Shaking out the oil industry, and maybe a few financiers as well

“If I reduce [oil production], what happens to my market share?” Saudi oil minister Ali al-Naimi asked. “The price will go up and the Russians, the Brazilians, U.S. shale oil producers will take my share.”[1] My feeling is that the Saudis aren’t laying all their cards on the table, but if al-Naimi is in fact telling the truth, the whole truth, and nothing but the truth, oil prices might be going down for a while.

It seems that other oil producers can’t afford to cut back as much as is needed to sustain higher oil prices. Producers are reducing exploration but had taken on debt to expand production when, just last year, prices were higher.[2] Some, like Russia, Iran, Iraq, and Venezuela, need all the revenue they can get.[3] So, “[a]ccording to Simmons & Company, based in Houston, the 93 million-barrel-a-day global market will continue to be oversupplied by at least one million barrels a day during the first half of 2015.”[4]

The International Energy Agency estimated that roughly 2.6 million barrels a day is now, in investment terms, stranded — priced too low to repay the capital spent developing it. Yet because most of those costs are sunk, even unprofitable crude keeps flowing. Meanwhile, Iran, Iraq and Venezuela desperately need to keep pumping oil to cover their budgets. Saudi hostility toward Iran made it too difficult for the Organization of Petroleum Exporting Countries to agree on production cuts. Even the Saudis would lose money if they unilaterally cut production. (If your oil costs only $30 a barrel to produce, you make a handsome profit even at $60 a barrel.) In Russia, economic sanctions may slow development of new Arctic fields, but Russia’s existing wells still have many years to run.

Shale oil production in the U.S., however, is on a different trajectory. Unlike conventional fields, which take many years to deplete, shale wells are generally tapped out in just three. At a certain price point — $65 a barrel might be the floor — fracking a new shale well becomes less attractive than drilling for natural gas in the Marcellus Shale region. And some analysts warn that the junk bonds that supported the U.S. drilling boom are now a threat to markets.[5]

Figure 1. A meme seen numerous times on Facebook and in email solicitations. One source is the Democratic Congressional Campaign Committee. Screenshot from Facebook, fair use.

Figure 1. A meme seen numerous times on Facebook and in email solicitations. One source is the Democratic Congressional Campaign Committee. Screenshot from Facebook, fair use.

That threat that junk bonds might actually be junk might be part of the reason the Dow Jones Industrial Average dropped over 400 points between yesterday’s open and today’s close. Investors are fleeing to bonds, pushing yields lower and—I’m surely missing a piece of this explanation—raising fears of deflation. Deflation is feared because consumers and businesses may defer spending in anticipation of lower prices, leading to lower growth.[6] There’s been other bad news as well, belying the Obama administration’s and Democratic Party apologists’ recent celebratory claims (fig. 1) about the economy:

A report that orders to U.S. factories fell for a fourth straight month in November stoked investors’ concerns about growth. The Commerce Department said Tuesday factory orders dropped 0.7 percent in November after falling by the same amount in October. The weakness was due to decreases in demand for primary metals, industrial machinery and military aircraft.

In a separate report, the Institute for Supply Management said Tuesday that its services index fell to 56.2 last month, down from 59.3 in November.[7]

Fig. 2. Ted Rall, Universal Comics, fair use.

Fig. 2. Ted Rall, Universal Comics, fair use.

Where all this actually leads remains to be seen. But the Obama administration’s response to the financial crisis was more about rescuing high finance than anything else (figure 1[8]). The program to rescue homeowners was a sham,[9] and the unemployed were simply left to twist in the wind. Now we’re in an oil price spiral that will stop only when Saudi Arabia decides it’s had enough and, with its appetite for risk, high finance sounds like it might be in trouble again. It might have helped had Obama worried more about a broad-based recovery for the rest of us.

  1. [1]Clifford Krauss and Peter Eavis, “Oil’s Fall Continues Into 2015, and Stock Markets Shudder,” New York Times, January 5, 2015, http://www.nytimes.com/2015/01/06/business/oils-fall-continues-to-below-50-a-barrel.html
  2. [2]Lynn Doan and Mario Parker, “Biggest Oil-Rig Drop Since 2009 Spells Tough Year Ahead,” Bloomberg, January 6, 2015, http://www.bloomberg.com/news/2015-01-06/biggest-oil-rig-drop-since-2009-spells-tough-year-ahead.html
  3. [3]Carl Pope, “When Oil Becomes Optional,” Bloomberg, December 7, 2014, http://www.bloombergview.com/articles/2014-12-07/when-oil-becomes-optional
  4. [4]Clifford Krauss and Peter Eavis, “Oil’s Fall Continues Into 2015, and Stock Markets Shudder,” New York Times, January 5, 2015, http://www.nytimes.com/2015/01/06/business/oils-fall-continues-to-below-50-a-barrel.html
  5. [5]Carl Pope, “When Oil Becomes Optional,” Bloomberg, December 7, 2014, http://www.bloombergview.com/articles/2014-12-07/when-oil-becomes-optional
  6. [6]Associated Press, “Market Continues Slide as Investors’ Unease Rises,” New York Times, January 6, 2015, http://www.nytimes.com/2015/01/07/business/daily-stock-market-activity.html; Clifford Krauss and Peter Eavis, “Oil’s Fall Continues Into 2015, and Stock Markets Shudder,” New York Times, January 5, 2015, http://www.nytimes.com/2015/01/06/business/oils-fall-continues-to-below-50-a-barrel.html
  7. [7]Associated Press, “Market Continues Slide as Investors’ Unease Rises,” New York Times, January 6, 2015, http://www.nytimes.com/2015/01/07/business/daily-stock-market-activity.html
  8. [8]Ted Rall, [cartoon], January 2, 2015, http://www.gocomics.com/tedrall/2015/01/02
  9. [9]Neil Barofsky, Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street (New York: Free Press, 2012).

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