Attention in the Crowded Theater: Fire!

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Firefighters try to snuff an oil well fire in Iraq in 2003. What is happening to the oil business today, especially in the United States, is akin to a thousand such fires. (Wikipedia Photo)

The flames of the next financial crash are leaping up everywhere you look (if you look without wearing the rose-colored glasses): in the Bakken fracking fields of North Dakota, the Eagle Ford in Texas, the tar sands of Alberta, the deep waters of the Gulf of Mexico. They are lighting up the night sky in all directions, and in the daytime the smoke is sickening the light and smelling up the air in the skyscraper offices of the Masters of the Universe where they shuffle decks of junk bonds, subprime loans and derivatives. Along with the smoke, you can smell the fear. This is going to be bad.

Serious testimony in a minute, but first an odd moment of clarity that I caught by accident yesterday on CNBC during its “Closing Bell” program. One of the female anchors was interviewing an analyst sent over from Central Casting to opine on oil prices. How low could they go, she asked him, somebody was predicting $20 a barrel? “Well,” oozed the analyst, “the models don’t support $20 a barrel.” Which is when the anchor person lost it (I was caught off guard, and am reconstructing this from memory, so consider it a paraphrase).

“You know what?” She said. “This conversation is driving me crazy. What do you mean the models don’t support $20? The models didn’t see any of this coming. None of them predicted any of this. Nobody saw any of it coming. Doesn’t anybody have any idea what is going on?”  

I wonder if we will see her face again, now that she has committed the worst sin a journalist can commit on air — blurting out the truth.

With respect to the narrow question of why oil prices collapsed in June, no one has a clue. One of the analysts on that very CNBC panel said as much, averring that the fundamentals of supply and demand do not explain the price movement. The best estimate of the current world surplus of crude oil over demand is two per cent. Two. On what planet does an oversupply of two percent for a machine burning 90 million barrels a day lead to a 50% drop in prices?

As to the larger question of what is happening to the oil industry and everything related to it — and everything is related to it — lots of people know what is going on but they can’t go on television with their hair on fire. It’s not considered audience-friendly. But let’s review what they know:

• The number of US oil rigs actively looking for or extracting oil is dropping fast. A report out Monday from oil field services company Baker Hughes showed the number of rigs operating in the United States declined for the fourth consecutive week — by 29 in the latest count, to 1,811. That, combined with last week’s decline of 35, marked the largest two-week drop in the U.S. rig count since 2009. (Ahem: you remember what else was going on in 2009?)
• Layoffs are rising of stunned workers who thought they were in a bonanza that would last for years. For weeks now, many players in the fracking patch have been announcing that nothing is wrong but that as precautions they are laying down rigs and reducing exploration budgets and cutting production forecasts. So far just one company, American Eagle Energy, has suspended drilling entirely until oil prices rebound. There will be more, directly.
• Collateral damage is spreading to oil-patch service providers: Civeo, a Houston-based company that builds lodging for oil workers, announced on December 29 that it would cut its workforce by 45 percent because of lower demand for “man camp” trailers. U.S. Steel has just announced the shuttering of two plants in Texas and Ohio that make oil drilling equipment and that employ 750 people. In Williston, North Dakota “The Bakken Club,” which offered exclusive services to oil-patch players including fine dining, airport shuttling, and corporate events, has been closed because it can’t pay its rent.The Federal Reserve Bank of Dallas, estimates that 250,000 jobs could be lost in 2015 if oil prices don’t rise.

 The “Don’t Worry Be Happy” chorale  has a new verse, about how it takes a year for plans to reduce output to show up as reduced output, so maybe prices will recover first and hesto presto, no pain! That was true when the average productive life of an oil well was on the order of 20 years, but the productive life of a fracking well is about three years. This, as they say, changes things.  Wells playing out in the Bakken in November, for example, subtracted 60,000 barrels per day from the field’s production. In November, that was more than made up for by new wells coming on line. In January, after God-knows-how-many more rigs have been idled, 77,000 barrels per day will be lost. Get the picture?

Not yet? Then look at this picture. Geological consultant and shale-oil expert Arthur Berman explained to Oilprice.com that the chorale’s other verse, about frackers breaking even at the new low price, because of their new technologies, makes no sense:

“Continental Resources is the biggest player in the Bakken. Their free cash flow—cash from operating activities minus capital expenditures—was -$1.1 billion in the third- quarter of 2014. That means that they spent more than $1 billion more than they made. Their debt was 120% of equity. That means that if they sold everything they own, they couldn’t pay off all their debt. That was at $93 oil prices. And they say that they will be fine at $60 oil prices? Are you kidding?”

But wait, there’s more. If you call right now, we’ll give you the latest increases in junk bond and leveraged-loan rates, which are driving up driller’s expenses as fast as their revenues are shrinking. And the latest quotes for the tanking share prices of just about any company having anything to do with oil. Oh, and the even-worse-case scenario in the Canadian tar sands.

You might have to let the phone ring for a while. I’ll be in the bunker, putting out my hair.