Over at National Review, where I occasionally post in the comment sections, I’ve taken some flak for pointing out that falling oil prices are not due to market forces and they are not necessarily a good thing. The people who post there tend to be running dog Republicans, worshipping at the alter of capitalism. They think suddenly cheap oil is vindication of their “drill baby, drill” chants from a decade ago. This post from the Beeb explains one of the down-side effects of an oil glut.
Oil companies and service providers are cutting staff and investment to save money.
Robin Allan, chairman of the independent explorers’ association Brindex, told the BBC that the industry was “close to collapse”.
Almost no new projects in the North Sea are profitable with oil below $60 a barrel, he claims.
“It’s almost impossible to make money at these oil prices”, Mr Allan, who is a director of Premier Oil in addition to chairing Brindex, told the BBC. “It’s a huge crisis.”
“This has happened before, and the industry adapts, but the adaptation is one of slashing people, slashing projects and reducing costs wherever possible, and that’s painful for our staff, painful for companies and painful for the country.
“It’s close to collapse. In terms of new investments – there will be none, everyone is retreating, people are being laid off at most companies this week and in the coming weeks. Budgets for 2015 are being cut by everyone.”
The thing that people don’t understand about the business of digging stuff up and selling it is there are costs. It cost money to set-up an oil well – lots of money. If you can get a million barrels from a well and the cost of extraction is fifty million dollars over the life of the well, you need to sell that oil for $50 a barrel to break even. If you started your project assuming $100 prices and now the prices are $40, your business collapses and the well closes.
Almost all of the new oil sources coming on-line were planned and executed in a world of $60-$70 oil. That was the assumption of the investors. That’s an important piece of the puzzle that no one considers. Every BTU of energy is backed by a debt instrument these days. In fact, those debt instruments are backed by debt instruments.
The debt pyramid in the energy business probably looks like every other asset market. That means bankruptcies in the energy markets ripple through the financial world in the same way that foreclosures in Nevada brought down the housing market.
There’s that and there is the fact the oil glut is about things other than supply and demand. Demand is slightly down of late as the world economy has slowed. That has driven up relative supply. There’s also more supply due to speculators jumping into a hot market the last decade. But, there’s also the financial war with Russia lead by the US and Saudi Arabia.
The Saudis, of course, see this as manna from heaven. They can knock out the Russians who have been a source of mischief to them in the Middle East. A collapsing Russia would take Syria and Iran down, plus open the door for the Saudi pipeline projects.
An oil glut also knocks out North American producers who suddenly face margin calls. No one pumps at a loss so the high cost producers will have to shut down. An extended price slump means they go bankrupt. It also means credit flees the market, making even profitable operations less profitable. The Saudis can weather even $30 oil so this is good for them in the long run.
Cheap energy is always a good thing, but it is not without trade-offs. It’s why our next currency arrangement will probably be pegged to energy. If everything is priced in joules, price stability in the energy markets becomes the default state. Until then, energy is a tool of war and even cheap gas has negative consequences.