The BBC on Sunday reported that ‘Opec producers and allies have agreed a record oil deal that will slash global output by about 10%’. In March the price had dropped dramatically because of a perfect storm which saw a headlong drop in demand caused by the Coronavirus coupled with a large increase in supply due to Saudi Arabia precipitously increasing production after it failed to reach an agreement on production quotas with Russia. It was yet another abject failure by the young hothead who seems to call the shots in Saudi Arabia, Prince Mohammed bin Salman.
Whether or not this agreed cut will hold, and if it does whether it will restore the price of oil to any thing like what it was at the start of the year, remains to be seen. I somehow doubt it will. However even if it does I doubt if it will rescue the shale oil industry in the United States, from what looks like a very shaky future.
Hydraulic fracturing, or fracking as it is more widely known, was first proved to be commercially viable in 1997. It works by pumping liquid at high pressure into horizontally distributed oil deposits in shale rock formations, below the surface. It has been used in producing oil and gas on a large scale for ten to fifteen years. But in that time it has turned the industry on its head. The USA used to worry about its increasing dependence on oil imports, but in that ten year span it has not only become self-sufficient and more, it has become the world’s largest oil producer, eclipsing even Saudi Arabia.
Perhaps this energy independence has been one of the causes of increased American self-assertion on the world stage. No longer reliant on Middle-Eastern oil, it no doubt feels it can afford policies, which lead to de-stabilization of the region, such as its support of jihadi rebels and civil war in Syria and the extreme tilt towards Israel, which has occurred during Donald Trump’s presidency. In fact instability in the energy ‘breadbasket’ of the Middle East, actually helps American shale producers by keeping oil prices high. It could be argued that this is one of the reasons for Trump’s antagonistic policies towards Iran - to keep Iranian oil off of the market.
Something not mentioned often in the triumphal boosting of the newfound American energy supremacy, is the fact that the industry can only be economically viable with energy prices suitably high. The break-even price for shale oil is put between $48 and $54 (USD) a barrel. Last week the price (West Texas Intermediate) bottomed out at around $20. Understandably the Trump administration worked very hard to get the Saudis and others to reduce production. But even with the reported success in getting an agreement, it seems unlikely that prices will rise to the $50 a barrel needed for shale oil to make a profit.
But the story is worse than that. In an article in the New York Times on Sunday, author Bethany McLean https://www.nytimes.com/2020/04/10/opinion/sunday/coronavirus-texas-fracking-layoffs.html
pointed out that very few shale oil producers have actually made any profit over the last ten years. The way the shale-oil producers have stayed in business is by drawing in billions in capital from investors convinced by the years of high energy prices and the talk of ‘peak oil’ that, in the long run, the supply of this non-renewable resource will dwindle and push prices up. In essence it has been like a Ponzi scheme.
To date this has kept most producers in business, but the current Coronavirus shock to prices is beginning to take its toll, with shutdowns and some bankruptcies (McLean mentions Whiting Petroleum whose stock once traded at $150 per share). Will investors still be prepared to pump money into an industry that hasn’t made any money during ‘good years’ now that the ‘bad years’ are here? No doubt many will start looking more closely at the way the shale oil industry operates, and whether it will ever be able to yield a return on investment even if prices rise well above $50 a barrel. For example the McLean article quotes hedge fund manager David Einhorn who analyzed 16 publicly traded shale companies and found that between 2006 and 2014 they spent $80 billion more than they received from selling oil.
Industry boosters argue that technological innovation will reduce costs and help make the industry more profitable. But the geology seems to suggest things will move in the opposite direction. The history of fracking seems to indicate that production from any well drops off sharply after about a year or so, forcing the search for new sites. And when wells are clustered too close together, extraction from one negatively affects the other wells.
Even before the current price shock investors were beginning to become impatient and wanted to see some return on their investments, before sinking more money into these companies. Indeed in September of 2018, Ms. McLean published an article (again in the NY Times)
pointing out all of these financial problems with the fracking industry. But the gist of her article was the suggestion that the collapse of the shale oil industry could bring about a financial collapse, not unlike the sub-prime collapse of 2008.
Moody’s reported that in the third quarter of 2019, 91% of defaulted corporate debt was because of oil and gas companies. Ms. McLean writes ‘And North American oil and gas drillers have almost $100 billion in debt that is set to mature in the next four years.’
‘It’s still unclear where most of this debt is held. Some of it has been packaged into so-called collateralized loan obligations, pieces of which are held by hedge funds. Some of it may be on bank balance sheets’. It all sounds very much like the mortgage debt of the sub-prime crisis of 2008. It could well be that, as Bethany McLean titled her 2018 article, ‘The next financial crisis lurks underground’.
Obviously early measures will reduce the spread, but there are other factors to consider, too. Firstly, is population density, which must be a major factor. The population of Greece is spread out over the country, whereas in the UK it is much more concentrated in cities. Athens is less than 700,000 people, London’ fifteen times as large. The UK has nine cities larger than Athens. Similarly, New York, the main concentration of US infection, is a large city.
ReplyDeleteSecond, public transport. Buses and tubes must be a major factor in spreading the disease and here London and New York, with their extensive and busy metro systems, are both highly at risk. Athens has just three metro lines. I don‘t know about their buses, but London buses are incredibly crowded in the rush hours.
Third, the numbers themselves are highly suspect. Countries count on different bases and so it is not easy to compare one with another. In the UK, the bulk of the testing has been on people who already show the symptoms. Who knows how many are actually carrying the disease, but are asymptomatic? Even the death counts are not reliable. In the UK, they have only included those dying in hospital who have been tested as having the disease. If you die in a care home or just at home, you are not included. It‘s been a farce, really.
Fourth is the testing and this is where both the UK and US have been particularly poor, especially compared with countries like Germany. Greece also seems to have a good record, with 500 mobile testing units being used. There’s lots more that could be said about testing, but I don’t have time.
Finally, its the long term effect that is going to be especially important. The impact on the economy will be horrendous. The massive government debts will mean either another long spell of austerity or governments printing money on a huge scale, with the possibility of hyper-inflation. There will be massive unemployment, at least for quite some time. All these factors could well lead to significant social unrest and the possibility of an extremist government (of either stripe), gaining power. It’s all too reminiscent of the thirties.
But as for your main point, I think there is little doubt that both the UK and the US have been very poor in handling the situation. They failed on testing, they failed to deliver sufficient PPE, and they are still failing on both counts. In the UK, the government now rules by slogan. First it was “Take Back Control”, then “Get Brexit Done” and now “Stay Home, Protect the NHS, Save Lives”. They won’t publish how they plan to release the country from the lockdown, the supposed reason being that they don’t want to dilute the message. They are pathetic.