The Oil Crash is Under Way [UPDATED 12/13]

When big trees come down, they start slow and end with a crunch. (Photo by geograph.org.uk)

When big trees come down, they start slow and end with a crunch. (Photo by geograph.org.uk)

When you are felling a really big tree, the first signs that it is coming down are subtle; a crack here and there, a twitching of the crown. By the time these clues register on you, the tree is on its way down. The cracks and twitches from the U.S. oil industry are coming almost hourly now, and although it is a really big tree, and won’t actually hit the ground until next year, its fate is pretty well sealed. Here are this week’s signs and portents:

  • British Petroleum announced Wednesday it will cut thousands of jobs worldwide, in addition to a previously announced two-billion-dollar cut in its operating budget and a fire sale of $43 billion dollars worth of assets (most of them in the US fracking patch). BP disclosed that over the next 18 months it will spend a billion dollars on “restructuring.” Deutsche Bank immediately upgraded BP stock to “buy.”
  • Goodrich Petroleum announced Wednesday it is exploring the sale of “some or all” of its shale-oil assets in the Eagle Ford play in Texas, the second-largest contributor to the country’s shale oil “boom.” Goodrich also said it will make a  drastic cut in 2015 capital expenditures (which, in the oil bidness, includes the search for new wells) to $150-$200 million, down from last year’s $375 million.
  • ConocoPhillips announced this week it will cut capital spending by 20% next year to $13.5 billion.
  • Chevron announced it is not going to make any decisions on next year’s capital expenditures until…next year.
  • In all, oil and gas exploration projects worldwide worth more than $150 billion are likely to be put on hold next year. Analysts are now predicting a 25 per cent decrease in exploration and production spending by the oil companies.
  • The long term implications of these cuts are dire for the oil companies, for the simple reason that you cannot sell oil you have not found, and oil is getting much  more difficult and expensive to find. The short-term consequences will be dire for the oil services sector, the companies such a Halliburton and Baker Hughes who provide the machinery for the drillers and frackers and transporters. According to Bloomberg News, the industry now expects 400 of the 1848 US onshore oil rigs now operating to be idled by next year. Another 200 new rigs, under construction for delivery next year, are now expected to have nothing to do.

Earnings forecasts are being downgraded almost daily across the whole sector. Stock prices are dropping. But wait, there’s more.

Two things about the fracking boom are not well understood: its voracious appetite for cash, given the expense of the process and the astonishing depletion rates of the wells; and the extent to which the industry has been financed with junk bonds and the even junkier leveraged loans (for borrowers whose credit is no longer good enough to issue junk bonds).  Until now, the hype about how huge fracking was going to be for decades to come had kept the suckers’ money coming in just fine. Just this year, until October, energy companies had no trouble borrowing $50 billion with junk bonds.  (Since 2010 the industry has loaded up on more than half a trillion dollars’ worth of high-interest debt.)

Now, that string has run out. Junk bonds and junk loans that secondary markets had been clamoring to buy at or near face value have lost 20% of their value. And secondary markets are crucial to the junk lending business, no one wants to be stuck owning a loan that isn’t going to be repaid; you have to get it out the door to the next idiot and bank your fees. When it starts costing you 20% to move it out the back door, you stop bringing it in the front door. That’s happening now.

The only way to get investors to touch this junk is raise the interest rate, which seems to work even when there are deep misgivings about ability to repay. Junk loans that used to cost less than six per cent this summer are now requiring over nine per cent. So just as oil companies revenues are plummeting, their stock prices are tanking, and their wells are going dry, their expenses are skyrocketing.

When you see that much trembling and hear that many cracks from a big tree, the only thing to do is step well back and yell “Timber.”

UPDATE 12/13/2014

The torrent of bad news from the beleaguered oil industry continues, with more every few hours.

North Dakota state officials said Friday that oil production in October declined by about 4,000 barrels per day to 1.18 million daily barrels compared with September, the first decline in eight months. Drilling for new wells also declined and is expected to decline even more in 2015.

Oasis Petroleum, one of the large operators in North Dakota, announced Wednesday that it would drop from 16 drilling rigs to six rigs. On Friday, stock prices for the 10 largest publicly traded oil companies with North Dakota operations were down by an average of 51 percent over three months.

Rigs targeting oil in the U.S. will drop below 1,100 for the first time in three years as drillers pull out of fields made unprofitable by a 43 percent plunge in crude prices. According to the energy data and analytics company Genscape, the oil count is set to drop by almost 600 rigs over the next eight months, bottoming out at 1,073 in August.

Major stock indexes tumbled Friday as a main crude oil benchmark fell below $60 a barrel to its lowest point since the depths of the Great Recession, leaving stunned analysts looking for a bottom. With some investors concerned about the energy sector and others taking profits from a high-priced market, the Dow Jones industrial average fell 315.51 points in a finishing touch to the worst week for stocks in three years.” — The Los Angeles Times

So the bloodletting continues: the Energy Select Sector ETF (XLE) is down 26% since June; S&P International Energy Sector ETF (IPW) is down 34% since July; and the Oil & Gas Equipment & Services ETF (XES) is down 46% since July. Goodrich Petroleum, in its desperation, announced it is exploring strategic options for its Eagle Ford Shale assets in the first half next year. It would also slash capital expenditures to less than $200 million for 2015, from $375 million for 2014. Liquidity for Goodrich is drying up. Its stock is down 88% since June. They all got hit. And in the junk-bond market, investors are grappling with the real meaning of “junk.” Sabine Oil & Gas’ $350 million in junk bonds still traded above par in September before going into an epic collapse starting on November 25 that culminated on Wednesday, when they lost nearly a third of their remaining value to land at 49 cents on the dollar.— Wolf Street

 

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10 Responses to The Oil Crash is Under Way [UPDATED 12/13]

  1. Tom says:

    Yes! 2015 looks to be the big downturn in the global economy. When everyone is “Greece” what happens? After oil goes through its “troubles” all the connected industries (besides Halliburton) like shipping and trucking will begin to have big problems (the truck-driver shortage is nothing when there’s no place to go), agriculture too will suffer and, whaddaya know – boom, there’s the food shortages.

