Tag Archives: OPEC

Crude Oil Market Structure Looks Weak, But It Is Only One Part Of A Complicated Puzzle

Summary

  • Term structure – contango says too much oil around.
  • Brent-WTI says Iran will flood the market.
  • Crack spreads could crack the recent lows for crude.
  • OPEC meeting is the next big event – signals are that these guys cannot agree on anything.
  • Crude oil and a turbulent world.
 

The price of crude oil has not looked this bad since March, when it made lows of $42.03, or on August 24, when it fell to $37.75. On Friday, November 20, active month January NYMEX crude oil settled at $41.90 per barrel. The expiring December contract traded down to lows of $38.99 on the session. There are very few positive things to say about the future prospects for the price of crude oil at this time. The fundamental structural state of the oil market is bearish for price.

Term Structure – contango says too much oil around

Two weeks ago, the IEA told us that the world is awash in crude oil. The international agency told us that worldwide inventories have swelled to 3 billion barrels.

When crude oil was trading over $100 per barrel on the active month NYMEX futures contract during the summer of 2014, the market was in backwardation. Deferred futures prices were lower than nearby prices. This condition tells us that a market is tight, or there is a supply deficit. As the price of oil began to fall, term structure moved from backwardation to contango. This told us that the market moved from deficit to a condition of oversupply. This past week, the contango on the nearby versus one-year oil spread once again validated the glut condition in crude oil.

(click to enlarge)The December 2015 versus December 2016 NYMEX crude oil spread closed last week at over $8.00 per barrel. The contango has increased to 20.46%, the highest level yet for this spread. The January 2016 versus January 2017 NYMEX spread also made a new high and traded above the $7 level.

Brent crude oil futures have rolled from December to January. The January 2016 versus January 2017 Brent crude oil spread was trading around the $7.62 or 17% level last Friday. Market structure is telling us that huge inventories of crude oil will weigh on the price in the weeks ahead. At their current levels, a new low below the current support at $37.75 seems likely. Meanwhile, a location/quality spread in crude oil is also telling us that prospects for the oil price are currently bleak.

Brent-WTI says Iran will flood the market

The benchmark for pricing North American crude is the NYMEX West Texas Intermediate (WTI) price. When it comes to European, African and Middle Eastern crudes, Brent is the benchmark pricing mechanism. For many years, Brent crude traded at a small discount to WTI. That is because WTI is sweeter crude; it has lower sulfur content. This makes WTI more efficient when it comes to processing the oil into the most ubiquitously consumed oil product, gasoline.

That changed in 2010. The Arab Spring caused uncertainty in the Middle East to rise. As the majority of the world’s oil reserves are located in this region, the price of Brent crude rose relative to the price of WTI. Brent crude included a political premium. Additionally, increasing production from the United States, due to the extraction of oil from shale, exacerbated the price differential between the two crudes. In 2011, the price of Brent traded at over a $25 premium to the price of WTI. Recently, the spread between these two crudes has been converging. While the spread on January futures was trading at a premium of $2.40 for the Brent futures as of last Friday, it had moved much lower during the week.

The premium of Brent over WTI has evaporated over the course of 2015. The reason is two-fold. First, the number of operating oil rigs in the United States has fallen dramatically over the past year, indicating that production of the energy commodity will fall. Last Friday, Baker Hughes reported that the total number of oil rigs in operation as of November 20 stands at 564 down from 1,574 at this time last year. While lower U.S. production is one reason for a decline in the spread, increased production of Iranian crude oil has had a more powerful effect on the spread.

The nuclear nonproliferation agreement with Iran means that sanctions will ease and Iran will pump and export more crude oil in the weeks and months ahead. Iran has stated that their production will initially rise by 500,000 barrels per day and it will eventually rise to over one million. These two factors have caused the Brent-WTI spread to converge. The price trend in this spread is a negative for the price of crude at this time.

Crack spreads could crack the recent lows for crude

Recently, we have seen divergence emerging in crude oil processing spreads. Gasoline cracks have been outperforming crude oil, while heating oil crack spreads continue to trade at the weakest level in years.

Last Friday, the NYMEX gasoline crack spread closed at just over $14 per barrel.

The monthly chart of the gasoline crack highlights the recent strong action in this spread. Gasoline is a seasonal product; it tends to trade at the lows during this time of year. In 2014, the high in the gasoline crack at this time of year was $12.36. Therefore, compared to last year, gasoline prices are strong relative to the price of raw crude oil. This could be due to the current low level of gasoline futures – the December NYMEX gasoline futures contract closed last Friday at $1.2866 and the January futures closed at $1.2670 per gallon. The current low level of gasoline prices has increased demand from drivers as refineries work to process heating oil as the winter is only a few weeks ahead. In September U.S. drivers set a record for miles traveled by automobile.

The heating oil processing spread is a very different story. While the gasoline crack is relatively strong, the heating oil crack is very weak.

(click to enlarge)Last Friday, the January heating oil processing spread closed at around the $17.50 per barrel level. Last year at this time, the low in this spread was $22.73. In 2013, the low was $24.53 and in 2012, the low was $37.75 per barrel. The current level of the heating oil crack spread is seasonally the lowest since November 2010 when it traded down to $12.35 per barrel. In November 2010, crude oil was trading above $84 per barrel.

One of the many reasons that the crude oil price is weak these days is that demand for seasonal products, heating oil and diesel fuel, is low and inventories of distillates are high. As you can see, there are very few bullish signs in the fundamental structure for the crude oil market these days. In two weeks, the oil cartel will sit down to decide what to do now that the commodity they seek to “control” is awash in a sea of bearishness.

OPEC meeting is the next big event – Signals are that these guys cannot agree on anything

When OPEC met in November 2014, the price of crude was around the $75 per barrel level. When they met late last spring, the price had recovered to around $60. In both cases, the cartel left production levels unchanged. The stated production ceiling for the members of OPEC is 30 million barrels per day. The member nations are currently producing over 31.5 million barrels per day and increasing Iranian production means that OPEC output will likely rise. As the price of oil falls, the members need to sell more to try to recoup revenue. For the weaker members, the oil revenue is an imperative. Even the stronger members are under pressure. Saudi Arabia recently began selling bonds; they are borrowing money from the markets to replace lost income due to the lower crude oil price.

Meanwhile, OPEC’s current strategy is to continue to produce to flush high cost producers out of the market and build market share for the cartel members. However, OPEC did not count on a global economic slowdown, particularly in China. At the December 4 meeting of oil ministers in Vienna, it is likely that demand for crude oil will be an important consideration.

Dominant members of the cartel remain at odds. Saudi Arabia and Iran are on opposite sides and are involved in a proxy war in Yemen. The weaker members of OPEC want the stronger members to shoulder the burden of production cuts, and that is not likely to happen any time soon. In a hint of the discord between the member nations, on November 17, OPEC’s board of governors was unable to agree on the cartel’s long-term strategy plan and they tabled the issue until 2016. The issues revolve around ceiling output, setting production quotas and methods of maximizing member profits.

This tells us that unless the cartel is planning a giant spoof on the market, there is probably going to be no change in production policy. The current level of cheating or daily sales above the production ceiling may even increase. At this point, I doubt whether OPEC members could agree on whether it is sunny or cloudy outside given vast political, economic and cultural divergences among member nations. This means that selling will continue and even increase over the months ahead.

Crude oil and a turbulent world

All of the news, fundamentals and technicals for crude oil point to new lows and a challenge of the December 2008 lows of $32.48 per barrel. Last week, Goldman Sachs came out with a prediction that oil could fall to $20 per barrel. This is not such a bold call given the current state of the oil market, the strength of the dollar and the overall bear market for raw material prices. Last week, copper put in another multi-year low, iron ore fell to new lows and the Baltic Shipping Index fell to the lowest level since 1985.

