Nov 292014
 November 29, 2014  Posted by at 7:21 pm Finance Tagged with: , , , , , , , ,

‘Daly’ Somewhere in the South, possibly Miami 1941

I thought it might be a nice idea to question a certain someone’s theories using their own words, while at the same time showing everybody what the dangers are from falling oil prices. There are many ‘experts and ‘analysts’ out there claiming that economies will experience a stimulus from the low prices, something I’ve already talked about over the past few days in The Price Of Oil Exposes The True State Of The Economy and OPEC Presents: QE4 and Deflation. And I’ve also already said that I don’t think that is true, and I don’t see this ending well.

Today, our old friend Ambrose Evans-Pritchard starts out euphoric, only to cast doubt on his self-chosen headline. He’d have done better to focus on that doubt, in my opinion. And I have his own words from earlier in the year to support that opinion. Ambrose is bad at opinions, but great at collecting data; his personal views are his achilles heel as a journalist. That’s maybe why he fell into the propaganda trap of picking this headline; after all, if you write for the Daily Telegraph you’re supposed to write positive things about the economy.

Oil Drop Is Big Boon For Global Stock Markets, If It Lasts

Tumbling oil prices are a bonanza for global stock markets, provided the chief cause is a surge in crude supply rather than a collapse in economic demand

Roughly one third of the current oil slump is a shortfall in expected demand, caused by China’s industrial slowdown and Europe’s austerity trap. The other two thirds are the result of a sudden supply glut, which Saudi Arabia and the Gulf states have so far chosen not to offset by cutting output. This episode looks relatively benign. Nick Kounis from ABN Amro says it will add $550 billion of stimulus to world markets. “That is fantastic news for the global economy,” he said. But it comes at a time when stocks are already high if measured by indicators of underlying value. The Schiller 10-year price earnings ratio is at nose-bleed levels above 27.

Tobin’s Q, a gauge based on replacement costs, is stretched to near historic highs. Andrew Lapthorne from SocGen says the MSCI world index of stocks has risen 38% over the last three years but reported profits have risen just 3%. “Valuations, as measured by median price to cash flow ratios, are near historical highs. As US QE has come to an end, depriving the world of $1 trillion printed dollars a year, there are plenty of reasons to be nervous,” he said.

Ambrose’s gauge of share values is dead on, and far more important than he seems to realize. He knows full well there are tons of reasons to doubt his own headline. But he still leaves out many of those reasons in that article today. So let’s move back in time to look at what he wrote this summer, before the drop in oil prices.

Here are a few lines from Ambrose on July 9 2014:

Fossil Industry Is The Subprime Danger Of This Cycle

The epicentre of irrational behaviour across global markets has moved to the fossil fuel complex of oil, gas and coal. This is where investors have been throwing the most good money after bad. [..] oil and gas investment in the US has soared to $200 billion a year. It has reached 20% of total US private fixed investment, the same share as home building.

This has never happened before in US history, even during the Second World War when oil production was a strategic imperative. The International Energy Agency (IEA) says global investment in fossil fuel supply doubled in real terms to $900 billion from 2000 to 2008 as the boom gathered pace. It has since stabilised at a very high plateau, near $950 billion last year. The cumulative blitz on exploration and production over the past six years has been $5.4 trillion [..]

upstream costs in the oil industry have risen 300% since 2000 but output is up just 14% [..] The damage has been masked so far as big oil companies draw down on their cheap legacy reserves.

companies are committing $1.1 trillion over the next decade to projects that require prices above $95 to break even. The Canadian tar sands mostly break even at $80-$100. Some of the Arctic and deepwater projects need $120. Several need $150. Petrobras, Statoil, Total, BP, BG, Exxon, Shell, Chevron and Repsol are together gambling $340 billion in these hostile seas.

… the biggest European oil groups (BP, Shell, Total, Statoil and Eni) spent $161 billion on operations and dividends last year, but generated $121 billion in cash flow. They face a $40 billion deficit even though Brent crude prices were buoyant near $100 ..

