A couple of things to keep firmly in mind as we watch the Crash of 2015 unfold, pretty much on the schedule I’ve been writing about here for six months. First, the drop in oil prices is not the cause of this disaster, merely an accelerant. The fracking industry is succumbing to its inherent high expense, toxicity, rapid depletion rates and over-reliance on junk financing. Similarly, the stock market crash we expect to follow the fracking collapse would have come anyway because of its inherent instability, and indeed may yet occur before the chain reaction in the fracking fields has run its course. And finally, what is happening to fracking is also happening to the legacy oil business, only slower.
Ignore the noise about how this is all a plot by Saudi Arabia, or by all of OPEC, to destroy the gallant frackers of America. The Saudis control the world oil business the way the legendary horse trainer said he controlled his horse: “I look real close and see what he’s going to do,” he’s supposed to have said, “and then I tell him to do that.” The Saudis look real close and see where the market just went, and then say yeah, we did that.
To remind ourselves of the sequence we’re expecting to see in this crash, beginning in the fracking patch: layoffs, contractions, capital starvation, production declines, defaults, junk-bond market collapse, widening financial damage, stock market crash, recession. So, how are we doing so far?
Layoffs and contraction, check: The number of oil rigs operating in the United States has dropped to its lowest since 2013, and most of that decline came in the Bakken play in North Dakota. The total dropped by 49 in the week ending Jan. 23, bringing the total down to 1,317, according to Baker Hughes. In seven weeks, The number of US rigs has dropped by a record 258. If the trend continues a few more weeks, there will not be enough rigs operating to maintain production, and analysts such as John Kemp of Reuters foresee a sharp decline in fracking production beginning at midyear.
The numbers are even worse than they look at first glance when you take into account that current procedure in the fracking patch is to use rigs to drill up to four wells from a single pad, rather than moving the rig each time. Thus a stacked rig doesn’t just mean the loss of one well, then another and another, but four wells, then eight, 16 and so on in the same time frame.
In slower motion, the same disaster is spreading through the legacy oil business. More than 30,000 layoffs have been announced across the industry as companies slash budgets, according to Bloomberg News. Exploration and production spending is expected to drop by more than $116 billion, a 17 percent decline, because of falling crude revenues, according to an estimate from Cowen & Co. BP has frozen wages, Chevron has delayed its 2015 drilling budget and Shell has canceled a $6.5 billion Persian Gulf investment; New York-based Hess Corp. on Wednesday reported a fourth-quarter net loss of $8 million
Capital starvation, check: The fracking boom got this far with stock offerings, junk bonds, and “leveraged” loans. The stock prices of the operators have tanked, and the markets for more junk bonds and loans are essentially closed to frackers. (The reason we will continue to see production continue, even increase, in the short term is that the operators, in debt to their eyeballs, have to pump oil or die.)
The damage is already metastasizing to the general junk-bond market. The total value of such bonds issued is down one-third from last year; just this week, two offerings by companies not in the oil business — Presidio Holdings ($400 million) and Koppers Holdings ($400 million) — failed for complete lack of interest, even though they were offering as much as 11% return; investors in high yield mutual funds withdrew nearly a quarter of a billion dollars last week, a week that saw leveraged-loan funds bleed out nearly three-quarters of a billion.
Next, production declines and defaults. Stay tuned.
[UPDATE: Red flags up at Bloomberg Business News, which counts $390 billion vaporized by the oil implosion so far, with losses now “starting to show up in investment funds, retirement accounts and bank balance sheets.” Read it and run.}