Why the Great American Oil Bust Will Be Long & Painful

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Oil Glut, Collapsed Prices, Layoffs… but US Production Soars

Layoff announcements have been ricocheting around the oil and gas sector, fleshed out with individual stories that percolate up to me. The entire sector is cutting operating costs and capital expenditures as fast as they can crunch the numbers. Revenues are plunging largely in sync with the collapsing prices of oil and natural gas.

Today, French oil giant Total’s CEO Patrick Pouyanne, while hobnobbing at the World Economic Forum in Davos, said that his company would “limit” its investments in US shale fields at least until prices come back up – “my instructions have been pretty clear,” he said.

On Tuesday, Oilfield services provider Baker Hughes, which is being acquired by Halliburton for almost $35 billion in a masterful piece of Wall Street engineering, chimed in with its own job cuts; its customers in the oil patch are slashing their capital expenditures and what they will pay Baker Hughes as their revenues are plunging due to the collapsing price of oil. The chain reaction goes on. Baker Hughes is going to axe 7,000 employees, mostly in the first quarter. That’s about 11.5% of its headcount!

Acquirer Halliburton, which has already cut 1,000 people outside North America in the fourth quarter, out of the 80,000 it employs worldwide, would do some cutting of its own at home. “Headcount adjustments” was the term COO Jeffrey Miller used during the earnings call, without going into details. Both companies get about half of their revenues from North America, which they expect to get hit harder than the rest of the world.

On Monday, oilfield services giant Schlumberger said it would cut 9,000 jobs. BP and ConocoPhillips already announced major budget cuts, as have dozens of smaller companies. Charge-offs are piling up. And it’s just the beginning [read… These Two Charts Show the True Fiasco of US Oil & Gas].

And now BHP Billiton, the world’s biggest mining company, spelled out, perhaps unwittingly, why the great American oil bust will lead to a terrific bout of bloodletting before it’s over. In its Operational Review for the second half of 2014, the company explained that its total production – which includes copper, coal, iron, manganese, nickel, alumina, and oil and gas – increased by 9% during the second half of 2014, despite the swoon in commodity prices. And it bragged that it achieved production records “for eight operations and five commodities.”

It needs to brag to prop up its shares which have plummeted 37% on the NYSE since mid-2014. So it reiterated its guidance for total group production to rise 16% for the two years ending in December 2015.

BHP’s production of US dry natural gas, whose price has been below the cost of production for years, inched up 5% in the fourth quarter to 110.3 billion cubic feet (bcf). But production of US shale oil, condensate, and natural gas liquids reached 12.9 million barrels of oil equivalent (MMboe) in the fourth quarter, nearly doubling from a year earlier!

That’s how the sector tries to overcome a glut: with soaring production! Now CEO Andrew Mackenzie explained how BHP would deal with the low-price debacle it finds itself in:

We are reducing costs and improving both operating and capital productivity across the Group faster than originally planned. These improvements will help mitigate some of the impact of lower commodity prices and we remain alert to opportunities to further increase free cash flow.

It will decimate its US drilling rigs by 40% before the year is up. The least economical areas will be hit the hardest. Drilling in shale plays with large amounts of dry gas will be cut to one rig in the Haynesville shale. This one solitary rig will focus on “drilling and completions optimization,” rather than full field development. BHP will taper fracking for dry gas down to nothing.

And it’s still trying to dump its acreage in the Fayetteville shale, which it had first announced during the peak of the gas glut in October 2012. Since it will only agree to a deal “if full value can be realized, consistent with our long-term outlook for gas prices,” it has not yet found a buyer.

“Our ongoing shale investment program will remain focused on our liquids-rich Black Hawk acreage,” Mackenzie said. “However, we will keep this activity under review and make further changes if we believe deferring development will create more value than near-term production.”

So if the price continues to wobble lower, more capex cuts may be on the horizon even in its most productive plays. Yet:

The reduction in drilling activity will not impact 2015 financial year production guidance, and we remain confident that shale liquids volumes will rise by approximately 50% in the period.

Oil glut and collapsing prices be damned.

And that’s the secret sauce: gutting operating expenses and capital expenditures by laying off people, shutting down fracking operations, shuttering facilities, dumping whatever can be dumped, and with each additional swoon of the price of oil, tighten the screws some more. All in order to limit cash outflow.

But production from existing wells and from new projects that will come on line in the near future – projects conceived during the junk-bond and energy-IPO bubble when money grew on trees – will be pushed to new records to salvage what’s left of the plunging revenues.

