic inevitability. USA power is in finance and military. Really just finance since it lubricates everything else (having the fiat peg is nice like that). Shale is propped-up and Russia is getting buried mostly because of finance industries. It is difficult to conclude otherwise when the executives of America’s financial institutions are honored guests at the White House regularly (they, in effect, are America’s real power). Couple that with the bottom line of a Capitalist system and we will get the same result on a repeated cycle. By my thinking, modes of exchange reflecting true nature based (materialist) metrics and a great deal of regulation and direction is the only way we can break it.

  6. Karma Fubar

    I find it ironic and amusing that three of the four banner ads I got for this article are for the oil and gas industry: The tall left banner was “Support Keystone XL and enhance US energy security”, the top banner was for TD Ameritrade, the square ad above the tip-jar cats was another one for Keystone XL, and the square ad below the tip-jar cats was “Invest in Oil and Gas drilling – Click Here to Invest Today!”.

    I have no idea how ads are actually selected for my viewing of this site. There is probably a lot that goes into personalization and optimization in the ad selection algorithm, but it evidently does not parse the context of an article describing the possibility of a catastrophic bust in an industry, and then decide to give me an and for LuLu Lemon or something instead of an ad for said industry.

    Anyone else get ads for the oil and gas industry with this article?

    1. Jim Haygood

      Every time I post something about Russia, I am inundated with offers of Russian mail-order brides.

      It’s the price we pay for freeish speech.

    2. Yves Smith

      It is based on what you have been reading lately, or better yet, shopping. I get makeup ads because I bought my sister-in-law some fancy makeup brushes. A hedgie buddy always gets men’s suit ads

  7. McMike

    Looking forward to the ghost town and bankruptcy profiles about North Dakota. The towns and economies will collapse under the burden of their overexpanded/overextended/overbuilt houses of cards, barely able to run the water/sewer system, repave all the roads, or heat the schools. The businesses will pull out, and long term residents will find they have less options to eat/drink/shop than they had before oil came to town. Desperate people will be trading white pickup trucks for bread, so to speak. One-way U-haul drop off fees will be $5,000. And entire blocks of trailer parks and sheetrock apartment buildings – curtains trailing from broken windows and cheap furniture smouldering in the alleys – will give Detroit competition for the most surreal urban moonscape.

    And the environmental catastrophes in PA/OH, as the well casings and retention ponds fail and there’s no one around to hold accountable. We’ll find that people there signed leases with defunct companies that left behind a massive mess in the backyards for the landowner to deal with, and they will be unable to sell their land or get mortgages.

    Twenty something roughnecks will return to their hometowns in Texas and Georgia and Arizona, hat in hand, and explain to their estranged families how despite all that money, all they have to show is an F350 and a wake board boat, with payments to make on both.

    And the politicos and media hacks will all wring their hands and rub their heads and say that no one could have seen this coming.

    Pass the popcorn indeed, and the bottle of booze.

    1. John

      Before the oil boom, I remember reading a proposal to return North and South Dakota to open pasture for the buffalo as the fed subsidized farming was so marginal. Looks like a good idea now. Return the Dakotas to free range buffalo.

  8. Jesper

    Production has increased, consumption has not matched the increase in production.
    What happens with the excess oil? How much storage is left to handle the expected future pumped excess?

      1. susan the other

        China replenished its strategic reserves with low-priced oil. For sure we did too. And both of us are still doing it. That’s one good reason to crash prices, besides the fact that it is a world-wide depression. What I mean is it’s a good reason to stop keeping prices absurdly high, etc. How much secret oil can we stash? I’m betting we can fill every hole in Texas, Oklahoma, Louisiana, California, Ohio and Pennsylvania – just to name the obvious ones. So we can buy up oil forever, and store it eternally mostly for military purposes. The military will never ever take a chance on not having sufficient oil, duh, and until there is a reliable replacement which is a long way off that’s what is going to happen. The secret money being shuffled to both banks and oil drillers (and Saudi Arabia) will accomplish this “securing” of oil and nobody will ever be able to really expose the massive operation that it is. Because, as Moneta so wisely says, it’s “unplanned.”

        1. Code Name D

          Ti te, ta tit e… Union News Flash

          President Obama, seeing an opportunity to replenish the strategic petroleum reserve has announce a new program to buy oil from oil producers – even before it has been pumped from the ground?

          “It makes no sense to me to extract oil from one hole, only to pump it down another hole for storage? Why not store it where we find it? Thank of it as TARP for oil. We are calling it the Financed Original Oil Ledger. And sense we are paying producers to keep the oil in the ground – they can produce as much oil as they want while also addressing tight inventory space issues.

