Nov 222014
 November 22, 2014  Posted by at 9:31 pm Finance Tagged with: , , , , , , , ,

Jack Delano Spectators at annual barrel rolling contest in Presque Isle, Maine Oct 1940

How low can and will oil prices go, and what will the effects of those prices be? I bet you’ll have a hard time finding even just two people who have the same opinion on that. Not that it’s merely a matter of opinion, mind you, there are a great number of real life factors that come into play. It’s not an easy game.

OPEC gets together next week, and it’s a cartel divided. Many if not most of its members are suffering some kind of losses at present prices, and the obvious choice seems to be to cut output in order to raise prices again. But that’s not easy either, because at lower prices they need more output, not less, to minimize the damage. Besides, is non-OPEC producers don’t cut their output, OPWC cuts may do very little to lift prices.

After the recent plunge in prices, WTI is in the $75 per barrel range, and Brent around $80, the playing field has already been altered significantly. Some producers are fine with oil at $60, others need $120. Many Middle East governments need high prices to keep domestic unrest at bay, even if they can produce relatively cheaply. Some, like Venezuela, are already very close to what looks like a collapse.

There doesn’t seem to be much doubt that Saudi Arabia’s decision to cut its prices has played a major role in bringing down prices. The reason why it’s done that, however, is not so clear. Weakening the economic and political power of Russia, Venezuela and ISIS is a very obvious underlying reason. That the House of Fahd would engage in some sort of battle with US shale seems less likely; the Saudi rulers don’t fight the US that has protected them militarily for decades in the volatile region they’re in.

These geopolitical reasons behind the price drop are interesting, but perhaps the purely economic background plays a far greater role than we tend to think. We know that most large economies are not doing well at all, and we also know that their leaders and central bankers do whatever they can to make us think that pig was born with lipstick on. But perhaps we lose something in the translation, perhaps things are worse than we realize.

An article at MarketWatch by ‘investment specialist’ Ivan Martchev suggests that the impact on the price of oil of the economic slowdown in China could be far greater, in the recent past as well as going forward, than most wish to acknowledge. Since a lot of demand growth comes from China, as Europeans and Americans drive less miles per capita, a significant slowing of that growth demand could be a major factor in where oil prices go in 2015. Martchev:

Cheap Oil May Be A Sign Of Bigger Problems

One thing that strikes me about this oil-price decline is how persistent and methodical it has been. Commodities trend much differently than stocks as strong trends sometimes seem almost linear in nature with very shallow countertrend moves. I have used the analogy that the zigs and zags of stocks are typically much better defined than those for key commodities in strong trends.

The other asset class that tends to show such “zagless” strong trends at times is currencies. This can easily be seen in the Japanese yen’s USD/JPY [..] The euro is also showing a weakening trend [..] Strong declines in commodity prices signify a supply-demand imbalance. You can’t quickly shut off supply, as there are many already-spent budgets and projects that need to be completed, so weakening demand can carry the oil price much further.

I think this oil situation has little to do with the U.S. and much more to do with Europe and China, much the same way in which commodity-price weakness in 1997-1998 was due to the Asian Crisis and not U.S. demand.

How low can the oil price go? [..] we know that the cash cost of shale oil is about $60 per barrel, varying among different producers, and that historically, commodity producers have been known to produce their respective commodities at a loss to keep personnel and equipment going, as well a service debts that have financed their recent expansion.

In that regard, it would be interesting to note that energy junk bonds comprise 16% of the junk-bond market, and their issuance is up 148% to $211 billion according to Fitch. So, yes, I think the oil price can decline below $60.

As to how low the oil prices can go, that depends on how much China will slow down as the number-one consumer of oil. China’s financial system is operating on record leverage at the moment. Record leverage in the financial system and a sharply weakening real-estate market suggest that their economic slowdown has the potential to carry far below Beijing’s GDP growth target of 7%.

Yes, China has had three real-estate downturns in the past seven years, but the latest one is coming at a time of debt-driven boom, which means the consequences this time can be quite different. I used to think that China was a classic savings-and-investment economic-growth model, and it was, but that was 10 years ago.

I no longer think that, since GDP growth in the past five years has come from ever-increasing leverage ratios in the banking system. No debt-driven boom is permanent by definition, so the decline in the Chinese real-estate market has the potential to create a domino effect there in 2015. If China does decelerate well below 7% in 2015, an oil price target in the $30 to $40 range is completely realistic.

I have to agree wit that conclusion. And I think China is doing far worse than it lets on. Even if official Beijing numbers fail to reflect this, the amount of oil imported should reflect it. recently, China, has stockpiled large quantities, but it has no limitless storage facilities. One would presume its demand on global oil markets may diminish quite a bit soon.

It’s interesting to see Martchev note that both the China economy and the US shale industry are extremely leveraged, i.e. both are in dangerously deep debt positions. The kind that a slowdown can hurt badly, if not murder outright.

