The Declining Price of Oil

by lizard

I had a request in the comments to write about oil, specifically the new world emerging from the new reality that we will supposedly never see $100 dollar barrels of oil ever again. At least that’s what the Saudis are saying:

Speaking to his favorite money-honey, billionaire Saudi Prince Alwaleed bin Talal told Maria Bartiromo that the negative impact of a 50% decline in oil has been wide and deep. As USA Today reports, the prince of the Saudi royal family said that while he disagrees with the government on most aspects, he agreed with their decision on keeping production where it is, adding that “if supply stays where it is, and demand remains weak, you better believe it is gonna go down more. I’m sure we’re never going to see $100 anymore… oil above $100 is artificial. It’s not correct.” On the theory that the US and the Saudis have agreed to keep prices low to pressure Russia, the prince exclaimed, that is “baloney and rubbish,” adding that, “Saudi Arabia and Russia are in bed together here… both being hurt simultaneously.

In Montana, the inevitable next step of boom/bust is knocking on the door. Will our legislators acknowledge the new reality? Ochenski points a cautionary finger at Sweetwater, Texas, in his column on Monday:

One of the major issues being considered by the newly seated Montana Legislature is spending millions of public tax dollars on new infrastructure to meet the demands of the oil and gas boom in the Bakken formation. But as Sweetwater, Texas, just found out, not all the big promises of oil and gas booms come true.

As noted in an Associated Press article titled “City that prepared for oil boom now waits for bust,” Sweetwater, Texas, “envisioned becoming a major player in the hydraulic-fracturing boom, thanks to its location atop the Cline Shale, once estimated to be the nation’s largest underground petroleum formation.” Thus, “expecting a huge influx of oil workers, local leaders spent tens of millions of dollars to improve the courthouse, build a new law-enforcement center and upgrade the hospital. Hotels, truck stops and housing subdivisions were to follow, all catering to truck drivers and roughnecks.”

If that sounds familiar, it’s not by coincidence. That’s the scenario now being faced as “man camps” spring up on the Northern Plains, bringing all the attendant problems caused by a flood of in-migrants seeking high-paying oilfield jobs.

But as noted in the AP article, “those ambitions are fading fast as the plummeting price of oil causes investors to pull back, cutting off the projects that were supposed to pay for a bright new future. Now the town of 11,000 awaits layoffs and budget cuts and defers its dreams.”

Spending a bunch of money on infrastructure amid the collapse of oil prices is increasingly appearing short-sighted and idiotic. Same goes for pushing through the Keystone XL pipeline. Oh, and then there’s derivatives. Ochenski points that out as well:

Second, there is an enormous sum of money currently held in oil derivatives by Wall Street’s largest banks and investment firms. As precious metals expert David Morgan explained in an article in Market Analysis last week, “the amount of debt that is carried by the fracking industry at large is about double what the sub-prime was in the real estate fiasco in 2008. In summary, we’re looking at an explosion in potential that is greater than the sub-prime market of 2008 because, number one, oil and energy are the most important sectors out there. Number two, the derivative exposure is at least double what it was in 2008. Number three, the banking sector is really more fragile … and we have less ability to weather the storm.”

While the Saudis maintain the notion that oil prices are being used as an economic weapon against Russia is baloney, the effect on Russia is undeniable:

Russia’s foreign reserves have dropped to the lowest level since the Lehman crisis and are vanishing at an unsustainable rate as the country struggles to defends the rouble against capital flight.

Central bank data show that a blitz of currency intervention depleted reserves by $26bn in the two weeks to December 26, the fastest pace of erosion since the crisis in Ukraine erupted early last year.

Credit defaults swaps (CDS) measuring bankruptcy risk for Russia spiked violently on Tuesday, surging by 100 basis points to 630, before falling back slightly.

Markit says this implies a 32pc expectation of a sovereign default over the next five years, the highest since Western sanctions and crumbling oil prices combined to cripple the Russian economy.

Total reserves have fallen from $511bn to $388bn in a year. The Kremlin has already committed a third of what remains to bolster the domestic economy in 2015, greatly reducing the amount that can be used to defend the rouble.

While Americans are enjoying cheap gas prices at the pump, and the extra dollars will probably act as a sort of stimulus for increased consumer spending (unless consumers behave crazily and spend down debt instead), the overall impact will be destabilizing, especially if falling oil prices trigger another economic crash, which is looking more than plausible.

But so far Montana legislators, and the Governor, don’t seem too worried:

Montana legislators will debate over the next three months how and where to spend money from the state budget. Neither party has expressed outward concern over plummeting oil prices, nor have they pulled away from plans to invest an estimated $45 million in eastern Montana communities that serve the Bakken.

Gov. Steve Bullock said that while oil prices are volatile, production is likely to continue into the future. Of the state’s $2.5 billion budget, he told the Missoulian, the $121 million generated by oil and gas taxes was relatively small.

