Oil Crunch Underway (Sand is next)

The Oil Crash is Under Way
By Tom Lewis | December 11, 2014 | Energy

When big trees come down, they start slow and end with a crunch. (Photo by geograph.org.uk)
When you are felling a really big tree, the first signs that it is coming down are subtle; a crack here and there, a twitching of the crown. By the time these clues register on you, the tree is on its way down. The cracks and twitches from the U.S. oil industry are coming almost hourly now, and although it is a really big tree, and won’t actually hit the ground until next year, its fate is pretty well sealed. Here are this week’s signs and portents:

British Petroleum announced Wednesday it will cut thousands of jobs worldwide, in addition to a previously announced two-billion-dollar cut in its operating budget and a fire sale of $43 billion dollars worth of assets (most of them in the US fracking patch). BP disclosed that over the next 18 months it will spend a billion dollars on “restructuring.” Deutsche Bank immediately upgraded BP stock to “buy.”
Goodrich Petroleum announced Wednesday it is exploring the sale of “some or all” of its shale-oil assets in the Eagle Ford play in Texas, the second-largest contributor to the country’s shale oil “boom.” Goodrich also said it will make a drastic cut in 2015 capital expenditures (which, in the oil bidness, includes the search for new wells) to $150-$200 million, down from last year’s $375 million.
ConocoPhillips announced this week it will cut capital spending by 20% next year to $13.5 billion.
Chevron announced it is not going to make any decisions on next year’s capital expenditures until…next year.
In all, oil and gas exploration projects worldwide worth more than $150 billion are likely to be put on hold next year. Analysts are now predicting a 25 per cent decrease in exploration and production spending by the oil companies.
The long term implications of these cuts are dire for the oil companies, for the simple reason that you cannot sell oil you have not found, and oil is getting much more difficult and expensive to find. The short-term consequences will be dire for the oil services sector, the companies such a Halliburton and Baker Hughes who provide the machinery for the drillers and frackers and transporters. According to Bloomberg News, the industry now expects 400 of the 1848 US onshore oil rigs now operating to be idled by next year. Another 200 new rigs, under construction for delivery next year, are now expected to have nothing to do.
Earnings forecasts are being downgraded almost daily across the whole sector. Stock prices are dropping. But wait, there’s more.

Two things about the fracking boom are not well understood: its voracious appetite for cash, given the expense of the process and the astonishing depletion rates of the wells; and the extent to which the industry has been financed with junk bonds and the even junkier leveraged loans (for borrowers whose credit is no longer good enough to issue junk bonds). Until now, the hype about how huge fracking was going to be for decades to come had kept the suckers’ money coming in just fine. Just this year, until October, energy companies had no trouble borrowing $50 billion with junk bonds. (Since 2010 the industry has loaded up on more than half a trillion dollars’ worth of high-interest debt.)

Now, that string has run out. Junk bonds and junk loans that secondary markets had been clamoring to buy at or near face value have lost 20% of their value. And secondary markets are crucial to the junk lending business, no one wants to be stuck owning a loan that isn’t going to be repaid; you have to get it out the door to the next idiot and bank your fees. When it starts costing you 20% to move it out the back door, you stop bringing it in the front door. That’s happening now.

The only way to get investors to touch this junk is raise the interest rate, which seems to work even when there are deep misgivings about ability to repay. Junk loans that used to cost less than six per cent this summer are now requiring over nine per cent. So just as oil companies revenues are plummeting, their stock prices are tanking, and their wells are going dry, their expenses are skyrocketing.

When you see that much trembling and hear that many cracks from a big tree, the only thing to do is step well back and yell “Timber.”

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Comments

  1. Good article. It will only slow down the fracking and sand mining, but we will not be rid of it all. The Saudis and OPEC can hold it down for only so long. The local tax payer will be paying for all the damage that those sand miners leave when they declare Bankruptcy. It is part of what I have been trying to warn against for over 3 years now. Now all we can do nis hope for the best.

    Jim Drost

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