Back in July, Wolf Richter pointed to the Ponzi that US shale has turned into:

[..] the Energy Department’s EIA has checked into it and after crunching some numbers found:

Based on data compiled from quarterly reports, for the year ending March 31, 2014, cash from operations for 127 major oil and natural gas companies totaled $568 billion, and major uses of cash totaled $677 billion, a difference of almost $110 billion.

To fill this $110 billion hole that they’d dug in just one year, these 127 oil and gas companies went out and increased their net debt by $106 billion. But that wasn’t enough. To raise more cash, they also sold $73 billion in assets. It left them with more cash (borrowed cash, that is) on the balance sheet than before, which pleased analysts, and it left them with a pile of additional debt and fewer assets to generate revenues with in order to service this debt.

It has been going on for years. During each of the last three years, the gap was over $100 billion.

If oil prices sink further on the lack of Chinese demand, perhaps even to $30-$40, what will be left of US shale? And I’m not even talking about the 75% or so output decline rates per well, which makes shale a questionable undertaking in the first place. I’ve said repeatedly that US shale is about money, not energy, that it’s a land speculation wager and not much else.

And even at $75 per barrel, that industry is already in big trouble. Not long ago, we saw indications that shale companies would keep drilling and producing full blast with their profit margins being strangled, out of fear that investors would walk away if they showed any sign of weakness. Now, that is no longer their biggest worry:

Drilling Slowdown on Sub-$80 Oil Creeps Into Biggest US Fields

The slowdown in the U.S. oil-drilling boom spread to two of the nation’s largest fields this week. The Permian Basin of Texas and New Mexico, the country’s biggest oil play, lost four rigs targeting crude, dropping to 558, Baker Hughes aid on its website today. Those in North Dakota’s Williston Basin, the third-largest and home to the Bakken shale formation, slid to the lowest level since August, according to the Houston-based field services company’s website.

It was the first time in four weeks that oil rigs dropped in the Williston. “We’ll start to see really big drops early next year if oil prices stay the same,” James Williams, president of WTRG Economics in London, Arkansas, said. Nineteen shale regions in the U.S. are no longer profitable with oil at $75 a barrel, data compiled by Bloomberg show.

Those areas, including parts of the Eaglebine and Eagle Ford in Texas, pumped about 413,000 barrels a day, according to the latest data available from Drillinginfo and company presentations. Domestic oil output slipped 59,000 barrels a day in the week ended Nov. 14 [..] Hess said in a conference call Nov. 10 that it’ll cut its rig count to 14 next year in response to the lower oil prices. Apache, with headquarters in Houston, will reduce spending in North America by 25% next year, a company statement issued yesterday shows.

And that’s just a Bloomberg account. You need salt with that. What is clear is that even at $75, angst is setting in, if not yet panic. If China demand falls substantially in 2015, and prices move south of $70, $60 etc., that panic will be there. In US shale, in Venezuela, in Russia, and all across producing nations. Even if OPEC on November 27 decides on an output cut, there’s no guarantee members will stick to it. Let alone non-members.

And sure, yes, eventually production will sink so much that prices stop falling. But with all major economies in the doldrums, it may not hit a bottom until $40 or even lower. Oil was last- and briefly – at $40 exactly 6 years ago, but today is a very different situation.

All the stimulus, all $50 trillion or so globally, has been thrown into the fire, and look at where we are. There’s nothing left, and there won’t be another $50 trillion. Sure, stock markets set records. But who cares with oil at $40?

Calling for more QE, from Japan and/or Europe or even grandma Yellen, is either entirely useless or will work only to prop up stock markets for a very short time. Diminishing returns.

The one word that comes to mind here is bloodbath. Well, unless China miraculously recovers. But who believes in that?

Home Forums Who’s Ready For $30 Oil?

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    Jack Delano Spectators at annual barrel rolling contest in Presque Isle, Maine Oct 1940 How low can and will oil prices go, and what will the effects
    [See the full post at: Who’s Ready For $30 Oil?]


    “There won’t be another $50 Trillion.”

    Don’t bank on that.

    There will be “Whatever it takes” until all resources are under such pressure prices explode. Then the Central Banks will get what they wanted all along. Call it what you will, I’ll call it devaluation of currencies.


    Like Professorlocknload, I tend to think that they will just keep printing … until they cannot. Japan is their prototype.


    This is too funny.
    Now will this happen before or after the 90% collapse in Canadian Real estate which was set to happen in 2010.


    Really awesome comment as the prices were rallying out of the bottom.
    Of course being wrong for a decade punctuated with a brief 6 months of glory has not stopped you. So party on. If you get $50 average oil price for 6 months I will donate a $1,000 to your site.

    Ken Barrows

    We know that the cost of shale oil is $60/barrel? No one ever shows their work on this issue.
    I say higher:

    If it is $60, no worries right now just a lower profit margin. If higher, drillers are strongly negative cash flow. I used to think that mattered, but maybe not. Government can always subsidize a little more.

    If subsidies reign, then we’re looking at energetic limits. Less energy recovered in the extraction than in the input.


    Someone has the $30.00.

    Someone said, “buy low, sell high”.

    Someone will become richer than before.