“We shouldn’t be setting state policy based on the fact that oil prices have dipped a little,” Bullock said. “But for those who say we don’t need $300 million in the bank, some of them are the same ones who are saying state revenues are going to be short because of oil prices. If that ends up being true, then we really do need $300 million for our rainy day fund.”

From that same article, though, the writing is on the wall:

For companies to continue drilling, the math often comes down to the break-even price, or what it costs to extract and ship the oil. Depending on the company, the price point for oil in the U.S. ranges from $38 to $77 a barrel, Seidenschwarz said.

The price on Friday was roughly $49 a barrel. Because of a pipeline shortage, the New York Times reported, Bakken shale producers are selling crude for roughly $34 a barrel.

What’s more, Seidenschwarz said, a lot of recent high-yield bonds were issued by the nation’s oil companies to finance the acquisition and expansion of projects.

“We’ve already seen a pull-back on bond prices out of concern over producers’ ability to meet their debt obligations,” he said. “That could be further exacerbated by a prolonged downturn in energy prices.”

Oil prices could be one of the biggest stories of 2015. Stay tuned…

  1. Did everybody here see Testers vote FOR XL?

    Getting closer to election time.

    • Damn, what a week so far. First Tester with his XL vote and now Al-jazeera shuts down it’s morning news shows.

      • Maybe the Al-jazeera money stream in drying up?

      • JC

        Read the fine print. Al Jazeera America did not shut down its morning news shows. It moved some personnel around, and is going to air shows produced elsewhere in its conglomerate.

        Speaking of which, Al Jazeera Media Network employs about 8 times the people as Fox Entertainment does (yes, Fox “News” is part of Fox Entertainment… hehe).

        And as to the funds “drying up” unless you hadn’t been paying attention, Al JAzeera is owned by the government of Qatar. So unless its oil fields are drying up — and they aren’t — it’s just another casualty of the drop in oil prices. Kind of like how the Bakken is going bust now.

      • JC

        Tester’s XL vote is nothing compared to his banding together to vote with the GOP to stall implementation of some of Dodd-Frank’s financial regulations.

        So when the next wave of financial instability forces the Congress to bail out Wall Street, you can rightfully point to Tester as being part of the corrupt cabal doing the Bankster’s will.

        • petetalbot

          We all knew Tester would vote for XL. But I’m not familiar with Tester’s vote on Dodd-Frank (Volcker Act, right?). Is there a link I can look at? Thanks.

          • Keep in mind that unless his vote is the one that determines the outcome, it is meaningless. Bob Dole advised freshmen senators, “you’ll never go wrong voting against something that is going to pass or for something that is going to fail.” That is, their voting records are cosmetic and can be fine tuned to please any constituency. Politicians are way too smart for that.

          • JC

            Here’s the article.

            Republicans, in TRIA [Terrorism Risk Insurance Program] reauthorization negotiations last year, decided that they wanted to sweeten the corporate welfare pot some more by rolling back part of Dodd-Frank, particularly by exempting non-financial companies from having to follow the same derivative regulations as banks. The White House has expressed its disapproval of this addition to the bill but has not issued a veto threat because of it:

            Broadening Dodd-Frank’s statutory exemptions is a complicated issue with serious implications for the health and stability of the Nation’s financial markets. The main purpose of S. 2244 is to reauthorize the Terrorism Risk Insurance Program; this bill should not be used as a vehicle to add entirely unrelated financial regulatory provisions.

            • Matthew Koehler

              Life is full of choices. And when you make a choice to take a job as head of the DSCC and you have to raise about $150 million in the next two years, you make some choices, right Senator Tester? I’m just glad Sen Tester is so opposed to “big money” in politics.

              • JC

                Tester started caving on Big Bank issues back in 2010 when his seat on the Banking Committee was a target for big money to influence critical FinReg issues. At one point he voted against small banks and credit unions in favor of the big banks on credit/debit card processing fees. Hugely corrupt vote. Here’s a couple of articles I wrote about the credit card transaction issue, and another about “Too Big to Fail.” Some things never change.

  2. Steve W

    It seemed to me our strategy for a long time was driving up world price. Bomb Iraq, sanction Iran, bomb Libya, sanction Russia. It will be interesting to see how low the price will go.

    • If oil is a weapon, either falling or skyrocketing prices can be used to affect desired changes. Skyrocketing prices drives money to Wall Street and London banks, and falling prices hurts vulnerable producers like Russia and Venezuela.

      Regards Prince Alwaleed bin Tala’s denial that the price drop is in any way contrived, coming from a Saud, is not reliable information. What is he going to do, fess up? Does not Washington have a gun pointed at his head?

      I think it helps to understand that there more no markets that are not rigged, oil just one, so that if prices are collapsing, various interests are either allowing it to happen or making it happen, and with purpose.

  3. Falling oil prices doesn’t seem to hurt MT as much as other states where oil revenues make up a larger % of their state budgets.

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