    The back end of the oil problems will be stock market problems, resource scarcity (once this huge glut is finished off), commodity price jumps (to the moon) and INFLATION here we come! We could also see infrastructure collapse and the end of reliable electricity in a few more years.

  2. pintada says:

    There is another scenario that might play out, and while it is certainly the minority position in the doomsphere I’m not so sure it might not happen.

    So the junk bonds that the frakers sold is 16% of the 1.6 trillion junk bond market ~250 billion. There is also 500 billion in direct debt. For a total of 750 billion – call it a trillion. How long will it take the fed to print $1 trillion? A millisecond? LOL Maybe QEn will be needed.

    So, what is the net effect? Some people get laid off, the demand for oil, and price goes down even more, but the stock market is up, the 1% are richer, and all is well.

    Rioting and the suffering of the 99% doesn’t matter.

  3. Good post! There IS another possible scenario along the lines of Pintada’s comment. Sometime next year, the US government could decide that it’s in the “national interest” to openly subsidize the fracking and tar sands industries as we presently support the oil industry.

  4. venuspluto67 says:

    I am of the mind that the oil-price collapse is part demand-destruction, part commodity-bubble collapse, with one factor probably feeding the other. QE and ZIRP did indeed create quite the commodities-bubble, so it’s reasonable to think that petroleum was one of those commodities, which was a good part of the reason the WTI price fluctuated between $90-110 per barrel between October 2010 and October 2014. The rapid price decline has been so abnormal and dramatic that I really do have to conclude that a “bubble-popping” is what’s going on here. However, the parallel collapse of the Euro and the Japanese Yen in relationship to the US Dollar tells us that old-fashioned demand destruction is certainly also part of the picture.

  5. venuspluto67 says:

    In response to your update, some poking around I did today reveals some real demand destruction going on.

  6. SomeoneInAsia says:

    You know, looking at the enormities now heading our way and what it’s going to mean for us all, I sometimes think of screaming: what the [insert well-known four-letter expletive here] have *I* (and my loved ones) ever done to deserve it?

    Well, guess I’m getting it as punishment for something I did in my previous life (and same with my loved ones)…

  7. Tom says:

    SomeoneInAsia:

    Don’t feel that way – it’ll effect everyone (probably every living species), so no need to take it personally. Besides you were born into captivity (same as the rest of us) and didn’t know anything about fossil fuel use (or agriculture, population overshoot, shopping for junk we don’t need – all of industrial civilization) being detrimental to the environment until MUCH later, so there’s no going back or trying to atone for anything. Try to enjoy the time you have left by living a life of excellence (using your own definition) and being as loving and kind as you can.

    • Tom Lewis says:

      Tom: That is without doubt the most profound and succinct statement of our condition that I have ever seen. With tears in my eyes, I thank you.

    • SomeoneInAsia says:

      Tom:

      Thanks for the consolation and words of advice, and for reminding me that we’re all in this together. (Misery loves company, huh?)

      I’ve actually already been concerned about environmental and resource issues since the late 1980s; I merely didn’t expect the terrible outcomes of the folly of industrial ‘civilization’ to come THAT soon.

      I hope there’ll be a place in Hell specially reserved for those whom Mr Lewis calls the Masters of the Universe. (And I’m sure he’s not talking about the 1980s Filmation cartoon series.)

    • colinc says:

      Yes, very well stated, Tom, and absolutely correct explicitly. Alas, simultaneously your sentiment is very much in error! There have been more than a few people, during the past century or more, who knew or at least had an inkling of what is and will be transpiring ecologically but just didn’t give a fuck because of the perceived consequences they, themselves, would suffer! Moreover, all of us in the OECD countries, at a minimum, claim to have received an education and yet so very, very few of us have been able to recognize, at any point, the outright fraud to which we have all been subjected and manipulated into playing a part. (Fuck W. Shakespeare and all the “teachers” and others who espoused his drivel as “great art.”) I, myself, am always deeply chagrined for not having recognized “the game” until my mid-to-late forties, roughly 2 decades ago and I have, or would, never claim to be “highly educated,” yet I know more than most.

      At one level, all of us are to “blame” and none of us are. As has been said many times, many places, we’re not confronted with “a problem,” it’s a “predicament,” we’re between the proverbial rock and hard place. The “hard place” is the construct of our civilization, culture, programming and society and is immovable and immutable. The “rock” is the planetary-sized boulder of AGW/climate-change/pollution which is hurtling at us, pinned against the “hard place,” at ever increasing velocity. When impact occurs, all too soon, little will remain but the feedstock for new petroleum stores a few thousand millennia hence.