… the sheer scale of “stranded assets” and potential write-offs in the fossil industry raises eyebrows. IHS Global Insight said the average return on oil and gas exploration in North America has fallen to 8.6%, lower than in 2001 when oil was trading at $27 a barrel.

What happens if oil falls back towards $80 as Libya ends force majeure at its oil hubs and Iran rejoins the world economy?

A large chunk of US investment is going into shale gas ventures that are either underwater or barely breaking even, victims of their own success in creating a supply glut. One chief executive acidly told the TPH Global Shale conference that the only time his shale company ever had cash-flow above zero was the day he sold it – to a gullible foreigner.

… the low-hanging fruit has been picked and the costs are ratcheting up. Three Forks McKenzie in Montana has a break-even price of $91. [..]

“Under a global climate deal consistent with a two degrees centigrade world, we estimate that the fossil fuel industry would stand to lose $28 trillion of gross revenues over the next two decades , compared with business as usual,” said Mr Lewis. The oil industry alone would face stranded assets of $19 trillion, concentrated on deepwater fields, tar sands and shale.

By their actions, the oil companies implicitly dismiss the solemn climate pledges of world leaders as posturing, though shareholders are starting to ask why management is sinking so much their money into projects with such political risk.

Those numbers alone, combined with the knowledge that prices are off close to 40% by now, should be enough to give anyone the jitters, about the oil industry, and therefore about the global economy. Any industry that’s so deeply in debt cannot afford a 40% dip in revenue, not even for a short while. Dominoes must start tumbling in short order.

And of course saying ‘any industry so deeply in debt’ is already a bit misleading, because there is no industry like oil in the world (except maybe steel, and look how that’s doing), and it’s highly doubtful there’s another one with such debt levels. Oil stocks are down somewhat, but it’s hard to see how they could not fall a lot further. And as for the huge amounts invested in energy junk bonds, one can but shudder.

On August 11 2014, Ambrose had some more:

Oil And Gas Company Debt Soars To Danger Levels To Cover Cash Shortfall

The world’s leading oil and gas companies are taking on debt and selling assets on an unprecedented scale to cover a shortfall in cash, calling into question the long-term viability of large parts of the industry. The US Energy Information Administration (EIA) said a review of 127 companies across the globe found that they had increased net debt by $106 billion in the year to March, in order to cover the surging costs of machinery and exploration, while still paying generous dividends at the same time.

They also sold off a net $73 billion of assets. [..] The EIA said revenues from oil and gas sales have reached a plateau since 2011, stagnating at $568 billion over the last year as oil hovers near $100 a barrel. Yet costs have continued to rise relentlessly.

… the shortfall between cash earnings from operations and expenditure – mostly CAPEX and dividends – has widened from $18 billion in 2010 to $110 billion during the past three years. Companies appear to have been borrowing heavily both to keep dividends steady and to buy back their own shares, spending an average of $39 billion on repurchases since 2011.

… “continued declines in cash flow, particularly in the face of rising debt levels, could challenge future exploration and development”. [..] upstream costs of exploring and drilling have been surging, causing companies to raise long-term debt by 9% in 2012, and 11% last year. Upstream costs rose by 12% a year from 2000 to 2012 due to rising rig rates, deeper water depths, and the costs of seismic technology. This was disguised as China burst onto the world scene and powered crude prices to record highs.

Global output of conventional oil peaked in 2005 despite huge investment. [..] the productivity of new capital spending has fallen by a factor of five since 2000. “The vast majority of public oil and gas companies require oil prices of over $100 to achieve positive free cash flow under current capex and dividend programmes. Nearly half of the industry needs more than $120,” ..

Analysts are split over the giant Petrobras project off the coast of Brazil, described by Citigroup as the “single-most important source of new low-cost world oil supply.” The ultra-deepwater fields lie below layers of salt, making seismic imaging very hard. They will operate at extreme pressure at up to three thousand meters, 50% deeper than BP’s disaster in the Gulf of Mexico.