However, all of the bad news for crude oil is currently in the price. We have seen this before. In March when crude oil traded to lows, there were calls for crude oil to fall – Dennis Gartman, the respected commodity analyst, went on CNBC and said that crude oil could fall to $10 per barrel as the energy commodity could go the way of “whale oil.” In late August, when oil fell to recent lows at $37.75, there were multiple calls for oil to fall to the low $30s and $20s. In both cases, powerful recovery rallies followed these bearish market calls. Following the March 2015 lows, oil rallied for over two months and gained 48.9%. In August of this year, a seven-week rally took oil 35% higher. The bearish prediction by Goldman Sachs last week could just turn out to be a contrarian’s dream.

There are a number of issues, big issues, going on in the world that can turn crude oil on a dime. First, Brent has fallen relative to WTI and the political premium for oil has evaporated. In 1990, when Saddam Hussein invaded Kuwait, the price of crude oil doubled in a matter of minutes. While the Middle East has always been a turbulent and dangerous part of the world, I would argue that today, it is far more turbulent and far more violent. The odds of attacks against oil fields and refineries in the Middle East have increased exponentially particularly given the recent ISIS attacks in France and around the world. At the same time, all of the bearish fundamental news about crude oil has decreased the political premium, and it is politics and war that could turn out to outweigh all of the current fundamentals.

Moreover, a surprise from outside of the Middle East could foster an increase in the price of oil. The world is now almost counting on Chinese economic weakness. Last week, Jamie Dimon, the Chairman of JPMorgan Chase, said that he is bullish on Chinese growth. If China does begin to show signs of growth, this could turn out to be supportive of crude oil and commodities in general, which remain mired in a bear market. Right now, the price of crude oil looks awful and fundamentals support a new low. However, all of that bearish data is in the price, and any surprise, in a world that always seems be full of surprises, could ignite the price once again. We saw this in March and again in August. As oil makes new lows, keep in mind that crude oil is a complicated puzzle. It is the unknown that will likely dictate the next big price move in oil. I am watching crude oil now and wondering whether Goldman Sachs called the turn in the market with their bearish forecast.

As a bonus, I have prepared a video on my website Commodix that provides a more in-depth and detailed analysis of the current state of the oil market to illustrate the real value implications and opportunities.

By Andrew Hecht in Seeking Alpha

Advertisements

Is Big Oil In Bed With The Saudis To Destroy The Fracking Industry?

Summary

  • Saudis want Big Oil to win – have predictable working relationship with them.
  • Big Oil is waiting on the sidelines until the price of properties drop.
  • Those with DUC wells and enough reserves will be able to survive the onslaught.
  • U.S. shale oil remains viable, but the players are going to change.

https://s16-us2.ixquick.com/cgi-bin/serveimage?url=http%3A%2F%2Fwww.cornucopia.org%2Fwp-content%2Fuploads%2F2015%2F08%2FUnlinedHotFrackingWaterPit-FacesofFracking.jpg&sp=5e83ddd577051c082e8bf0083737a243

As the strategy of Saudi Arabia becomes clearer, along with the response of shale producers to low oil prices, the question now has to be asked as to whether or not the big oil companies support the decision by Saudi Arabia to crush frackers until they have to offer their various plays at fire sale prices.

With the emergence of frackers came a significant number of new competitors in the market that didn’t have an interest in playing nice with OPEC and Saudi Arabia, as major oil companies have in the past. This was a real threat as other OPEC members and shale companies started to take share away from Saudi Arabia.

The general consensus is Saudi Arabia isn’t interested in crushing any particular competitor, rather it’ll keep production at high levels until the weakest producers capitulate. I have thought that as well until recently.

What changed my thinking was analyzing who was the biggest threat to OPEC and Saudi Arabia, and in fact it is the shale industry in the U.S. The reason I draw that conclusion is the energy industry had its traditional competitors in place for many years, and other than occasional moves to impact the price of oil using production levels as the weapon, it has been a relatively stable industry. Shale changed all that.

I think what bothered Saudi Arabia in particular was it didn’t have a working relationship with many of these new competitors, who have been very aggressive with expanding production capacity over the last few years. They were in fact real competitors who were working to take market share away from existing players. And with Saudi Arabia being the low-cost producer with the highest reserves in the world, it was without a doubt a direct assault on its authority and leverage it historically has had on the oil market. Its response to frackers is obvious: it isn’t willing to give up share for any reason.

Where the challenge for Saudi Arabia now is it has started to have to draw on its own reserves and issue bonds to make up for budget shortfalls. It has plenty of reserves, but it appears we now have a clear picture on when it would really come under pressure, which is within a four to five year period. That’s the time it has to devastate its shale competitors.

The other problem for the country is it could take down some members of OPEC in the process, where there are already significant problems they’re facing, which could lead to unrest.

From a pure oil perspective, it seems to be an easy read. Saudi Arabia can outlast the small shale producers with no problem. I think that’s its goal. But it is putting enormous pressure on other countries as well, and there will be increasing pressure for them to slow production in order to support oil prices.

This even extends to Russia, which produces more oil than any other country.

My belief is Saudi Arabia is attempting to force consolidation in the shale industry, so it can resume its dealings with big oil players it has worked with for many years. I believe it’s also what big oil players want. All they have to do is sit back and experience some temporary pain and wait for some of the attractive plays to come onto the market at low prices.

So far the price is still high in the U.S., but as time goes on, the smaller companies will be forced to sell, one way or another. That’s the big opportunity for investors. Identifying those companies with the resources and desire to acquire these properties is the key. That and evaluating the plays with the most potential for those buying them up.

At what price can Saudi crush shale oil?

There are analysts predicting oil price levels that are all over the board. I’ve seen those that believe it’s going to shoot up to over $100 per barrel again, and those that have estimated it could fall to as low as $15 per barrel.

The best way to analyze this is to consider what Saudi Arabia can handle over the longest period of time without destroying its own economy and industry, meaning at what price it can remain fairly healthy and outlast its competitors.

Looking at the price movement of oil and the range it’s now settled into, I think it’s close to what the Saudi have been looking for.

Most smaller shale producers will struggle to make it, if the price of oil remains under $60 per barrel, which it will probably do until Saudi Arabia cuts back on production. There will be occasional moves above that, and probably below $50 per barrel again as well, but I think we can now look to somewhere in the $50 per barrel area as the target being sought. We’ll probably see this be the price range oil will move in for the next couple of years, with $50 being the desired low and $60 being the desired high.

I don’t mean by this Saudi Arabia can absolutely control the price of oil, but it can influence the range it operates in, and I think that’s where we are now.

For that reason oil investors should be safe in investing under these assumptions, understanding there will be occasional price moves outside of that range because of usual trading momentum.

Response from shale oil companies

Some may question why the price of oil got slammed not too long ago, falling below $40 per barrel, if the probable price range for oil is about $10 to $20 per barrel higher.

As mentioned above, some of that was simply from trading momentum. It didn’t take long for it to rebound soon afterward.

The other element was the response by shale companies to the new price of oil, which threatened their ability to pay interest on loans that were due.

Frackers weren’t boosting production because they believed they could outlast Saudi Arabia; they kept production levels high because they had to continue to sell even into that low-price environment or default on their payments. This was a major factor in why prices dropped so far over the short term.

With the bulk of the over $5 trillion spent on shale exploration and development coming from companies operating in the U.S., that is also where the bulk of the risk is.

Much of the efficiencies have been wrung out of operations, and moving to higher producing wells that are less costly to operate can only last so long. I believe efficiencies will position some in the industry to survive the current competitive environment, but they will also have to have enough reserves to tap into in order to do so.

