“First, the development of the ‘shale oil’ production over the last five years has caused oil inventories to surge at a time when demand for petroleum products is on the decline as shown below.”
“The obvious ramification of this is a ‘supply glut’ which leads to a collapse in oil prices. The collapse in prices leads to production ‘shut ins,’ loss of revenue, employee reductions, and many other negative economic consequences for a city dependent on the production of oil.
Secondly, I have also discussed that the ‘fracking miracle’ may not be all that it is believed to be due to fast production decline rates and massive amounts of leverage. Just recently Yves Smith posted an article discussing this very issue stating:”
‘The oil and gas sector is capital intensive. Drillers have borrowed phenomenal amounts of money, which was nearly free and grew on trees, to acquire leases and drill wells and install processing equipment and infrastructure. Even as debt was piling up, the terrific decline rates of fracked wells forced drillers to drill new wells just keep up with dropping production from old wells, and drill even more wells to show some kind of growth. One heck of a treadmill. Funded in part by junk debt.
Junk bond issuance has been soaring as the Fed repressed interest rates and caused yield-hungry investors to close their eyes and take on risks, any risks, just to get a teeny-weeny bit of extra yield. Demand for junk debt soared and pushed down yields further. And even within this rip-roaring market for junk bonds, according to Bloomberg, the proportion issued by oil and gas companies jumped from 9.7% at the end of 2007 to 15% now, an all-time record.’
I received many emails on those comments that deserved a response and/or further clarification.
As with all things, the question of oil prices is nothing more than a supply/demand issue. As shown above, the sharp increase in production brought on by “fracking” has certainly been quite remarkable. However, this remarkable resurgence in oil production currently faces two extremely strong headwinds. The total amount of available refining capacity and the level of end demand are both declining.
While the “fracking miracle” has boosted the production of raw crude in recent years, such production is only useful if you can convert the base commodity into a useful byproduct. The problem, as shown in the two charts below, is that the the number of operating refineries has continued to fall, as the regulatory environment has stifled the ability to build new plants, and operating plants are already running near full capacity.
This post was published at StreetTalkLive on 20 October 2014.
Follow on Twitter
Recent Comments