Petrobras is committed to spending $102 billion on development by 2018. It already has $112 billion of debt. The company said its break-even cost on pre-salt drilling so far is $41 to $57 a barrel. Critics say some of the fields may in reality prove to be nearer $130. Petrobras’s share price has fallen by two-thirds since 2010.

… global investment in fossil fuel supply rose from $400 billion to $900 billion during the boom from 2000 and 2008, doubling in real terms. It has since levelled off, reaching $950 billion last year. [..] Not a single large oil project has come on stream at a break-even cost below $80 a barrel for almost three years.

companies are committing $1.1 trillion over the next decade to projects requiring prices above $95 to make money. Some of the Arctic and deepwater projects have a break-even cost near $120 . The IEA says companies have booked assets that can never be burned if there is a deal limit to C02 levels to 450 (PPM), a serious political risk for the industry. Estimates vary but Mr Lewis said this could reach $19 trillion for the oil nexus, and $28 trillion for all forms of fossil fuel.

For now the major oil companies are mostly pressing ahead with their plans. ExxonMobil began drilling in Russia’s Arctic ‘High North’ last week with its partner Rosneft, even though Rosneft is on the US sanctions list. “Exxon must be doing a lot of soul-searching as they get drawn deeper into this,” said one oil veteran with intimate experience of Russia. “We don’t think they ever make any money in the Arctic. It is just too expensive and too difficult.”

Plummeting oil prices not only mirror the state of the – real – economy, they will also drag the state of that economy down further. Much further. If only for no other reason than that today’s oil industry swims in debt, not reserves. Investment policies, both within the industry and on the outside where people buy oil company stocks and – junk – bonds, have been based on lies, false presumptions, hubris and oil prices over $100.

The oil industry is no longer what it once was, it’s not even a normal industry anymore. Oil companies sell assets and borrow heavily, then buy back their own stock and pay out big dividends. What kind of business model is that? Well, not the kind that can survive a 40% cut in revenue for long. The industry’s debt levels were, in Ambrose’s words, at a ‘danger level’ when oil was still at $110.

Is Big Oil still a going concern? You tell me. I don’t want to tell the whole story bite-sized on a platter, there’s more value in providing the numbers, this time from Ambrose but there are many other sources, and have you make up your own mind, do the math etc.

Ambrose’s exact numbers can and will be contested three ways to Sunday, but his numbers are not that far off, and if anything, he may still be sugarcoating. WTI closed at $66.15 on Friday, Brent is at $70.15. Given the above data, where would you think the industry is headed? What will happen to the trillions in debt the industry was already drowning in when oil was still above $100?

And how will this be a boon to the economy even if, as Ambrose puts it, the ”oil drop lasts”? Do you have any idea how much your pension fund is invested in oil? Your money market fund? Your government? I would almost say you don’t want to know.

There can be very little doubt that oil prices will at some point rise again from whatever bottom they will reach. Even if nobody knows what that bottom will be. At the same time, there can also be very little doubt that when that happens, the energy industry’s ‘financial landscape’ will look very different from today. And so will the – real – economy.

Cheap oil a boon for the economy? You might want to give that some thought.

Home Forums Cheap Oil A Boon For The Economy? Think Again

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    ‘Daly’ Somewhere in the South, possibly Miami 1941 I thought it might be a nice idea to question a certain someone’s theories using their own words, w
    [See the full post at: Cheap Oil A Boon For The Economy? Think Again]


    Your essay is right on the money. However, what industry or segment of our society is not loaded down with massive debt? We are now in the “musical chairs” economy where there is too much unpayable debt and not enough time and growth to ever pay it back. Anyone who directly benefits from these lower fuel prices would be wise to pay off debt as fast as possible-which will only speed up the deflationary process. What a fine mess we’re in Ollie!


    30$ x33 billion barrels makes 1 trillion tax cut or 2% of global GDP.
    However if Iwere a stock analyst on the energy side I would be running thenumbers for all the energy companies. They are all now debt leveraged like the big banks before the 2008 crisis. So if it keeps going like this negative cash flow burn rate will force whole industry to its knees. Mergers, nationalizations, field shutdowns follow. For any other industry this would be bad but isolated but less oil will boomerang prices. Problem is all professionals will be gone along with infrastructure and so noone will be there to take up the oil investments again in shale, offshore, tarsands. National oil companies in Russia, Gulf will survive if governments survive economic loss. Eonmobil, BP, Total bankrupt, Russia in default, gulf states, venezuela in revolution?