Top producing shale wells are at their highest level of productivity in the first 6 months it goes into operation. It gradually fades after that.

Larger players like EOG Resources (NYSE:EOG) have continued to drill, but they are stopping short of production, with approximately 320 DUC wells ready to bring online when the price of oil reaches desired levels. Its smaller competitors don’t have the resources to wait out existing production levels, which is what will again offer the opportunity for patient investors.

In other words, most of what can be done has been or is currently being done, and from now on it’s simply a waiting game to see how long the Saudis are willing to keep the oil flowing.

Most shale producers believed the lowest oil prices would sustainably fall and would be about $70 per barrel. Decisions were made based upon that assumption.

Big oil and Saudi Arabia

Saudi Arabia and big international energy companies have had close relationships a long time via Saudi Aramco, the state-owned firm.

Those relationships, while competitive, still operated within parameters most agreed upon. Shale producers weren’t playing that game, as they invested trillions and aggressively went after market share. If Saudi Arabia wanted to maintain market share, it had to respond.

If the smaller shale producers thought their strategy though, they must have underestimated the will of Saudi Arabia to fight back against them. Either that or they became overly optimistic and started to believe their own press about the shale revolution.

It’s a revolution for sure, but the majority of those that helped launch it won’t be finishing it.

My point is big oil, in my opinion, doesn’t mind quietly standing on the sidelines as their somewhat friendly competitors destroys their competition and prepares the way for them to acquire shale properties at extremely attractive prices.

I’ve said for some time the shale revolution will go on. The oil isn’t going anywhere. What is changing is who the players will end up being, and what properties they’ll end up acquiring.

With EOG, the strongest shale player, it said the prices of those plays now for sale are still too high; that means the smaller players still think they have some leverage.

My only thought is they are hoping for the large players to enter a bidding war and they can at least recoup some of their capital. I think they’re going to wait until they’re desperate and have no more options.

Sure, some big players may lose out on a desirable property or two, but everyone will get a piece of the action. It appears once the prices move down to levels they’re looking for, at that time they’ll swoop in and make their bids. At that time it’s going to be a buyer’s market.

Big oil companies are the preferable players Saudi Arabia wants to do business with and compete against. They will play the game with them, and there won’t be a lot of surprises.

Some of the companies to watch

Some of the larger companies that have already filed for bankruptcy this year include Hercules Offshore (NASDAQ:HERO), Sabine Oil & Gas (SOGC) and Quicksilver Resources (OTCPK:KWKAQ).

Companies known to have hired advisers for that purpose are Swift Energy (NYSE:SFY) and Energy XXI Ltd. (NASDAQ:EXXI).

Some under heavy pressure include Halcón Resources Corporation (NYSE:HK), SandRidge Energy, Inc. (NYSE:SD) and Rex Energy Corporation (NASDAQ:REXX).

There are more in each category, but I included only those that had at least a decent market cap, with the exception of those that already declared bankruptcy.

Here are a couple of other companies to look at going forward, which can be used for the purpose of analyzing ongoing low prices.

Stone Energy’s credit facility of $500 million is reaffirmed, but may not be liquid enough to endure the next couple of years, even though in the short term it does have decent liquidity. If Saudi Arabia keeps up the pressure, it’s doubtful it will be able to survive on its own. There are quite a few companies falling under these parameters, including Laredo (NYSE:LPI). The basic practice of all of them was to limit the amount of leverage they have in place in order not to have paying off interest as the priority use of their capital, while maintaining a strong credit facility.

I’m not saying these companies will survive, but they will survive if the price of oil stays low, but it will take a lot more to root them up than their highly leveraged peers.

Clayton Williams (NYSE:CWEI) recently put itself up for sale because it can’t afford to continue operating at these prices. It has approximately 340,000 acres under its control, and two of the most productive shale basins in the U.S.

Once it announced it was open to selling, the share price skyrocketed, but since it’s struggling to afford extracting the oil, it’s puzzling as to why some believe it’s going to attract a premium price. It’s possible because of the quality of assets, but it would make more sense for larger companies to wait.

This will be a good test on how big oil companies are going to respond. It’s possible they may be willing to pay for the higher quality shale plays, but under these conditions shareholders would resist paying a significant premium.

If Clayton Williams does go for a premium, it doesn’t in any way mean that’s how it’ll work out for most of the shale companies.

There would have to be a significant reason they would pay such a high price. In the case of CWEI, the catalyst would be high production.

Conclusion

All of this sounds neatly packaged, and if all things proceed as planned, this is how it will play out.

Where there could be some risk is if the Middle East explodes and oil production is interrupted. That would change this entire scenario, and if it were to happen soon, shale companies still in operation would not only survive, but thrive.

Barring that level of disruption, which would have to be something huge, this is how it will play out. After all, with everything going on there now, it hasn’t done anything to disrupt Middle East oil. It would take a big event or a series of events to bring it about. That’s definitely a possibility, but it’s one that is unlikely.

Once all of this plays out, there is no doubt in my mind the bigger oil companies will be much stronger and able to produce a lot more oil.

What we’ll probably see happen is for them to cut back on production to levels where everyone is happy, including the Saudi.

That’s what this war is all about, because shale oil deposits remain in the ground. While some companies can quickly resume production because of the nature of shale oil, which can ramp up production fast, it depends on the will and determination of Saudi Arabia and whether or not the geopolitical situation remains under control.

I don’t care too much about the number of rig counts in shale plays because production can be resumed or initiated quick. The risk is how leveraged the shale companies are, and whether or not they have to continue production at a loss in order to pay off their interest on loans in hopes the price of oil will rise.

What I’m looking for with existing plays is for companies like EOG Resources, which continues to develop wells, but does so without the idea of completing them and bringing them into production until the price of oil rebounds.

Shale oil in the U.S. is alive and well, but those companies overextended and few resources are going to be forced to sell at bargain prices. That will produce a lot of added value to the big oil companies waiting on the sidelines watching it all unfold.

Read more by Gary Bourgeault on Seeking Alpha

Is $50 “Hard Floor” Oil Price Already In?

Volte-Face Investments believes that it is …

https://martinhladyniuk.files.wordpress.com/2015/04/011bb-peak-oil-situation-31-jul-12.jpg?w=456&h=342

The Last Two Oil Crashes Show Peak Oil Is Real

Summary

  • Recent oil crashes show you the hard floor for gauging value oil company equities.
  • Properly understood, the crashes lend an insight into the concept of Peak Oil.
  • All oil equity investors should understand the overarching upward trend on display here.
 

Note: ALL prices used in this article are using current 2015 dollars, inflation adjusted using the
US BLS inflation calculator.

Generally, when I invest, I try to keep my thesis very simple. Find good companies, with good balance sheets and some kind of specific catalytic event on the horizon. But when one starts to concentrate their holdings in a sector, as I have recently in energy (see my recent articles on RMP Energy (OTCPK:OEXFF) and DeeThree Energy (OTCQX:DTHRF), you need to also get a good handle on the particular tail or headwinds that are affecting it. Sometimes a sector like oil (NYSEARCA:USO) can be subjected to such forces, like the recent oil price crash, where almost no company specific data mattered.

One of the biggest arguments, normally used by proponents of owning oil stocks as core holdings, in the energy sector is “Peak Oil.” For the unfamiliar, it is a theory forwarded first by M. King Hubbert in the 1950s regarding U.S. oil production. Essentially, the theory stated that the U.S. would reach a point where the oil reserves would become so depleted that it would be impossible to increase oil production further, or even maintain it at a given level, regardless of effort. This would inevitably lead to oil price rises of extreme magnitudes.