    Personally I’m sceptical we will see oil at $30 dollars/barrel let alone $40, $50 or even $60/barrel for very long, if at all, because the US shale oil industry would be bust well before the Saudi’s started to feel serious financial pain, and they too would not escape either, just arrive at the same point a little later. Gail Tverberg recently wrote a good article exploring the issues from falling oil prices in Oil Price Slide – No Good Way Out; link below.

    Oil Price Slide – No Good Way Out

    Based on Figure 7 the article implies that Saudi Arabia needs oil prices within a range of c. $80-115/barrel, and below the lower price they too would be in trouble with the prices you suggest may be possible. The reason being that at some point they would be forced to cut back on the level of subsidies needed to keep their growing population “quiet and happy”. Interestingly Figure 6 shows that since the early 1990’s their modest increase in oil output has been taken up by increased internal oil consumption explaining why exports have remained fairly flat; a good example of the increasing impact the Export Land Model will have on exports.


    If they want oil to stop falling and stabilize, or rise, it will. The “they” being those who want higher stock prices,low interest rates, low gold and silver price, etc. I don’t particularly buy that ‘they’, the Fed in one case, are in the stock futures at all times or even ever, directly. It’s more a matter of consensus and will.

    So oil at $30? Only if ‘they’ lose control. With $XX trillion at the ready it doesn’t seem likely.


    >>“There won’t be another $50 Trillion.”

    Don’t bank on that.

    There will be “Whatever it takes” until all resources are under such pressure prices explode. Then the Central Banks will get what they wanted all along. Call it what you will, I’ll call it devaluation of currencies.<<

    Hi Professor, I have some questions I’d like you to answer to suss out the foundation of your articulated belief system…
    1. Why do you believe the Federal Reserve or the other Central Bank agents are telling the truth when they say they want something? They have a history of lying – they’ve lied about their true Section 2A Mandate for 30 years running.
    2. What does the corporate structure of the Federal Reserve reveal to be the CONTROLLERS of the Federal Reserve system? Are a few Big Banks the shareholders of the Federal Reserve corporation? Do the majority OWNERS of the few Big Banks exert control over the Big Banks that own and control the Federal Reserve?
    3. How do the OWNERS of the trillions in cash and trillions in debt benefit from hyperinflating the currency?
    4. Is Council on Foreign Relations historian Carroll Quigley right when he, after extensive research with the CFR library, claims the following:
    “The powers of financial capitalism had (a) far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent meetings and conferences. The apex of the systems was to be the Bank for International Settlements in Basel, Switzerland; a private bank owned and controlled by the world’s central banks which were themselves private corporations. Each central bank… sought to dominate its government by its ability to control Treasury loans, to manipulate foreign exchanges, to influence the level of economic activity in the country, and to influence cooperative politicians by subsequent economic rewards in the business world.”
    – Carroll Quigley, member of the Council on Foreign Relations
    “It must not be felt that the heads of the world’s chief central banks were themselves substantive powers in world finance. They were not. Rather they were the technicians and agents of the dominant investment bankers of their own countries, who had raised them up, and who were perfectly capable of throwing them down. The substantive financial powers of the world were in the hands of these investment bankers who remained largely behind the scenes in their own unincorporated private banks. These formed a system of international cooperation and national dominance which was more private, more powerful, and more secret than that of their agents in the central banks. ”
    – Carroll Quigley, Tragedy And Hope
    If Quigley is right, the whole Federal Reserve system is one big Sun Tzu Art of War deception that amounts to a Debt Money Monopoly Trojan Horse system.
    My view is that the bankrupting America and seizing its physical assets through forfeiture benefits these criminals more than zeroing out the value of their trillions in debt paper and trillion more in debt receipt money held by the mega corporations they control.
    The idea these people are “stupid” and “don’t know what they are doing” such that they will “zero out their own wealth” to assist the hoi polloi is indicative of someone who actually believes the Rockefeller engineered false narratives promoted in the schooling system he helped to engineer and finance.
    For more on that scam, I highly recommend John Taylor Gatto’s Underground History of America Education free audio book.


    >>Really awesome comment as the prices were rallying out of the bottom.
    Of course being wrong for a decade punctuated with a brief 6 months of glory has not stopped you. So party on. If you get $50 average oil price for 6 months I will donate a $1,000 to your site.<<

    Ha – the irony of that statement is that if this actually occurs then you might not be able to afford the $1000 donation any more!

    I highly recommend the following audio book..
    Memoirs of Extraordinary Popular Delusions and the Madness of Crowds
    If anyone has a good reading voice and decent recording equipment, it would a good volunteer opportunity to read for LibriVox.

    V. Arnold

    @ TheTrivium4TW

    Thanks for that link, radio4all. Pure gold.
    Being in another sphere, far, far away, books in English are not at hand. And hugely expensive to ship, so this is great.


    On the other hand, here’s a forecast for you:


    “Ha – the irony of that statement is that if this actually occurs then you might not be able to afford the $1000 donation any more!”
    Don’t worry. Not everyone begs for donations for a living.
    I will save it in physical cash.
    And I am sure this website will be running on solar powered generators.

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