    Sounds like a Saudi gamble to kill alt -oil production and risking own hide in a game of chicken to see who pulls the parachute string first.


    Ilargi, with the sudden drop in oil prices as well as the dollars surge, do you think the Fed will hold off raising rates in 2015?


    I was hoping that someone would clarify something for me.

    I am under the impression that the currently operation “fracked” wells are a “use-it-or-lose-it” proposition. That if the wells are not pumped constantly, they lose their production.

    Is this true? I sincerely hope it is not, but I can’t seem to find information on this.

    Golden Oxen

    If this debt problem were just confined to the oil industry it would be bad enough, in my experience with markets however, that is hardly ever the case.
    Once a bomb goes off and a fire starts, it rages through the entire forest, in this case, the entire junk debt jungle, and it won’t stop there.
    When I think for a moment of the debt and leveraged speculation dependent on this fracking bubble expanding, it gets truly frightening. Suppliers, jobs, real estate values, equity and bond positions, leases, state and county tax revenues etc.; one can easily entertain the thought that the grand party has ended and it’s time to run for the exits.
    Don’t be tardy, they get crowded in an instant and one can be trampled to poverty if hesitant.


    Karl Denninger posted re the Financial Institution Bankruptcy Act today:

    “The Financial Institution Bankruptcy Act enjoys broad bipartisan support and has received little public examination. Not much will be said about it on Monday either. The bill will be considered under suspension of the rules, meaning it cannot be amended and will be subject to limited debate, though to pass the House it will need to attract a two-thirds vote.”

    Karl commented:

    “It sounds good on the surface — it creates a specific section of the bankruptcy code for big banks. That’s good. What’s not so good is what it doesn’t do.

    It doesn’t prevent taxpayer bailouts.

    It forces a 48 hour stay on counterparty demands – potentially ruinous in a “fast” market where leverage is very high.

    And it has, and will receive, little or no public exposure.”

    Are they gearing up for the inevitable?


    A commenter agrees with what rapier said a few days ago:

    “These crooks are running the system while Congress, the SEC, CFTC are completely ignoring them. Look at oil. It stayed up over the past 5 years and all of a sudden it collapses. The economy didn’t change much and never justified the run up and now the drop. I bet that the leverage on derivative exposure on oil hit a high at over $110 a barrel and now someone is cleaning up with the drop in price.
    I am betting that we will see the same action on the stock market when these crooks are ready to make some real money on the downside.”


    RE am under the impression that the currently operation “fracked” wells are a “use-it-or-lose-it” proposition. That if the wells are not pumped constantly, they lose their production.

    That’s kind of the wrong question. Such wells are spent in 3 years in most every case with the 3rd year pretty bad. They go downhill fast. Once the pipe is put down no matter what they will utilize it because of the sunk cost. It’s not about use it or lose it, it’s about start it or not.

    As to the question of why the Saudis are set on seeing the price drop maybe some day we will know, and what part the US played but we know now that it’s a profound blunder. It’s stupid which is what is to be expected. It’s twilight of the elites baby. The product of inbred stupidity.


    Professor LnL, while deploying the currency “Bazooka” is one of a few options on the table, you have yet to explain why the Debt Money Monopolists would deploy said “Bazooka” in the direction of their own assets. In fact, nobody with your position has ever addressed to this my satisfaction – and no, “because they are stupid” is not to my satisfaction and exposes the poor level of intellect that developed that line of “reasoning.”


    GO: Yeah, you can’t take Big Oil out of the picture and expect the rest to just move along. The entire shebang is fueled by oil, and thus the oil industry.