          Now skeptics may wonder how this will work. If we are to buy oil before it comes out of the ground, and before it makes it to market, how do we know how much to pay for this oil? Well we have decided to use legacy prices that were set a few months ago.”

    1. Code Name D

      I am wondering the same thing.

      Oil storage, especially for BITTMEN must be finite. It’s not like you can just pile thus stuff on the ground. What happens when the global take is completely full?

      When happens when a producer has a full take truck come back because the depot simply can’t take it – at any price. Oil suddenly goes from being $57 to $0. Even if financing for the drillers remain available all work stops – simply because they have no place to put it. Is this even a likely scenario?

      Is this also why the price of gas is also dropping? Refineries might be processing this as fast as they can to try and keep the incoming inventory with open capacity and distributing the gas as fast as possible. But even then they can only process it so fast, and what happens should gas inventories fill?

      Or best yet, is oil being produced faster than it can be processed? Or what happens if one of the refineries has an accident as is forced off line for a time? Would rushing processing make this more likely as they forgo maintenance to keep production high?

      Part of the problem with understanding this crises is the official narrative lacks any connection with the real world. This is ultimately why the financial industry is so unstable – they operate on faith that it’s all just about the money. But thanks to QE, money can be created out of thin air.

      1. susan the other

        Most interesting. They call shale gas a “perishable” like veggies. So it has to be sold off quickly. But oil not so much.

      2. Yves Smith

        Oil is very inefficient to store and above ground storage is therefore not all that much. The normal course of events is to “store” it by keeping it in the ground.

  9. peteybee

    Rapid decline of fracked wells shortens the timescale of these projects, so shale producers are actually the most agile of the unconventionals, in terms of responding to market changes. Oil price collapses are nothing new, it last happened less than 10 years ago. In all likelyhood, they will be the first ones to slow down production growth, but I don’t think they’ll be going away anytime soon.

  10. sd

    If price is being forced down, doesn’t this represent a massive buying opportunity for an unknown party to essentially scoop up a an internationally diversified portfolio of oil sources?

    1. peteybee

      yep, if they believe the investment is worthwhile.

      another opportunity, for a large oil consumer (1) with lots of cash or good credit, and (2) whose decision-making is not incentivized by wishing to maximize their stock price in a low interest rate environment*, is to buy futures and lock in their resource prices for the next few years.

      * this is a interesting effect… when management acts to maximize stock price, they have an incentive to borrow and use the borrowing to take on risk. I.e., they are basically required to under-hedge in order to maximize stock price … options tell us that a 50% chance of having $1.00 next year is worth more, today, than a 100% chance of having $0.50 next year. Additionally, when interest rates are low and borrowing is cheap, the equilibrium point of how under-hedged everyone is shifts towards extreme under-hedging. Hence what is happening now. I have a feeling that the futures markets work fine and are totally able to smooth out the kind of price shock going on, there just happens to be disincentive to make full use of that mechanism, because of the stock-price-maximizing dynamic combined with low interest rates.

    2. McMike

      That’s the beauty of playing the game with an unlimited zero interest bankroll of cash.

      – Raise the prices for everyone and draw everyone in (willing or not).
      – Crash the prices for everyone and bust everyone else out.
      – Buy up prime assets on the cheap.

      It’s happening in real estate, companies, commodities, public assets & infrastructure….

      1. Paul Niemi

        Yes, you’ve got it. It happens through price-fixing, collusion, and restraint of trade. When a commodity’s price is artificially supported higher than market demand in a speculative bubble, there is a time lag while producers ramp up production to respond to the higher prices. After about five years production increases, making supporting the higher prices more and more expensive. Then a sudden collapse in price occurs, overshooting lower what the normal price would be. It is an opportunity for the big producers to gobble up the small and bankrupt alternative product producers.

    3. Synapsid

      sd,

      Yes.

      It’s been happening all year–the majors and the smaller majors like Apache have been selling assets for months. A site called Rigzone will show you this in daily and enthralling detail.

      For every sale there’s a buyer.

  11. DJG

    Great analysis by Ilargi. I blame Naomi Klein. She publishes This Changes Everything, which talks about the corruption of the oil companies, their impetus to overproduce, their outsized political-economic influence, and the importance of our learning to keep carbon in the ground (before it’s too late, and “too late” isn’t far off–a couple of decades)–and then this collapse in prices happens. Yet we aren’t ready to deal with these companies deemed too big to fail, which have to be dismantled.

