The Declining Price of Oil

January 13, 2015 in Montana
Tags: Montana, oil prices, Russia, Sweetwater, Texas

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…