Since those early beginnings, the details have been argued over in an ever-evolving fashion. The argument has shifted with global events, technological developments, and grown to encompass nearly every basin in the world (even best-selling books have been written about peak oil like Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy by Matt Simmons about a decade ago) consuming endless bytes of the Internet in every kind of investment forum and medium of exchange.

In general, I believe that the term “peak oil” is a highly flawed one. Some picture peak oil in a Mad Max fashion, with oil supplies running out like a science fiction disaster movie. Others simply dismiss peak oil as having failed to predict these so-called peaks repeatedly (the world is producing a record amount of oil right now, so all previous absolute “Peak Oil” calls below these amounts are obviously wrong). But what people should be stating when they use these terms is a Peak Oil Price.

Using my own thinking and phrasing, I believe civilization has probably passed $25 Peak Oil. This means that if you set the oil price to $25 a barrel, there is no method available to humanity to provide enough oil to meet demand over any period of time that’s really relevant. I also believe we are in the middle of proving that we have also passed $50 Peak Oil. My final conjecture here is that we will prove in the near-term future to have reached $75 Peak Oil. I don’t believe we are quite at $100 Peak Oil.

Notice that in my formulation the term Peak Oil is always stated as a peak price. Oil is not consumed in a vacuum. The price affects the demand the world has for the product and simultaneously changes the ability of all sorts of entities (businesses and governments) to retrieve deposits of it. This is what I hope to prove in this article.

So what data could I bring to this crowded table?

Well we have one thing we now have that previous entrants into the Peak Oil melee didn’t, which is the recent price crash in oil. Peak oil is often falsely portrayed as a failed idea since it hasn’t resulted in a super squeeze to ultra high prices. These spike prices are viewed as the really critical element by energy investors since they are trying to find the best case. After all, who doesn’t want to own an oil producer if they can identify a spot in which oil prices will rise to some enormous number.

But that is the wrong way to go about it for your oil investments over the long haul. Because what $50 Peak Oil really provides is a floor. In a world where we have passed $25 Peak Oil, it should be impossible, without exogenous events of enormous magnitude (world war, etc.), to press the price of the product below that price. If you could do so, you would immediately disprove the thesis. You would then know the floor provided by whichever peak oil price level you selected was wrong. The same idea seems to hold true for $50 Peak Oil now.

To prove this “floor” we need to choose times of extreme stress in the oil markets, and look at those oil prices and see what the bottoms were. For these examples, let’s select WTI oil, whose weekly average prices are reported all the way back to 1986 by the EIA.

Let’s take the three big crashes in the oil markets. I will use a full year’s average to try to smooth out the various difficulties presented by weather, seasonal effects, or various one-off events (outages, etc.). The first crash I will use as a benchmark is The 1986 Oil Crash. The 1986 breakdown was a supply crash, caused by supply swamping demand. How big a disaster was it for the oil industry?

In 1986, the Saudis opened the spigot and sparked a four-month, 67 percent plunge that left oil just above $10 a barrel. The U.S. industry collapsed, triggering almost a quarter-century of production declines, and the Saudis regained their leading role in the world’s oil market.

This was quite a crash obviously. Triggering a 25 year decline? Not going to find a lot worse than this. So in inflation adjusted dollars what was WTI oil at for the year of 1986? It sold for around $32 a barrel. Now let’s note that at this time WTI crude was actually at a higher price vs. Brent and other world prices. On a Brent basis, crude would have been just around $25 for the year. This will prove to be an important point in a short while.

The next crash we will use to benchmark was the 2008 Financial Crisis. On this website, I should hope that this world crisis will need no introduction and little explanation. This crash in oil prices (and just about every other thing priced by human beings) was a demand crash. The financial disintegration across the world led to massive drops in demand, as jobs were lost across the world by the millions. So with this demand crash what was the average price of WTI crude in the year 2009? It sold in that year for a little over $60.

The last crash I will add is the current drop, starting sometime around October by my reckoning. I would find it hard to imagine any reader of this article is unfamiliar with the current situation in North America or the world regarding oil, at least in a headline sense. This seems to be a supply crash again, where North American-led tight oil drillers have caused an increase in production that the world’s demand couldn’t handle at the $100 price level. Since then, prices have dropped down to a level that suppresses the production of oil and enhances demand.

In the first four months of 2015, the North American oil rig count has already dropped by more than 50% as compared to last year and the demand for oil has begun to increase according to EIA statistics. The current price of WTI oil has been just over $49 as an average for the year 2015. However, let us note that WTI oil now sells for a large discount to world prices, and during the previous two crashes, WTI sold for a premium.

Now we have three data points. Each one is a fairly long period of time, not just a single week. We know that the world in 1986 nearly ended for the oil industry, yet in current dollars, WTI oil was unable to trade for a year below $30 a barrel. Then we had in 2008 and 2009 an economic crisis which was widely described as being the most dire financial disaster since WWII. In 2009, WTI oil still ended up trading well over the 1986 low. In fact it was nearly double that price. This shows just how hard it can be using almost any technique to push oil prices below a true peak number.

Now we have another supply led crunch. One that is widely described as the worst oil crash since 1986, a nearly 30 year time gap. We are attacking the oil price from the supply side instead of 2008’s demand side. Yet thus far, in 2015, oil is still trading more than 50% higher than the 1986 year average, inflation adjusted. In fact, WTI, when adjusted for its current discount to world prices, is trading close to its 2009 average price. Again, nearly double the price of the 1986 crash.

What does this all mean for investing? It means to me that $25 Peak Oil is behind us. You couldn’t really hit and maintain that number in the 1986 crash when many more virgin conventional reservoirs of oil were available. Despite the last three oil crises, not one of them could get WTI oil to $25 and keep it there. Now, using much more expensive oil resources (shale fracing, deep water drilling, arctic development, etc.), it doesn’t seem like the last two disasters have been able to press WTI oil much below $50 for a material length of time. In this recent crash, the $50 floor was able to be reached only with several years of hyper-investment made possible by the twin forces of sustained high prices and access to ultra-cheap capital. Both of these forces are no longer present in the oil markets.

Therefore, I think using a $50 Peak Oil number is a very reasonable hard floor to use when stress testing your oil stocks. It means that when I am choosing a stock that produces oil, it can survive both from supply and the demand led crashes using the worst the world can throw at it.

Some will say this reasoning is simplistic. One could claim any number of variables in the future (technology, peace in the Middle East, etc.) could change all the points I am relying on here. But we have thrown everything at the oil complex between 2008 and now; both from the supply side and the demand sides; breakdowns of the whole world economy, wars, sanctions, natural disasters, hugely stupid governmental policies, OPEC’s seeming fade to irrelevance, biofuels, periods of ultra-high prices, technological progress, electric cars, etc. Yet, here we stand with these numbers staring us in the face.

In conclusion, I feel these price points prove the reality of $50 Peak Oil (WTI). If WTI oil averages more than $50 in 2015 (which I strongly feel the data shows will happen), then it will confirm my thesis that no matter what happens in the world, human beings cannot seem to produce the amount of oil they require for less than that number. Therefore, one will know what the hard floor for petroleum is provided by the hugely complex interplay of geology, politics, economics, and technology by simply measuring those effects on one easy-to-measure point of data, namely price. This version of peak oil also means I have a minimum to test my selections on. I can buy companies that can at least deal with that floor, then make large profits as the prices rise from that hard floor. All oil fields deplete, and for the past twenty years, the solution has universally been to add more expensive technological solutions, exploit smaller or more physically difficult deposits, or use more expensive alternatives. The oil market does not have the same options available to it like it did 1986. Large, cheap conventional oil deposits are no longer available in sufficient supply, which is likely what the oil price is telling us by having higher Peak Floors during crashes. Without the magic of sustained ultra high prices, the investment levels that made this run at the $50 Peak Oil level will not exist going into the future. This means that the Peak Oil floor price should be creeping higher as a sector tailwind, giving a patient and selective investor a tremendous advantage for themselves.