    1. Synapsid

      Jan,

      What are called conventional reservoirs of oil and gas are something like sponges holding water: you can drill into them and there are various ways of getting the oil and gas to come out of the pore spaces that hold them (the oil and gas).

      The shale reservoirs that are called unconventional are different in that the rock is solid so oil and gas don’t flow through it. Some of those shales (they aren’t all shales but no matter here) are naturally fractured, though, and the fractures contain oil or gas. Drilling into such a reservoir doesn’t do you any good because the bore hole will only intersect a tiny proportion of those desirable fractures, but if you force water with sand in it into the bore under great pressure (that is hydraulic fracturing, or fracking) you can create your own fractures radiating out from the bore hole (the sand then holds them open) and gas or oil can flow from the natural fractures into the ones you’ve created and into the well bore and you can get it out from there.

      A given well can yield oil or gas or both. Currently there’s so much natural gas being produced from oil wells (“associated gas”) that there’s little drilling or producing from just reservoirs that yield only gas (“dry gas”).

      1. Code Name D

        I recall accounts from North Dakota where they would simply burn off the natural gas in order to extract the oil. Local markets could not absorb gas productions, so they just burn it off into the atmosphere. All the CO2 pollutants without any of the energy benefits. That is how the free market thinks.

        1. Synapsid

          Code,

          They do burn off natural gas (NG) in North Dakota–it’s called flaring–and the State finally set standard reductions in the practice that have to be followed. If I remember correctly, 28% is flared currently, down from somewhat more; less will be allowed next Spring.

          Most oil wells produce NG as well as oil. If there’s no oil pipeline available then oil can be hauled off in trucks, but NG isn’t so easy to deal with. If there’s no pipeline and associated compressor stations available then it’s flared. To prevent this North Dakota would have had to have required NG gathering and transport infrastructure to be in place before drilling for oil could begin; that would have delayed development (and payments to the State) for some years, I guess, so it didn’t happen.

          Flaring is quite common for that reason, and some areas such as North Dakota’s Bakken play and oil-producing regions of Nigeria are clearly visible from space at night. It’s a terrible waste.

  12. MartyH

    Count me among the popcorn and whiskey crowd.

    Those who drive prices of sin up to make it too expensive (or legislate against it) are always disappointed that their prohibitive actions backfire. Those who raise specters of great misfortunes sometime “Real Soon Now” are always disappointed that there warnings are, in the larger society, ignored.

    We are deep in a multi-generational effort to free “our betters” from the annoying strictures of good taste, reasonable consideration of their fellow community members, and do-gooder meddling in their (blatantly criminal) affairs. Now that most Western Governments are wholly owned subsidiaries of the Energy, War, Telecommunications, Media, and Financial industries (as a cartel of the wealthy) the end-game appears inevitable.

    Where was that popcorn again?

  13. Jim Haygood

    ‘Who wants to be manager of Norway’s huge oil-based sovereign fund these days? With all these long-term obligations entered into when oil was selling for $110, no questions asked? The Vikings must be selling assets east, west, left and right. But they’re not going to tell us, not if they can help it.’

    Wrong on every count. Lower oil prices will slow the fund’s purchases, but it isn’t selling anything, since it would continue growing 3% annually from income even without capital infusions.

    In fact, the fund’s investment policy is designed to reduce Norway’s exposure to oil prices:

    The reduction in oil price risk resulting from reallocation of [Norway’s] petroleum wealth into investments in the GPFG may be reinforced by the fact that a large portion of global oil reserves and oil companies are not represented on global stock exchanges. Consequently, listed companies as a whole are large net purchasers of oil.

    Countries that are net importers of oil and gas have, at the same time, a large portion of global financial markets. Hence, a lower oil price implies a transfer of wealth from oil-producing countries to the companies and countries in which the major part of the GPFG portfolio is invested.

    http://tinyurl.com/k42pfem

    ————

    Ilargi must’ve spent too much time in Minneapolis, taking those Norwegian jokes told by the Swedes WAY too seriously.

  14. Eduardo Quince

    I can’t help but feel that Illargi is going overboard with his apocalypticism re: shale oil. Yes, the shale bust is a big deal but it’s hardly the end of the world.

    1. Yves Smith

      Depends where the leverage sits. If it’s with players that are already pretty levered, the knock-on could be significant. Plus you do have real economy effects. The only states post 2008 with decent job growth were energy producing states.

