Yes, Forbes, the magazine of the Masters of the Universe has uncharacteristically published some discouraging words about the only good news the American economy has had to celebrate in many decades.
Oil output from the most productive U.S. shale fields is expected to drop off next month by 57 million [sic — they mean thousand] barrels of crude daily from April to May, the U.S. Energy Information Administration said Monday. That would represent the first monthly decline in more than four years, according to Reuters.
And then there’s Bloomberg Business, a more objective reporter of what’s going on in American industry, with the headline: “Shale Oil Boom could End in May After Price Collapse.”
Output from the prolific tight-rock formations such as North Dakota’s Bakken shale will decline 57,000 barrels a day in May, the Energy Information Administration said Monday. It’s the first time the agency has forecast a drop in output since it began issuing a monthly drilling productivity report in 2013.
Yet even after admitting that it’s over in the shale patch, the Pollyannas insist that it’s only for a while, until reduced supply brings prices back up and everybody starts doing exactly what they were doing before. How shall we put this?
It ain’t gonna happen. Here’s why.
The only way that a rise in prices could cure the situation is if the fall of prices caused the situation. But it didn’t. Virtually every operator in the shale patch was suffering negative cash flows, and accumulating impossible debt loads, from the very beginning of the oil “revolution.” (Sure. they declared impressive operating profits on individual wells, but had to spend outrageous sums to replace them when they played out — in two or three years.)
The frackers are, pretty much without exception, up to their eyeballs in debt. They have junk bonds that have to be rolled over, subprime loans that have to be repaid, lines of credit that are being called and stockholders who are bailing out. They have kept pumping oil since the price collapse last fall for two reasons:
- With their enormous debt obligations, the operators know that to stop, or even pause, is to miss payments and die. So the zombies kept walking.
- Most operators hedged the output of their wells — that is, signed contracts guaranteeing their price in advance, for a fee — and thus were booking not the market price of $50 a barrel, but the hedged price, closer to $100. It works great until the hedges run out, or the counterparties go broke.
It turns out that this hedge thing is casting a rather long and dark shadow over financial institutions that are far from the fracking patch — the biggest banks in the world. I have written often here about how this carnage is going to spread, from the oil patch to the junk-bond market, to the entire bond market and then the stock market. But the calling of the hedges is now taking the fire to the big banks.
As of December 31, 2014, Bloomberg says the frackers had bought $26 billion worth of hedges, up fivefold in three months, from the likes of JP Morgan, Citigroup, Wells Fargo and Bank of America. These banks may be too big to fail, but they are not too big to cry when they take a hit like they’re taking right now.
Here’s the bottom line: US oil production peaked in 1970 at 9.6 million barrels per day. Development of the Alaskan oilfields brought an oil renaissance leading up to a second, lesser peak, in 1985, of 8.9 million barrels per day. The fracking “revolution” has brought us to a third peak, of 8.6 million barrels a day (the average for 2014).
From here there is nowhere to go but down. The crash of 2015 is proceeding, at its ponderous pace, and although it’s true that the fall never kills, it is also true that the sudden stop does.