Read more: Volte-Face Investments: The Last Two Oil Crashes Show Peak Oil Is Real

US Oil Rig Count Decline Quickened This Week

Idle rigs in Helmerich & Payne International Drilling Co.'s yard in Ector County, Texas. North Dakota has also been hit hard, forcing gains in technology.

Source: Rigzone

The fall in U.S. rigs drilling for oil quickened a bit this week, data showed on Friday, suggesting a recent slowdown in the decline in drilling was temporary, after slumping oil prices caused energy companies to idle half the country’s rigs since October.

Drillers idled 31 oil rigs this week, leaving 703 rigs active, after taking 26 and 42 rigs out of service in the previous two weeks, oil services firm Baker Hughes Inc said in its closely watched report.

With the oil rig decline this week, the number of active rigs has fallen for a record 20 weeks in a row to the lowest since 2010, according to Baker Hughes data going back to 1987.
Since the number of oil rigs peaked at 1,609 in October, energy producers have responded quickly to the steep 60 percent drop in oil prices since last summer by cutting spending, eliminating jobs and idling rigs.

After its precipitous drop since October, the U.S. oil rig count is nearing a pivotal level that experts say could dent production, bolster prices and even coax oil companies back to the well pad in the coming months.

https://jafrianews.files.wordpress.com/2015/04/shia-houthi-threatens-to-attack-saudi-arabia-it-air-strikes-continue.jpg?w=296&h=166

Pioneer Natural Resources Co, a top oil producer in the Permian Basin of West Texas, said this week it will start adding rigs in June as long as market conditions are favorable. U.S. crude futures this week climbed to over $58 a barrel, the highest level this year, as a Saudi-led coalition continued bombings in Yemen.

That was up 38 percent from a six-year low near $42 set in mid March on oversupply concerns and lackluster demand, in part on expectations the lower rig count will start reducing U.S. oil output.

After rising mostly steadily since 2009, U.S. oil production has stalled near 9.4 million barrels a day since early March, the highest level since the early 1970s, according to government data.

The Permian Basin in West Texas and eastern New Mexico, the nation’s biggest and fastest-growing shale oil basin, lost the most oil rigs, down 13 to 242, the lowest on record, according to data going back to 2011.

Texas was the state with the biggest rig decline, down 19 to 392, the least since 2009.
In Canada, active oil rigs fell by four to 16, the lowest since 2009. U.S. natural gas rigs, meanwhile, climbed by eight to 225, the same as two weeks ago.

Cheaper Foreign Oil Caps US Drilling Outlook

https://irancorner.files.wordpress.com/2012/05/spiegel-iran-oil-embargo1.jpg?w=625

By Chris Tomlinson | Houston Chronicle | MRT.com

The shale oil revolutionaries are retreating in disarray, and cheap foreign oil may banish them to the margins of the market.

As oil and natural gas move into a period of low prices, new data shows that North American drillers may not have the wherewithal to keep producing shale wells, which make up 90 percent of new drilling. In fact, if prices remain low for years to come, which is a real possibility, then investors may never see a return on the money spent to drill shale wells in the first place.

The full cost of producing oil and natural gas at a representative sample of U.S. companies, including capital spent to build the company and buy assets, is about $80 per barrel of oil equivalent, according to a study from the Bureau of Economic Geology’s Center for Energy Economics at the University of Texas.

The analysis of 2014 corporate financial data from 15 of the top publicly traded producers, which I got an exclusive look at before it’s published this week, determined that companies will have a hard time recovering the capital spent that year and maintaining production unless prices rise above $80 a barrel.

The price for West Texas Intermediate has spent most of the year below $50 a barrel.

Low prices, though, won’t mean that producers will shut in existing wells. Many of these same companies can keep pumping to keep cash coming into the company, and they can still collect a 10 percent return above the well’s operating costs at $50 a barrel of oil. They just won’t make enough money to invest in new wells or recover the capital already spent.

This harsh reality of what it will take to keep the shale revolution going shows how vulnerable it is to competition from cheap overseas oil.

“Everyone walks around thinking that they know how much this stuff costs because they see published information on what people spend to just drill wells,” explained Michelle Foss, who leads the Houston-based research center. “That is not what it takes for a company to build these businesses, to recover your capital and to make money.” The bureau was founded in 1909 and functions as the state geological agency.

Low oil prices will also exacerbate the economic impact of low natural gas prices. For years natural gas has kept flowing despite prices below $4 for a million British thermal units because about 50 percent of wells produced both gas and liquids, such as crude oil and condensate.

True natural gas costs

High oil prices have helped companies subsidize natural gas wells, but lower oil prices mean natural gas wells that don’t produce liquids will need to stand on their own economics.

The center’s analysis found that among the sample companies focused primarily on gas, prices will need to top $6 a million BTUs just to cover full costs and rise above $12 a million BTUs to recover the capital expended to develop the wells.

“We have important resources, but people have to be realistic about the challenges of developing them,” Foss told me. “There will have to be higher prices.”

Everyone predicts prices will rise again. The only questions are how quickly and to what price. Some experts predict WTI prices will reach $70 a barrel by the end of 2015, while others see $60. The soonest most expect to see $80 a barrel oil is in 2017. Saudi Arabian officials have said they believe the price has stabilized and don’t see oil returning to $100 a barrel for the next five years.

High prices and shale

https://i2.wp.com/www.arabamericannews.com/news/images/articles/2008_05/1049/u1_SAUDI.gif

The Saudi opinion is particularly important because that nation can produce oil cheaper than any other country and can produce more oil than any other country. As the informal leader of the Organization of the Petroleum Exporting Countries, Saudi Arabia kept the price of oil inside a band between $80 and $100 a barrel for years. Now, the Saudis appear ready to keep the price low.

That’s because high prices inspired the shale revolution, where American companies figured out how to economically drill horizontally into tight rocks and then hydraulically fracture them to release oil and natural gas. Since OPEC countries rely on high oil prices to finance their governments, everyone assumed OPEC would cut production and keep revenues high.

Arab leaders, though, were more concerned about holding on to market share and allowed prices to fall below levels that make most shale wells economic. Foss, who recently returned from meetings in the United Arab Emirates, said OPEC is unlikely to change course because developing countries are seeking alternatives to oil and reducing demand.

“The Saudis and their partners see pressures on oil use everywhere they look, and what they want is their production, in particular their share of the global supply pie, to be as competitive as it can be to ensure they’ve got revenue coming into the kingdom for future generations,” she said.

OPEC is afraid rich countries like the U.S. are losing their addiction to oil, and by lowering prices hope to keep us hooked. And OPEC has plenty of product.

“There’s 9 million barrels a day in current and potential production capacity in Iraq and Iran that is tied up by political conflicts, and if you sort that out enough, that’s a flood of cheap oil onto the market,” Foss said.

On the losing end

If prices remain low, the big losers will be the bond holders and shareholders of indebted, small and medium-size companies that drill primarily in North America. Since these companies are not getting high enough prices to pay off capital expenditures through higher share prices or interest payments , they are in serious trouble.

The inability of Denver-based Whiting Petroleum to sell itself is an example. The board of the North Dakota-focused company was forced to issue new shares, reducing the company’s value by 20 percent, and take on more expensive debt. Quicksilver Resources, based in Fort Worth, filed for Chapter 11 bankruptcy on March 17 because it couldn’t make the interest payments on its debt and no one was willing to invest more capital.

