Nov 272014
 November 27, 2014  Posted by at 6:34 pm Finance Tagged with: , , , , , ,

Jack Delano Cafe at truck drivers’ service station on U.S. 1, Washington DC Jun 1940

We should be glad the price of oil has fallen the way it has (losing another 6% today as I write this). Not because it makes the gas in our cars a bit cheaper, that’s nothing compared to the other service the price slump provides. That is, it allows us to see how the economy is really doing, without the multilayered veil of propaganda, spin, fixed data and bailouts and handouts for the banking system.

It shows us the huge extent to which consumer spending is falling, how much poorer people have become as stock markets set records. It also shows us how desperate producing nations have become, who have seen a third of their often principal source of revenue fall away in a few months’ time. Nigeria was first in line to devalue its currency, others will follow suit.

OPEC today decided not to cut production, but whatever decision they would have come to, nothing would have made one iota of difference. The fact that prices only started falling again after the decision was made public shows you how senseless financial markets have become, dumbed down by easy money for which no working neurons are required.

OPEC has become a theater piece, and the real world out there is getting colder. Oil producing nations can’t afford to cut their output in some vague attempt, with very uncertain outcome, to raise prices. The only way to make up for their losses is to increase production when and where they can. And some can’t even do that.

Saudi Arabia increased production in 1986 to bring down prices. All it has to do today to achieve the same thing is to not cut production. But the Saudi’s have lost a lot of clout, along with OPEC, it’s not 1986 anymore. That is due to an extent to American shale oil, but the global financial crisis is a much more important factor.

We are only now truly even just beginning to see how hard that crisis has already hit the Chinese export miracle, and its demand for resources, a major reason behind the oil crash. The US this year imported less oil from OPEC members than it has in 30 years, while Americans drive far less miles per capita and shale has its debt-financed temporary jump. Now, all oil producers, not just shale drillers, turn into Red Queens, trying ever harder just to make up for losses.

The American shale industry, meanwhile, is a driverless truck, with brakes missing and fueled by on cheap speculative capital. The main question underlying US shale is no longer about what’s feasible to drill today, it’s about what can still be financed tomorrow. And the press are really only now waking up to the Ponzi character of the industry.

In a pretty solid piece last week, the Financial Times’ John Dizard concluded with:

Even long-time energy industry people cannot remember an overinvestment cycle lasting as long as the one in unconventional US resources. It is not just the hydrocarbon engineers who have created this bubble; there are the financial engineers who came up with new ways to pay for it.

While Reuters on November 10 (h/t Yves at NC) talked about giant equity fund KKR’s shale troubles:

KKR, which led the acquisition of oil and gas producer Samson for $7.2 billion in 2011 and has already sold almost half its acreage to cope with lower energy prices, plans to sell its North Dakota Bakken oil deposit worth less than $500 million as part of an ongoing downsizing plan.

Samson’s bonds are trading around 70 cents on the dollar, indicating that KKR and its partners’ equity in the company would probably be wiped out were the whole company to be sold now. Samson’s financial woes underscore how private equity’s love affair with North America’s shale revolution comes with risks. The stakes are especially high for KKR, which saw a $45 billion bet on natural gas prices go sour when Texas power utility Energy Future Holdings filed for bankruptcy this year.

And today, Tracy Alloway at FT mentions major banks and their energy-related losses:

Banks including Barclays and Wells Fargo are facing potentially heavy losses on an $850 million loan made to two oil and gas companies, in a sign of how the dramatic slide in the price of oil is beginning to reverberate through the wider economy. [..] if Barclays and Wells attempted to syndicate the $850m loan now, it could go for as little as 60 cents on the dollar.

That’s just one loan. At 60 cents on the dollar, a $340 million loss. Who knows how many similar, and bigger, loans are out there? Put together, these stories slowly seeping out of the juncture of energy and finance gives the good and willing listener an inkling of an idea of the losses being incurred throughout the global economy, and by the large financiers. There’s a bloodbath brewing in the shadows. Countries can see their revenues cut by a third and move on, perhaps with new leaders, but many companies can’t lose that much income and keep on going, certainly not when they’re heavily leveraged.

The Saudi’s refuse to cut output and say: let America cut. But American oil producers can’t cut even if they would want to, it would blow their debt laden enterprises out of the water, and out of existence. Besides, that energy independence thing plays a big role of course. But with prices continuing to fall, much of that industry will go belly up because credit gets withdrawn.

The amount of money lost in the ‘overinvestment cycle’ will be stupendous, and you don’t need to ask who’s going to end up paying. Pointing to past oil bubbles risks missing the point that the kind of leverage and cheap credit heaped upon shale oil and gas, as Dizard also says, is unprecedented. As Wolf Richter wrote earlier this year, the industry has bled over $100 billion in losses for three years running.

Not because they weren’t selling, but because the costs were – and are – so formidable. There’s more debt going into the ground then there’s oil coming out. Shale was a losing proposition even at $100. But that remained hidden behind the wagers backed by 0.5% loans that fed the land speculation it was based on from the start. WTI fell below $70 today. You can let your 3-year old do the math from there.

