The economy of the United States and the world is on fire, and with the flames and smoke visible in any direction one cared to look, the President of the United States declared last night that the worst is over, “the shadow of crisis has passed,” and happy days are here again. In reality (a state that presidents and candidates for president never seem to visit) 2015 is shaping up to be one of the worst any of us have ever seen.
It’s a potent mix of flammable situations, from an unhinged stock market to a drought-ravaged West to the fiscal convulsions of China, Russia and Europe. But for us in America, the collapse of the bogus New American Oil Revolution is the fire that’s burning hottest and spreading fastest. This is how it’s likely to go:
First, drill rigs are being shut down and workers laid off, especially in the fracking plays; as unemployment rises and income declines, production will start to fall; as fracking-company stock prices tank, their junk bonds will become worthless and their leveraged loans will go into default, their money sources will dry up and fracking production will virtually halt; as similar problems beset the legacy oil business world wide, the entire edifice of energy junk bonds, derivatives, hedges, credit default swaps and rabbits’ feet will collapse and the stock market will crash. Welcome to The Great Recession: the Sequel.
So, how are the frackers doing on Day 21?
1. Laying down rigs, shedding people.
- In October of last year, America had 1609 active oil rigs working. We’re down to 1366, and the last one-week decline was the largest since the last crash in 2008.
- The giant provider of oilfield services Baker Hughes announced yesterday it will lay off 7,000 employees, or 11% of its staff. CEO Martin Craighead said “we are taking proactive steps to manage the business through these challenges.” Which translates from PR-Speak as “Run! Run for your lives!”
- Another giant provider of oilfield services, Halliburton (which is about to acquire Baker Hughes) announced it will be laying people off but would not provide a number. Halliburton cut a thousand jobs in the last quarter of 2014.
- And the world’s biggest provider of oilfield services, Schlumberger, announced a few days ago it will cut 9,000 jobs, 8% of its workforce, after reporting fourth-quarter 2014 profits that were just 18% of the profits they racked up in the same period of 2013.
- North Dakota, responsible for nearly half the oil-fracking revolution in the United States, has been booming since development of its Bakken oil-shale formation hit stride in 2000. According to United Van Lines’ Annual National Movers Study, North Dakota now has the country’s fourth highest outbound migration rate.
2. Production Reduction
Those who are pumping oil have to keep pumping oil as long as they can. Simply stopping production and waiting for prices to rise is not an option because they are deeply in debt and mired in contract obligations. They may be only running in place, but if they stop running they vanish. So we won’t be seeing actual drops in production for a few months. But here’s how we know they’re coming.
The Bakken play in North Dakota is about 40% of the “new American oil revolution.” Its production has gone from 500 barrels per day in 2008 to just over a million barrels a day. They had to drill 6,000 wells to do that. The Achilles Heel of the fracking revolution is the hideous decline rate of fracked wells: production declines by about 90% in just three years. So if they drilled another 6,000 wells in the next three years (at an average cost per well of $8-$10 million) all they would do is keep production at a million barrels a day. And that’s assuming they found as many “sweet spots” in the next four years as they did in the last. And you can’t assume that. It’s also assuming they can find the cheap money — the junk bonds and junk stock and junk loans — that financed the first 6,000. And you can’t assume that.
To put it another way, if no new wells were drilled in the Bakken in 2015, by the end of the year its production would be about 550,000 barrels a day, or one half its current production.
3. To follow the money, you have to find it.
It was possible to satisfy the enormous appetite of the fracking industry for cash (see “decline rate”) as long as oil prices were high, money was cheap, and the Masters of the Universe were delirious about America achieving “energy independence” and becoming “number one in oil” again. The Masters are still delirious, but nothing else is true.
In the past, the oil companies either sold stock, issued bonds, or took out loans to stay on the drilling treadmill. How’s that working out for them? The Bloomberg index of North American oil producers finds that since last June, their value has declined by over half and their debt has increased by 85% — hardly a sustainable trajectory. Going public, up until last year a sure-fire way to cash in big and finance whatever the hell you wanted to do, is simply not an option in 2015. Not for anybody in the fracking oil business.
As for debt, interest rates on junk-rated energy bonds are over 10%, double what they were last June. Previously issued bonds are trading on the secondary market for dimes on the dollar. And more than 20 US exploration and production companies have used 60 per cent of their credit lines, according to Bloomberg.
A financial situation for frackers that could best be described as sour now will turn completely rancid in April (at the latest). That is the month that lenders conduct one of two annual reviews of the collateral they are holding for their lines of credit. Typically, the frackers turn to lenders only after exhausting the possibilities of issuing stock and junk bonds, so by the time they get to banks they need what are politely referred to as leveraged loans, or loans to a company that has all its assets locked up and is hemorrhaging cash. When the bankers review the cinders of the assets they accepted as “security,” there are going to be some cardiac arrests.
At that point the Crash of 2015, if it hasn’t already, will metastasize.
[UPDATE: DAY 22]
According to a story in Bloomberg News, which is not exactly one of your fringe Doomer news sources, not only oilfield service providers but oil drilling companies themselves are going to “begin to die” in the second quarter of 2015 as bigger and bigger dominoes fall toward a crash. The January 22 story begins:
Oil drillers will begin collapsing under the weight of lower crude prices during the second quarter and energy explorers who employ them will shortly follow, according to Conway Mackenzie Inc., the largest U.S. restructuring firm.