Until one of these companies is bought, we won’t know the true value of the shale producers at the current oil and natural gas prices.

But as more data reaches the market, there is a real danger that these companies are worth even less than investors fear, even though they may have high-quality assets.

Junk-Rated Oil & Gas Companies in a “Liquidity Death Spiral”

by Wolf Richter

https://ashwinikumar007.files.wordpress.com/2011/06/blackmoney.jpg?w=355&h=284

On the face of it, the oil price appears to be stabilizing. What a precarious balance it is, however.

Behind the facade of stability, the re-balancing triggered by the price collapse has yet to run its course, and it might be overly optimistic to expect it to proceed smoothly. Steep drops in the US rig count have been a key driver of the price rebound. Yet US supply so far shows precious little sign of slowing down. Quite to the contrary, it continues to defy expectations.

So said the International Energy Agency in its Oil Market Report on Friday. West Texas Intermediate plunged over 4% to $45 a barrel.

The boom in US oil production will continue “to defy expectations” and wreak havoc on the price of oil until the power behind the boom dries up: money borrowed from yield-chasing investors driven to near insanity by the Fed’s interest rate repression. But that money isn’t drying up yet – except at the margins.

Companies have raked in 14% more money from high-grade bond sales so far this year than over the same period in 2014, according to LCD. And in 2014 at this time, they were 27% ahead of the same period in 2013. You get the idea.

Even energy companies got to top off their money reservoirs. Among high-grade issuers over just the last few days were BP Capital, Valero Energy, Sempra Energy, Noble, and Helmerich & Payne. They’re all furiously bringing in liquidity before it gets more expensive.

In the junk-bond market, bond-fund managers are chasing yield with gusto. Last week alone, pro-forma junk bond issuance “ballooned to $16.48 billion, the largest weekly tally in two years,” the LCD HY Weekly reported. Year-to-date, $79.2 billion in junk bonds have been sold, 36% more than in the same period last year.

But despite this drunken investor enthusiasm, the bottom of the energy sector – junk-rated smaller companies – is falling out.

Standard & Poor’s rates 170 bond issuers that are engaged in oil and gas exploration & production, oil field services, and contract drilling. Of them, 81% are junk rated – many of them deep junk. The oil bust is now picking off the smaller junk-rated companies, one after the other, three of them so far in March.

On March 3, offshore oil-and-gas contractor CalDive that in 2013 still had 1,550 employees filed for bankruptcy. It’s focused on maintaining offshore production platforms. But some projects were suspended last year, and lenders shut off the spigot.

On March 8, Dune Energy filed for bankruptcy in Austin, TX, after its merger with Eos Petro collapsed. It listed $144 million in debt. Dune said that it received $10 million Debtor in Possession financing, on the condition that the company puts itself up for auction.

On March 9, BPZ Resources traipsed to the courthouse in Houston to file for bankruptcy, four days after I’d written about its travails; it had skipped a $60 million payment to its bondholders [read… “Default Monday”: Oil & Gas Companies Face Their Creditors].

And more companies are “in the pipeline to be restructured,” LCD reported. They all face the same issues: low oil and gas prices, newly skittish bond investors, and banks that have their eyes riveted on the revolving lines of credit with which these companies fund their capital expenditures. Being forever cash-flow negative, these companies periodically issue bonds and use the proceeds to pay down their revolver when it approaches the limit. In many cases, the bank uses the value of the company’s oil and gas reserves to determine that limit.

If the prices of oil and gas are high, those reserves have a high value. It those prices plunge, the borrowing base for their revolving lines of credit plunges. S&P Capital IQ explained it this way in its report, “Waiting for the Spring… Will it Recoil”:

Typically, banks do their credit facility redeterminations in April and November with one random redetermination if needed. With oil prices plummeting, we expect banks to lower their price decks, which will then lead to lower reserves and thus, reduced borrowing-base availability.

April is coming up soon. These companies would then have to issue bonds to pay down their credit lines. But with bond fund managers losing their appetite for junk-rated oil & gas bonds, and with shares nearly worthless, these companies are blocked from the capital markets and can neither pay back the banks nor fund their cash-flow negative operations. For many companies, according to S&P Capital IQ, these redeterminations of their credit facilities could lead to a “liquidity death spiral.”

Alan Holtz, Managing Director in AlixPartners’ Turnaround and Restructuring group told LCD in an interview:

We are already starting to see companies that on the one hand are trying to work out their operational problems and are looking for financing or a way out through the capital markets, while on the other hand are preparing for the events of contingency planning or bankruptcy.

Look at BPZ Resources. It wasn’t able to raise more money and ended up filing for bankruptcy. “I think that is going to be a pattern for many other companies out there as well,” Holtz said.

When it trickled out on Tuesday that Hercules Offshore, which I last wrote about on March 3, had retained Lazard to explore options for its capital structure, its bonds plunged as low as 28 cents on the dollar. By Friday, its stock closed at $0.41 a share.

When Midstates Petroleum announced that it had hired an interim CEO and put a restructuring specialist on its board of directors, its bonds got knocked down, and its shares plummeted 33% during the week, closing at $0.77 a share on Friday.

When news emerged that Walter Energy hired legal counsel Paul Weiss to explore restructuring options, its first-lien notes – whose investors thought they’d see a reasonable recovery in case of bankruptcy – dropped to 64.5 cents on the dollar by Thursday. Its stock plunged 63% during the week to close at $0.33 a share on Friday.

Numerous other oil and gas companies are heading down that path as the oil bust is working its way from smaller more vulnerable companies to larger ones. In the process, stockholders get wiped out. Bondholders get to fight with other creditors over the scraps. But restructuring firms are licking their chops, after a Fed-induced dry spell that had lasted for years.

Investors Crushed as US Natural Gas Drillers Blow Up

by Wolf Richter

The Fed speaks, the dollar crashes. The dollar was ripe. The entire world had been bullish on it. Down nearly 3% against the euro, before recovering some. The biggest drop since March 2009. Everything else jumped. Stocks, Treasuries, gold, even oil.

West Texas Intermediate had been experiencing its biggest weekly plunge since January, trading at just above $42 a barrel, a new low in the current oil bust. When the Fed released its magic words, WTI soared to $45.34 a barrel before re-sagging some. Even natural gas rose 1.8%. Energy related bonds had been drowning in red ink; they too rose when oil roared higher. It was one heck of a party.

But it was too late for some players mired in the oil and gas bust where the series of Chapter 11 bankruptcy filings continues. Next in line was Quicksilver Resources.

It had focused on producing natural gas. Natural gas was where the fracking boom got started. Fracking has a special characteristic. After a well is fracked, it produces a terrific surge of hydrocarbons during first few months, and particularly on the first day. Many drillers used the first-day production numbers, which some of them enhanced in various ways, in their investor materials. Investors drooled and threw more money at these companies that then drilled this money into the ground.

But the impressive initial production soon declines sharply. Two years later, only a fraction is coming out of the ground. So these companies had to drill more just to cover up the decline rates, and in order to drill more, they needed to borrow more money, and it triggered a junk-rated energy boom on Wall Street.

At the time, the price of natural gas was soaring. It hit $13 per million Btu at the Henry Hub in June 2008. About 1,600 rigs were drilling for gas. It was the game in town. And Wall Street firms were greasing it with other people’s money. Production soared. And the US became the largest gas producer in the world.

https://martinhladyniuk.files.wordpress.com/2015/03/be197-deathspiral2.jpg?w=287&h=191

But then the price began to plunge. It recovered a little after the Financial Crisis but re-plunged during the gas “glut.” By April 2012, natural gas had crashed 85% from June 2008, to $1.92/mmBtu. With the exception of a few short periods, it has remained below $4/mmBtu – trading at $2.91/mmBtu today.

