It wasn’t that many years ago that the world was wrestling with legitimate worries over so-called “peak oil.” Then came the U.S. shale boom. The narrative did a “180.” Now, we think, America is swimming in so much cheap oil (and natural gas) that will be around for decades that tens of billions of dollars are being committed to build export markets. Natural gas is being compressed and supposedly America and Canada alike will be sending gas overseas. As for crude oil, there is a not-insignificant move in Washington to remove export restrictions on U.S. producers so they can ship crude oil abroad as well.
Peak Oil is Re-emerging
Few understand, though, that—a year or two from now—we will be taking a big step back toward those “peak oil” worries. At the least, present, price-crushing worries about oversupply will be gone. The trouble is--as the pendulum swings back that way--a lot of damage is going to be done.
Late last week, Bloomberg ran this story: http://www.bloomberg.com/news/articles/2015-12-10/billions-of-barrels-of-oil-vanish-in-a-puff-of-accounting-smoke. I doubt there is a more important story—together with its accompanying story line—that investors can be aware of right now. A significant player in the shale boom of recent years will be required in one fell swoop to admit that nearly half of the energy assets that investors, bankers, regulators and others thought existed NEVER DID EXIST is staggering. And Chesapeake will not be alone.
Tricky Accounting: Assets were Assumed, not Proven
And this is not your garden-variety write down of previously-proven assets that occurs with any resource after a prolonged price decline. That’s all bad enough when it comes to oil (and gas) as it makes it that much harder for companies to keep existing credit lines, let alone get new ones. It’s why at the end of a downturn you see fire sales of assets, well shut-ins, a collapse of capital spending and some bankruptcies sprinkled into the mix. That’s all normal; and that alone where the present energy downturn is concerned is probably enough—given the debt loads involved—to lead to enough casualties among energy companies that will spread to hedge funds, banks, and the broad financial markets.
But what makes this problem worse—in two respects—is that many of these companies, like Chesapeake, will now be writing off “assets” that were NOT previously proven. They were an assumption. Some say, a complete mirage. And at the end of the day, a probable basis for a myriad of after-the-fact lawsuits and criminal prosecutions such as we saw in the aftermath of the mortgage/real estate bust. And just like then, nobody at the Fed or the big banks that enabled and fostered all of this will be among the targets.
When all is said and done, we will have presently-unknowable (but I suspect considerable) damage to the broad markets, the banking system and more. We have not seen much of this so far for a few reasons. Chief among them is that a great many companies have not been selling their crude oil for $40 a barrel or thereabouts during 2015 but were able to hedge/sell forward their production (or a good chunk of it) at higher prices before the big collapse. For many companies, the new year will bring with it the end of those contracts; and the end of selling their production for, perhaps, $60-$70 per barrel. That will intensify the financial pressure, and likely mark 2016 as a year of “peak devastation” for energy companies and perhaps the credit markets.
No Real Surplus Energy
Beyond the evolving financial turmoil looms a bigger issue. Simply put, a lot of plans for the future have been made by energy companies, non-energy companies and our country as a whole based on the notion of this virtually endless, cheap shale-housed source of energy for decades to come. On my “Other Experts” page as well, I have been carrying a few well-documented and thoughtful commentaries by others as well on what some call an outright financial scam. However you look at it, America—not just the markets—is in for a very rude awakening as we return to the reality that we DON’T have surplus energy to export and that a creaky economy WON’T be getting added help any longer from such cheap energy as we have seen in the recent past thanks to the overproduction fostered by greedy companies and their financers.
But, Short-Term, Oversupply is an Issue
On the way to that point, though, the present “reality” continues to be punctuated by continuing oversupply and the battle to “maintain market share.” Like it or not, most producers have been dragged by Saudi Arabia into that old saw, “Yes, I’m losing money on my product. But I’ll make it up on volume.”
At its latest confab, O.P.E.C. pretty much ratified its recent 2 million barrel per day overproduction above its official target as a de facto new target. U.S. production in 2015 has declined only marginally, thanks to those hedges as well as to banks and others who until now have been willing to throw good money after bad, hope for the best and keep their zombie clients afloat until better days arrive. (That latter will be a lot harder to do in 2016 unless the bankers and other investors want to get in line for when the prosecutions commence.) Production aside from Saudi Arabia in the Middle East is slated to increase of all things, both from Iraq and Iran.
Appropriately, the International Energy Agency is warning that the supply/demand imbalance could get worse before it gets better going toward 2017. The irony here—and a lesson in what could have been if market forces were at work all along and not skewed by all that cheap credit—is that demand has continued to rise globally at a decent pace despite the global economic slowdown. 2015 will end with somewhere in the neighborhood of a 1.5 million barrel per day increase over 2014. That might slow to about 1 million barrels per day in 2016. What is not being used by industry has been more than made up for by brisk increases in gasoline demand, most notably in China and the U.S. But again—as with the mortgage crisis of several years ago—the present problem and the dominoes that will fall were caused by finance.
Coming: High Debt Spurs Reduced Production
In the end, the Saudis are likely to get their way and achieve their objectives; but every bit as much due to the inherent debt issues among America’s energy companies leading to a 2016 plunge in production in the U.S. One remaining question is what kind of devastation we will see outside of America’s shale oil (and gas) patch; such as a financial breakdown or major unrest in an oil exporter that doesn’t have the piggy bank it can blow as do the Saudis in this quest to destroy competitors. Time will tell.
Though there may be a respite if an especially dovish Fed causes big counter trend rallies in energy and energy stocks (and I may advocate trading into them, as I’ve already suggested) the worst of the damage is still ahead of us. There will be perhaps a few trades of various kinds on both sides of this story as we near the climax over the next year, give or take. And in addition to that, there will come a generational opportunity to load up on the survivors of this; those companies that will be part of a considerably trimmed stable that will bring us energy into the future.
Excerpted from the year-end Double Issue of The National Investor. Chris Temple, The National Investor, www.nationalinvestor.com, 847-986-6320, December 15, 2015
