Small Oil

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.

10 thoughts on “Small Oil

  1. I was oil field trash until I got out on my own after college. All my relatives were oil field workers. I know from experience that it has always been a cyclical business. Boom and bust, forever.

    I’m still oil field trash, of course. It ain’t gonna be washed out, and besides, I’m kinda proud of it.

  2. Which is why I have no time to be re-re-explained to about solar/hydro/bio/geo/wind “energy” hobbies until there are 12 new Nuke plants actually on line, and Yucca Mountain holds their open house.
    And yes, I DO have the old coal burning furnace in place, (not worth removing for the oil/steam system that NOW heats water during heating season) as a matter of fact. 6′ of duct work and it’s good to go.

  3. The Fed stepped in to prop up the asset markets, but there’s not much they can do about wholesale prices. That’s where energy costs show up. But, that just gives them an excuse to keep the money spigot open.

    As far as the Saudis, they probably accept the fact it will take years to get everyone back in-line as far as production. They can live with $30 oil more than they can live with a nuclear Iran. Plus, they are looking to diversify into natural gas. They want that Qatar-Turkey pipeline to run through the Arabian peninsula. That gives them a big chunk of the European market. it also make Europe the guarantor of the regime’s health.

    The great game is afoot. WW3 comes if Israel decides they have to strike Iran. The only reason they would strike Iran is if the Russians give them the bomb. The Russians are now at war on two fronts, banking and energy. Everyone is betting they blink before it gets too hot.

  4. Could this be the beginning of the dreaded “deflation” of all commodity prices? Perhaps an overdue correction of the ratio between long stagnate wages and ever rising prices?

    I live in Delaware, Z-man, please, please don’t give Joe Biden any bright ideas. Many here wish he would run away, take his crooked sons with him, and never come back.

  5. This has all happened before. OPEC fixes, literally, high prices, producers explore and drill, the Saudis–the largest and cheapest cost producer–flood the market (in this case they need only to not cut back) to collapse the new producers. The effect will not be so lasting and widespread this time because the world, especially going forward, needs far more oil than OPEC can deal with.

    Those investors who need $70 to break even deserve to be separated from their money. That goes for government owned producers, and most of them which are not in America are government owned.

  6. A question I have is- is there a way we can tell the Saudis to go pound sand? I realize that oil is a global market and all but… I hate the idea of those guys being rich. If the North Americans were to develop all our resource could we cut the sheiks out?

  7. No one can really pinpoint an explanation for why oil fell so much, but the factors that were in place to make oil go up so much are still in place so this decline in price will likely be temporary. Unless it stays at $50-60 for years at a time, it is hard to assess the economic effects.

  8. The GDP boost is probably not as big as hoped, but there’s a reason every post-WW2 recession has been preceded by a spike in energy costs. Of course, an interesting side effect will be a boost to the candidacy of Joe Biden. A suddenly booming economy in 2015 means Biden gets a bump from the suddenly popular Obama.

  9. Yes there are losses to be suffered by the low cost oil situation but there are great multiplier gains to be reaped. Every dollar not spent by consumers for “oil” is freed up to rove elsewhere. Increased travel, additional purchases of hard goods, etc., yield benefits to those outside the energy complex. Capitalism has its risks for those in the energy business as well as those without. I love the dance.

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