Throughout, gas drillers had to go back to Wall Street to borrow more money to feed the fracking orgy. They were cash-flow negative. They lost money on wells that produced mostly dry gas. Yet they kept up the charade. They aced investor presentations with fancy charts. They raved about new technologies that were performing miracles and bringing down costs. The theme was that they would make their investors rich at these gas prices.

The saving grace was that oil and natural-gas liquids, which were selling for much higher prices, also occur in many shale plays along with dry gas. So drillers began to emphasize that they were drilling for liquids, not dry gas, and they tried to switch production to liquids-rich plays. In that vein, Quicksilver ventured into the oil-rich Permian Basin in Texas. But it was too little, too late for the amount of borrowed money it had already burned through over the years by fracking for gas below cost.

During the terrible years of 2011 and 2012, drillers began reclassifying gas rigs as rigs drilling for oil. It was a judgement call, since most wells produce both. The gas rig count plummeted further, and the oil rig count skyrocketed by about the same amount. But gas production has continued to rise since, even as the gas rig count has continued to drop. On Friday, the rig count was down to 257 gas rigs, the lowest since March 1993, down 84% from its peak in 2008.

US-rig-count_1988_2015-03-13=gas

Quicksilver’s bankruptcy is a consequence of this fracking environment. It listed $2.35 billion in debts. That’s what is left from its borrowing binge that covered its negative cash flows. It listed only $1.21 billion in assets. The rest has gone up in smoke.

Its shares are worthless. Stockholders got wiped out. Creditors get to fight over the scraps.

Its leveraged loan was holding up better: the $625 million covenant-lite second-lien term loan traded at 56 cents on the dollar this morning, according to S&P Capital IQ LCD. But its junk bonds have gotten eviscerated over time. Its 9.125% senior notes due 2019 traded at 17.6 cents on the dollar; its 7.125% subordinated notes due 2016 traded at around 2 cents on the dollar.

Among its creditors, according to the Star Telegram: the Wilmington Trust National Association ($361.6 million), Delaware Trust Co. ($332.6 million), US Bank National Association ($312.7 million), and several pipeline companies, including Oasis Pipeline and Energy Transfer Fuel.

Last year, it hired restructuring advisers. On February 17, it announced that it would not make a $13.6 million interest payment on its senior notes and invoked the possibility of filing for Chapter 11. It said it would use its 30-day grace period to haggle with its creditors over the “company’s options.”

Now, those 30 days are up. But there were no other “viable options,” the company said in the statement. Its Canadian subsidiary was not included in the bankruptcy filing; it reached a forbearance agreement with its first lien secured lenders and has some breathing room until June 16.

Quicksilver isn’t alone in its travails. Samson Resources and other natural gas drillers are stuck neck-deep in the same frack mud.

A group of private equity firms, led by KKR, had acquired Samson in 2011 for $7.2 billion. Since then, Samson has lost $3 billion. It too hired restructuring advisers to deal with its $3.75 billion in debt. On March 2, Moody’s downgraded Samson to Caa3, pointing at “chronically low natural gas prices,” “suddenly weaker crude oil prices,” the “stressed liquidity position,” and delays in asset sales. It invoked the possibility of “a debt restructuring” and “a high risk of default.”

But maybe not just yet. The New York Post reported today that, according to sources, a JPMorgan-led group, which holds a $1 billion revolving line of credit, is granting Samson a waiver for an expected covenant breach. This would avert default for the moment. Under the deal, the group will reduce the size of the revolver. Last year, the same JPMorgan-led group already reduced the credit line from $1.8 billion to $1 billion and waived a covenant breach.

By curtailing access to funding, they’re driving Samson deeper into what S&P Capital IQ called the “liquidity death spiral.” According to the New York Post’s sources, in August the company has to make an interest payment to its more junior creditors, “and may run out of money later this year.”

Industry soothsayers claimed vociferously over the years that natural gas drillers can make money at these prices due to new technologies and efficiencies. They said this to attract more money. But Quicksilver along with Samson Resources and others are proof that these drillers had been drilling below the cost of production for years. And they’d been bleeding every step along the way. A business model that lasts only as long as new investors are willing to bail out old investors.

But it was the crash in the price of “liquids” that made investors finally squeamish, and they began to look beyond the hype. In doing so, they’re triggering the very bloodletting amongst each other that ever more new money had delayed for years. Only now, it’s a lot more expensive for them than it would have been three years ago. While the companies will get through it in restructured form, investors get crushed.


This Chart Shows the True Collapse of Fracking in the US

by Wolf Richter
https://feww.files.wordpress.com/2009/08/rex-wtillerson-exxon.jpg?w=264&h=210

Rex Tillerson, Exxon Mobile CEO

“People need to kinda settle in for a while.” That’s what Exxon Mobil CEO Rex Tillerson said about the low price of oil at the company’s investor conference. “I see a lot of supply out there.”

So Exxon is going to do its darnedest to add to this supply: 16 new production projects will start pumping oil and gas through 2017. Production will rise from 4 million barrels per day to 4.3 million. But it will spend less money to get there, largely because suppliers have had to cut their prices.

That’s the global oil story. In the US, a similar scenario is playing out. Drillers are laying some people off, not massive numbers yet. Like Exxon, they’re shoving big price cuts down the throats of their suppliers. They’re cutting back on drilling by idling the least efficient rigs in the least productive plays – and they’re not kidding about that.

In the latest week, they idled a 64 rigs drilling for oil, according to Baker Hughes, which publishes the data every Friday. Only 922 rigs were still active, down 42.7% from October, when they’d peaked. Within 21 weeks, they’ve taken out 687 rigs, the most terrific, vertigo-inducing oil-rig nose dive in the data series, and possibly in history:

US-rig-count_1988_2015-03-06=oilAs Exxon and other drillers are overeager to explain: just because we’re cutting capex, and just because the rig count plunges, doesn’t mean our production is going down. And it may not for a long time. Drillers, loaded up with debt, must have the cash flow from production to survive.

But with demand languishing, US crude oil inventories are building up further. Excluding the Strategic Petroleum Reserve, crude oil stocks rose by another 10.3 million barrels to 444.4 million barrels as of March 4, the highest level in the data series going back to 1982, according to the Energy Information Administration. Crude oil stocks were 22% (80.6 million barrels) higher than at the same time last year.

“When you have that much storage out there, it takes a long time to work that off,” said BP CEO Bob Dudley, possibly with one eye on this chart:

US-crude-oil-stocks-2015-03-04So now there is a lot of discussion when exactly storage facilities will be full, or nearly full, or full in some regions. In theory, once overproduction hits used-up storage capacity, the price of oil will plummet to whatever level short sellers envision in their wildest dreams. Because: what are you going to do with all this oil coming out of the ground with no place to go?

A couple of days ago, the EIA estimated that crude oil stock levels nationwide on February 20 (when they were a lot lower than today) used up 60% of the “working storage capacity,” up from 48% last year at that time. It varied by region:

Capacity is about 67% full in Cushing, Oklahoma (the delivery point for West Texas Intermediate futures contracts), compared with 50% at this point last year. Working capacity in Cushing alone is about 71 million barrels, or … about 14% of the national total.

As of September 2014, storage capacity in the US was 521 million barrels. So if weekly increases amount to an average of 6 million barrels, it would take about 13 weeks to fill the 77 million barrels of remaining capacity. Then all kinds of operational issues would arise. Along with a dizzying plunge in price.