    Koso: The rate rise will come. They’re very busy painting a picture of recovery, see Bloomberg’s headline ‘Black Friday Online Sales Jump 22% as Jobs Spur Shopping’ today, exactly because they’re preparing to hike rates. They’ll ‘show’ us how well America’s doing, and say they have no choice but to hike. It may come sooner than we think, as in before the oil collapse translates into broader markets.


    I don’t buy that this oil price crash is a debt unravelling event, the long-anticipated great deflationary crash finally unfolding. I see no evidence of any sudden collapse in consumer demand to warrant this. There are more nefarious forces at play here.

    One could be that Saudi has now aligned with Russia and/or China and wishes to crash the west’s financial system. Why do this now? Presumably because the gold has run out and it is time. A nice diversion. However, Saudi switching alliances like that would be a big deal and if so I’d presume we would have seen a lot more drama coming from Washington about that.

    Another possibility could be that it is actually the West’s elites who are still working with Saudi Arabia as they always have, and deliberately crashing the West’s financial system and energy infrastructure. That way they can “buy when there’s blood on the streets”. Most of the weaker producers with low EROEI and high debt will go belly up, leaving only the strong producers standing, albeit in a fragile state. Those strong producers would be the Middle East, Alberta oil sands, various offshore projects, and the remaining legacy producers still pumping away their old wells. Then after the deliberately-triggered deflationary crash happens the currency will hyperinflate as that is the next rung of untenable debt down the ladder of lies, and real oil prices will skyrocket as reality finally sets in to the financial system after 4 decades. Then the elites will be left holding all the cards. Why are they doing this now? Probably the same reason as in possibility #1 above, because the gold is now gone!

    I don’t believe for a second that this price crash is happening on its own accord as a result of genuine market forces, and especially not from lack of demand.


    Mark – if they have a “deliberately-triggered deflationary crash,” they can then blame the drop in oil prices as triggering it. “Oh, it was out of our hands! Those damn oil producers are waging a war against each other.” But I don’t see much difference between a “deliberately-triggered deflationary crash” and “deliberately-created inflationary bubbles”. After all, how long can they be expected to keep the ball in the air?

    The crash should have happened in 2008, but they prevented it with sub-prime autos, sub-prime education, QE’s, free money to the elites, stimulus, and on and on and on and on. That’s been the “deliberate” and “artificial” make-believe world we’ve been living in. Artificially-created demand. They painted over the crash with lipstick, and now the lipstick is wearing off. Whenever cheap money is handed out, it flows to all the wrong places. Now we have a glut of supply.

    As Ambrose said above, he figures demand is down by one-third because of China and Europe, and two-thirds is a sudden supply glut. It was all artificial – ghost cities and bridges to nowhere.

    The only “deliberate” act was the artificial pumping back up. All parties end and they always leave a big mess to clean up.


    Raleigh, I agree with most of what you say. But if we now have a glut of supply, then where are all the overflowing oil storage tanks?

    Apparently the producers aren’t slowing production, according to what I am hearing here and elsewhere (they can’t afford to), so there is now a supply/demand imbalance which doesn’t make sense.

    The artificially pumped up demand for oil since 2008 was matched with artificially pumped up supply via the shale oil bubble — no way those things would have been possible in a normal interest rate environment without free Wall Street money flowing.


    Mark – nothing makes sense in this central bank-engineered world. It’s all artificial and engineered. Who knows what they’ll manufacture next month in the way of lies and propaganda! That’s why it’s near impossible to know which way to go, because apparently we can’t prepare for the future until they manufacture what it’s going to be. It’s insane, like living in a work of fiction.


    Thanks for the reply Ilargi!


    I think falling oil prices is a mixed bag. Obviously good for some parts of the economy. Obviously a disaster for over-indebted drillers, and yes, the loss of jobs in this sector will turn North Dakota into a ghost town. It was not too long ago that the conventional wisdom was that we would never see recovery because oil prices would never fall back below $100. High oil prices were the problem. Now it seems that the problem is low oil prices that are too low.

    I for one suspect that oil prices were manipulated lower to try to kickstart a “return to growth.” They already tried monetary policy. That failed. So why not try lowering the price of the most important commodity to the entire world?

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