  15. Chauncey Gardiner

    IMO a number of issues are in play here that transcend the fairly narrow set which were the focus of this article directed towards the effects of lower oil prices on U.S. shale oil producers and the related financial impacts. I feel many of these are “known unknowns” for ordinary citizens like myself, although they have likely been labeled “known knowns” by key sovereign producers, some U.S. and foreign government policy makers, large industry players, and large banks, albeit with a measure of uncertainty attached by the latter groups.

    For myself, I would include the following as “known unknowns”:

    Aggregate production and breakeven points for various producers from various sources of oil production over different time frames are unclear, including the magnitude of the impacts on different individual shale producers. They have varying breakeven points in both the short term (variable costs: labor, maintenance, repairs) and intermediate/ long term (which would include costs associated with acquisition of land/mineral rights, seismic, drilling and infrastructure costs) for the various U.S. “tight rock” regions. Too, there are different breakeven points for Canadian bitumen, legacy vs. new Canadian oil sands, Gulf of Mexico production, and legacy U.S. oilfields.

    Aggregate rate of depletion of U.S. “tight rock” wells appears to me to be largely unknown at this time. I have been surprised that the so called “Red Queen” has not been a more assertive factor in the Bakken, for example.

    The extent to which the price decline is attributable to blowback from an intentional and organized effort to weaken Russia’s Putin regime and other sovereign oil producers, and/or an effort by producers to stimulate declining global demand for oil, and/or disrupt development of alternative sources of energy is unknown. If true, with the arguable exception of global demand, these are all essentially political decisions that can be changed or modified at any time, with related effects on prices. In a related vein I have wondered why the price of Brent crude was kept above $100 bbl for the better part of four years preceding this price decline which began in late June.

    1. ian

      If the low price of oil right now is the result of a political pressure from Washington, then it makes me wonder why I have been paying so much before.

  16. Rosario

    We started drilling ourselves into oblivion once we tapped the first well in Pennsylvania over 150 years ago, and it has completely altered our perception of growth and our relationship to the world and each other ever since. To borrow the often used thought exercise to illustrate oil as an “energy slave”. Put a gallon of gas in any car (the least fuel efficient car makes the scenario conservative) and drive it as far as you can go on that gallon. Then push it back. This stuff is currently at $56 a barrel! I’m not seeing a soft landing. Maybe we won’t have a Road Warrior world, but it will be very difficult for at least a generation or so to adjust to not having a readily available, transportable, low volatility fuel source.

  17. rijswaanvijand

    Oh that’s a business plan allright.. Draw a lot of investment on the next “booming business”, pay yourself and all of your friends a handsome amount, and then go bust. It’s called a pyramid-sceme, and it has been proper mainsteam business practice since the dot com bubble at least..

  18. Jay M

    I faced the mirror and adjusted my triple collar. It really increases the tie expense, you know. You should see how complicated the shoes are now, you have to decrypt the shoelaces. Ever since the fetishists got control of shoe manufacturing, what can I say. It is so thrilling to be living in the now. I called Bernie in the pen and asked “are they printing money or making it up as they go along”. The latter, he said and I said “hallelujah” it’s to bad Ponzi nailed your category so early.
    Faced with bankrupting middle america and bankrupting itself, the domestic oil industry opted for the latter.

  19. Fiver

    As Obama and his Republican Congress have already pre-bailed the biggest US (and some foreign) banks for nearly $4 trillion in potential oil derivatives losses, I would expect both banks and well-connected oil to go on a great big buying binge as big US oil eats smaller oil to beef up reserves (for which this criminal system will automatically reward them) and banks eat everything, including countries, caught in this epic US/Saudi squeeze play.

    It would be interesting to know how much ‘protection’ the Saudis and other Oil Kingdoms carried and with which banks or even Central Banks. For my part, this has all the marks of a set piece, i.e., the biggest players time their moves around the instability brought about by the onsets, or shuttings down of US and other QE, eg, Japan’s immediate moon-shot post Fed QE spikes the dollar far higher than expected only as a result of ‘normal’ end of QE program. Oil was of course the preference for QE speculation each time the Fed rolled it out. And the intersection of the supply/demand curves was perfect – even to the point of bringing on previously locked down Libyan and Iraqi production on cue.

    Putin says essentially ‘give it 6 months’ for prices to come back. As I just don’t buy the notion the US has ‘de-coupled’ from the rest of the global economy, that only constant ‘revisions’ and other stats manipulation have kept the official headline numbers looking half-assed OK, I suspect he intends to be there 6 months from now when QE is back on top of Wall Street’s must-do list and the ‘war premium’ is back in spades.

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