In early 2012, when natural gas hit a decade low of $1.92 per million Btu, they predicted the same: storage would be full, and excess production would have to be flared, that is burned, because there would be no takers, and what else are you going to do with it? So its price would drop to zero.

They actually proffered that, and the media picked it up, and regular folks began shorting natural gas like crazy and got burned themselves, because it didn’t take long for the price to jump 50% and then 100%.

Oil is a different animal. The driving season will start soon. American SUVs and pickups are designed to burn fuel in prodigious quantities. People will be eager to drive them a little more, now that gas is cheaper, and they’ll get busy shortly and fix that inventory problem, at least for this year. But if production continues to rise at this rate, all bets are off for next year.

Natural gas, though it refused to go to zero, nevertheless got re-crushed, and the price remains below the cost of production at most wells. Drilling activity has dwindled. Drillers idled 12 gas rigs in the latest week. Now only 268 rigs are drilling for gas, the lowest since April 1993, and down 83.4% from its peak in 2008! This is what the natural gas fracking boom-and-bust cycle looks like:

US-rig-count_1988_2015-03-06=gasYet production has continued to rise. Over the last 12 months, it soared about 9%, which is why the price got re-crushed.

Producing gas at a loss year after year has consequences. For the longest time, drillers were able to paper over their losses on natural gas wells with a variety of means and go back to the big trough and feed on more money that investors were throwing at them, because money is what fracking drills into the ground.

But that trough is no longer being refilled for some companies. And they’re running out. “Restructuring” and “bankruptcy” are suddenly the operative terms.


“Default Monday”: Oil & Gas Face Their Creditors

by Wolf Richter

https://i2.wp.com/www.macleans.ca/wp-content/uploads/2013/02/MAC04_OILSANDS01-wide.jpg

Debt funded the fracking boom. Now oil and gas prices have collapsed, and so has the ability to service that debt. The oil bust of the 1980s took down 700 banks, including 9 of the 10 largest in Texas. But this time, it’s different. This time, bondholders are on the hook.

And these bonds – they’re called “junk bonds” for a reason – are already cracking. Busts start with small companies and proceed to larger ones. “Bankruptcy” and “restructuring” are the terms that wipe out stockholders and leave bondholders and other creditors to tussle over the scraps.

https://martinhladyniuk.files.wordpress.com/2015/03/27560-bankruptcy.jpg?w=171&h=136

Early January, WBH Energy, a fracking outfit in Texas, kicked off the series by filing for bankruptcy protection. It listed assets and liabilities of $10 million to $50 million. Small fry.

A week later, GASFRAC filed for bankruptcy in Alberta, where it’s based, and in Texas – under Chapter 15 for cross-border bankruptcies. Not long ago, it was a highly touted IPO, whose “waterless fracking” technology would change a parched world. Instead of water, the system pumps liquid propane gel (similar to Napalm) into the ground; much of it can be recaptured, in theory.

Ironically, it went bankrupt for other reasons: operating losses, “reduced industry activity,” the inability to find a buyer that would have paid enough to bail out its creditors, and “limited access to capital markets.” The endless source of money without which fracking doesn’t work had dried up.

https://i1.wp.com/fm.cnbc.com/applications/cnbc.com/resources/img/editorial/2013/09/03/101003666-89cb3e34560372ba5382f629569eaecb4db09256.530x298.jpg

On February 17, Quicksilver Resources announced that it would not make a $13.6 million interest payment on its senior notes due in 2019. It invoked the possibility of filing for Chapter 11 bankruptcy to “restructure its capital structure.” Stockholders don’t have much to lose; the stock is already worthless. The question is what the creditors will get.

It has hired Houlihan Lokey Capital, Deloitte Transactions and Business Analytics, “and other advisors.” During its 30-day grace period before this turns into an outright default, it will haggle with its creditors over the “company’s options.”

On February 27, Hercules Offshore had its share-price target slashed to zero, from $4 a share, at Deutsche Bank, which finally downgraded the stock to “sell.” If you wait till Deutsche Bank tells you to sell, you’re ruined!

When I wrote about Hercules on October 15, HERO was trading at $1.47 a share, down 81% since July. Those who followed the hype to “buy the most hated stocks” that day lost another 44% by the time I wrote about it on January 16, when HERO was at $0.82 a share. Wednesday, shares closed at $0.60.

Deutsche Bank was right, if late. HERO is headed for zero (what a trip to have a stock symbol that rhymes with zero). It’s going to restructure its junk debt. Stockholders will end up holding the bag.

https://i0.wp.com/bloximages.newyork1.vip.townnews.com/tulsaworld.com/content/tncms/assets/v3/editorial/f/d8/fd890ea6-d8e7-59fc-b849-cf74b6c4a4cd/527b48bba3b05.preview-300.jpg

On Monday, due to “chronically low natural gas prices exacerbated by suddenly weaker crude oil prices,” Moody’s downgraded gas-driller Samson Resources, to Caa3, invoking “a high risk of default.”

It was the second time in three months that Moody’s downgraded the company. The tempo is picking up. Moody’s:

The company’s stressed liquidity position, delays in reaching agreements on potential asset sales and its retention of restructuring advisors increases the possibility that the company may pursue a debt restructuring that Moody’s would view as a default.

Moody’s was late to the party. On February 26, it was leaked that Samson had hired restructuring advisers Kirkland & Ellis and Blackstone’s restructuring group to figure out how to deal with its $3.75 billion in debt. A group of private equity firms, led by KKR, had acquired Samson in 2011 for $7.2 billion. Since then, Samson has lost $3 billion. KKR has written down its equity investment to 5 cents on the dollar.

This is no longer small fry.

https://i1.wp.com/www.yourindustrynews.com/upload_images/BPZ_Energy.jpg

Also on Monday, oil-and-gas exploration and production company BPZ Resources announced that it would not pay $62 million in principal and interest on convertible notes that were due on March 1. It will use its grace period of 10 days on the principal and of 30 days on the interest to figure out how to approach the rest of its existence. It invoked Chapter 11 bankruptcy as one of the options.

If it fails to make the payments within the grace period, it would also automatically be in default of its 2017 convertible bonds, which would push the default to $229 million.

BPZ tried to refinance the 2015 convertible notes in October and get some extra cash. Fracking devours prodigious amounts of cash. But there’d been no takers for the $150 million offering. Even bond fund managers, driven to sheer madness by the Fed’s policies, had lost their appetite. And its stock is worthless.

https://i0.wp.com/b.vimeocdn.com/ts/433/407/433407397_640.jpg

Also on Monday – it was “default Monday” or something – American Eagle Energy announced that it would not make a $9.8 million interest payment on $175 million in bonds due that day. It will use its 30-day grace period to hash out its future with its creditors. And it hired two additional advisory firms.

One thing we know already: after years in the desert, restructuring advisers are licking their chops.

The company has $13.6 million in negative working capital, only $25.9 million in cash, and its $60 million revolving credit line has been maxed out.

But here is the thing: the company sold these bonds last August! And this was supposed to be its first interest payment.

That’s what a real credit bubble looks like. In the Fed’s environment of near-zero yield on reasonable investments, bond fund managers are roving the land chasing whatever yield they can discern. And they’re holding their nose while they pick up this stuff to jam it into bond funds that other folks have in their retirement portfolio.

Not even a single interest payment!

Borrowed money fueled the fracking boom. The old money has been drilled into the ground. The new money is starting to dry up. Fracked wells, due to their horrendous decline rates, produce most of their oil and gas over the first two years. And if prices are low during that time, producers will never recuperate their investment in those wells, even if prices shoot up afterwards. And they’ll never be able to pay off the debt from the cash flow of those wells. A chilling scenario that creditors were blind to before, but are now increasingly forced to contemplate.