I wonder how many people will scratch their heads as they’re filling up their tanks this week and wonder how much of a mixed blessing that cheap gas is. They should. They should ask themselves how and why and how much the plummeting gas price is a reflection of the real state of the global economy, and what that says about their futures. Happy Turkey.

Home Forums The Price Of Oil Exposes The True State Of The Economy

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    Jack Delano Cafe at truck drivers’ service station on U.S. 1, Washington DC Jun 1940 We should be glad the price of oil has fallen the way it has (los
    [See the full post at: The Price Of Oil Exposes The True State Of The Economy]


    Price of oil goes down by 50% then sell 50% more oil.
    “Drill baby drill”
    I saw a blogger saying, “American Spring”
    I prefer, “American Fall”


    Actually when price goes down 50% you have to produce 100% more to get the same income. If your expences were 50$ per barrel and price fell from 130$ to 80$ you would have to produce 266% more to get the same profit.


    The question I keep asking myself is whether the US government even cares about the economic losses to fracking companies, banks (which were likely informed and agreed) and sundry businesses as long as they can punish Russia, oust Putin and pressure Iran. This is a no holds barred struggle for power. My sense is though that all of this will end very badly. And what will the general public make of the price drop in gas. Will they drive more?


    @ tob
    things are going to get interesting. nobody wants to be the first one to give up their lifestyle

    John Day

    Thanks Ilargi,
    Happy Thanksgiving.
    Commenters are having a hard time understanding deflation/depression, not having lived through it.
    I was the best listener to my Grandfather, who was a radio operator and observer-gunner in a Spad in WW-1, raised a family and built them a house from local wood and stone during the depression, then was in OSS counter-intelligence in WW-2.
    I always, and still, feel that I’ll have to assume his cloak, and relatively soon.
    We all have our roles to play in life. No spook stuff for me, though.


    John Day – I listened too, and I think what I heard greatly affected me my whole life. The words and stories seemed to resonate with me, but the others hardly listened. People forget that what has happened before can happen again, and they find history boring.

    “That men do not learn very much from the lessons of history is the most important of all the lessons that history has to teach.” Aldous Huxley


    If you haven’t already, give Extraordinary Popular Delusions and the Madness of Crowds
    a listen.
    Also, for those who have not seen it…
    The Coming Crash: Usury and the Irrelevant Church
    I’m not convinced that Ilargi and Nicole fully comprehend that the foundation of debt monetary systems are fraudulent.
    The operators of such systems are, by definition, criminals.
    They aren’t dumb. They aren’t out of touch academics. They are criminals to the core – and the most sophisticated criminals the world has ever seen, hence, their average victim has no idea they even exist! Even their well above average victim.
    Inequality: Why are the rich getting richer?

    How to Be a Crook

    Does everyone here know that private banking corporate fronts lend money to society and THEN COLLECT ANNUAL INTEREST ON THE ENTIRE DEBT MONEY SUPPLY?
    That’s every Federal Reserve Note, every dollar of bank credit, every investment count dollar, every Euro in existence, every Euro of bank credit, etc…
    Can you imagine collecting even 5% of the world’s money supply every year for 20 years, because a small group of owner / controllers can’t imagine making such a low percentage because they get a much higher percentage!
    Oh, and the kicker? Every one of their net positive monetary unit is society’s INEXTINGUINGISHABLE DEBT!
    Two Faces of Money Slide Presentation

    The summation and conclusion?
    The monetary system “operating system” has been hacked by criminals and contains a usury based Trojan Horse malware program.
    The very foundation of society is a fraud – and your pay check was initially emitted by the criminals running the system… and was based on societal debt.
    I’ve never heard Ilargi or Nicole address this fundamental truth, although I’ve brought it up numerous times on these comment boards and proved it using simple 5th grade mathematics.
    And not just I, but several others. This is the root cause to all other major problems – and if people won’t admit to the root cause then there is no solution.


    John Day, Raleigh, my grandmother was born in 1917. Before she passed on a couple of years ago, I sat down with her one afternoon and peppered her with all sorts of questions about living through the Great Depression. She shrugged it off like it was no big deal. She said: “We lived on a farm. We grew our own food. Sure we were all poor, but it wasn’t much different from before or after the depression.” On another occasion I asked her why the whole family moved from Nebraska to California during World War II. She said: “Everyone was poor back then, and the best job opportunities on the West Coast.” It was only after the move to California that they started climbing the ladder into the middle class.

    I guess that’s when it hit me. The Great Depression was a bigger calamity for rich people than it was for poor people. For poor people it was just life as usual, maybe a bit worse, but not the “sky is falling” panic it must have been for the banking class.

    Of course my grandmother was a teenager during those years, and I guess if you don’t own anything, you just sort of shrug everything off.


    Price of oil is falling because there is too much supply.
    Who were the biggest buyer of oil?
    China? India? Have they stopped buying? Why? Do they have more oil than they need?
    If they are not using as much oil, did they shut down their mfg?

    So many questions. So few answers.


    The “wizard” behind the energy companies like Exxon, Shell, etc, controls the oil price from the beginning to the end. They have such a large profit margin, that making the price half, is not a problem for them. As I see, they have one target here – Russia -. They want to weaken it and brink it to its knees. It is the only remaining country they don’t control yet.


    Oil price is falling because of economic slowdown.

    Adam Ash

    USA net imports: nine million bbl per day. Russia net exports: nine million bbl per day. Regardless of the price of oil, it does not take a genius to see whose eyes are going to water first in this face off.


    I recently saw a meme on Facepalm that attributed the drop in oil price to President Obama-sama’s brilliant leadership. How utterly out of touch with reality! The camp-followers of both the major parties are such Kool-Aid-drinking religionists these days that I have no doubt Republicans would be attempting to float the same meme had Mitt Romney won the previous presidential election (unlikely because people just didn’t like him and were generally weirded out by his Mormonism).


    Instead of the system, any system monetary or otherwise, being labeled, prim facie, as corrupt or criminal it is better to think in terms of them becoming corrupt.

    My Catholic/Christian education is speaking here (in old fashioned pre modern Christianist terms) in declaring that man is imperfect, cannot create a perfect system and will eventually corrupt any system. Any of a myriad of systems would serve the majority well if were not corrupted. The fractional reserve fiat money system worked pretty well post Great Depression, for Americans in America anyway, until pick your date. 1973, or 80 or 87, the latter placing Greenspan as the important actor.

    To repeat. There is no possible perfect system and every system will end up being corrupted because of human nature.


    I don’t believe there is such a thing as a right or correct price for a fungible centrally traded in auction markets commodity like oil. Such things are always strongly subject to liquidity flows based upon greed and fear compounded by leverage. One can argue the correct price is around the price of production but there is never a single cost of production. A better measure might be the the cost of the last marginal unit but how do you figure that? Gross stats from 3/13 to 3/14 of US gas and oil producers showed a loss of over $100bn and yet you can see now those claiming the cost of production in the Balken play is $65.

    It occurs to me, right or wrong, that oil has had several years of speculative long side support, just because. That oil could easily have been in the $70/bbl all along.

    Ken Barrows

    I think you’re wrong and you’re almost certainly wrong on new production. But post a link or two if you like.

    EM’s profit per dollar of revenue is MUCH lower than, say, Apple or JPMorganChase.


    rapier – “It occurs to me, right or wrong, that oil has had several years of speculative long side support, just because. That oil could easily have been in the $70/bbl all along.”

    That’s what I think, same as gold, the stock market, and practically everything else. Lots of speculation keeping prices up. Is that what you were meaning?


    Just a question about the physical mechanics of a fracked well. I have been told by an not completely unreliable source that fracked wells can’t really be “turned off”. My source was fairly adamant that a lot of the production in fracked wells is of a use-it-or-lose-it nature.

    If this is true, and if someone here with certain knowledge about this would chime in about its veracity, how would this ground-truth effect the equation in a “lower than production cost” set of wells?

    John Day

    Fellow students of history.
    I remember the oil price drop in the mid 1980s. I was in med school in Houston, and houses were selling at auction for 20-25 cents on the dollar at auction weekly. Our landlord came by to pick up the check in person one day, in his Corvette.
    We’d heard he had financial problems. We never sent him another check.
    A bank in Louisiana contacted us half a year later, and said to end them the rent.
    We told them about the rats. They didn’t know I’d killed the rats and plugged the hole they got in. We lowered our rent by 20% and they just cashed the checks.
    That half year rent free was never questioned.
    Your Mileage May Vary.


    There seems to be something inconsistent in the argument in this post. On one hand, they say that the price of oil is plunging because of a crash in consumer demand as presumably the great widely predicted deflationary crash is happening. Because of simple supply/demand dynamics, this would entail that supply is dropping, since the market is so tight. But then on the other hand, they argue that no country can afford to cut production, and that OPEC isn’t. So how does that jive? How can demand tank, but then production remain full tilt? This makes no sense, as it would be creating gluts of oil everywhere. The market is razor thin, with very little above ground supply held. Demand has always virtually identically matched supply. The Strategic Petroleum Reserve is only a few months of supply.

    So where is all this excess oil then? Do we have evidence of it spilling over all the storage tanks around the world? That’s why I do not believe this oil price plunge is a result of tanking demand. I think it is a strategic move, probably by OPEC (Saudi Arabia) and Russia, to flood the market with cheap oil to hurt certain producers, most probably the US. And they are probably lying about their production numbers. It is a supply side shock, not a demand side shock.


    TheTrivium, lending at 3% causes the lender to lose money since real inflation is greater than that. The criminals don’t make money by loaning out money and making a paltry 2 or 3%, they make money by gaming the system with derivatives and looting it that way. And by counterfeiting.

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