The cash has already been drilled into the ground. Now it’s just a matter of getting the oil and gas out to service the debt. The more the price drops, the harder they have to try to increase production. This is the irony of a debt-fueled oil boom that turned into an oil bust: producers cannot back off regardless of how low the price may be because they have to generate the cash from lower and lower oil prices to service their mounting piles of debt.

Producers in the US are all doing it. State-controlled oil companies in Russia, Venezuela, Iran, Mexico…. They’re all doing it too. They’re trying to make up with volume what they can’t achieve with price, while they still can, and the bloodletting this strategy inevitably leads to is going to be epic.

This is how years of wondrous Wall-Street engineering dissolve into reality. Read…   Money Dries Up for Oil & Gas, Layoffs Spread, Write-Offs Start

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  11 comments for “Why the Great American Oil Bust Will Be Long & Painful

  1. mick
    Jan 22, 2015 at 12:33 am

    Still can’t help but think these guys aren’t getting the message yet. Oil down 60%, but they cut 11% of their workforce and thats supposed to do the trick? Heck, they’re still spending more on capex than 2014, although they’ve cut back.
    Let me know when they’ve slashed their budgets back to 20% of 2014’s figures, then they’ll be getting serious.

    • badcowboydan
      Jan 22, 2015 at 10:19 am

      Layoffs aren’t the only place that they are cutting back. They are achieving the rest of the necessary cost cuts through better pricing with vendors and services. Up until now it’s just been all about getting the oil out at any cost, with prices lower they are going to have to be more aggressive with any purchase of services or goods. Also cut the overtime on a lot of these projects and you’ll achieve the 20% right there…

  2. Al Tinfoil
    Jan 22, 2015 at 2:47 am

    Reminds me of the old story:

    Merchant to customer: “My prices are so low I lose money on every sale.”

    Customer: “Well, how do you stay in business then?”

    Merchant: “I do a huge volume.”

    • Louis
      Jan 22, 2015 at 9:24 am

      Wasn’t there also an old Saturday Night Live sketch along similar lines, involving the “Change Store?”

  3. Julian the Apostate
    Jan 22, 2015 at 4:17 am

    There was a man who worked at the big manufactory in town as the timekeeper. The great joy of his day was to blow the great steam whistle at high noon as the second hand touched the hour.
    Every morning he would walk past a watch repair shop that sported a huge clock in its display window and set his watch.
    One morning his watch stopped running and he had to dig out his spare watch and left a little earlier to drop of his broken one with the repair shop. The repairman said the mainspring had broken and the timekeeper could pick it up in a couple of days.
    The timekeeper mentioned how much he loved the big clock in the window and that he stopped and set the watch by it on his way to work each day.
    The repairman beamed, for the clock was his pride and joy. “I know it’s accurate to the minute”, he said. “Because I set it by the noon whistle at the factory.”

  4. M. Rains
    Jan 22, 2015 at 4:20 pm

    Very astute article and facts but I have a slightly different take on things. I predict that this debt will NOT become a problem. The Fed will intervene. Now I’m not saying that fracking won’t be impacted. They will throttle back employees, infrastructure spending for now……..but, this is a national priority (whether it is economical now or not….it will be in the future according to the central planners).
    Also, I think this drop in oil prices is only intended to last for 6-12 months; then back up into the 80’s. This drop was orchestrated by our leaders to punish Putin (and get a shot of adrenaline in the world economies); but they don’t/can’t let it go too far. Oil is the one thing that can make or break inflation/deflation. If they allow oil to stay low for too long, then price transmission will work its way into the real economy and prices will drop. Oil is how they engineered inflation in 2009-now. They held price up because they knew that monetary means wouldn’t work (transmission broken).
    Questions?

    • CrazyCooter
      Jan 23, 2015 at 9:56 am

      Maybe deflation is just finally setting in … oil, which is heavily financialized, could not keep all the check-kiting-balls in the air and collapsed … which means to bring price back up (1) supply has to fall to demand or (2) demand has to rise to supply.

      The latter ain’t happening and the former is going to take time, probably a couple years at a minimum, at which point deflation may have officially started its virtuous cycle.

      Regards,

      Cooter

    • john tucker
      Jan 23, 2015 at 3:46 pm

      Olio Petrolio sat on a wall.
      Olio Petrolio had a great fall.
      All of the Kinng’s bankers
      and all of the Bureau of Printing and Engraving’s inkjet printer pens
      could not put Oily back together again.

      QE only benefits the rich. In order to increase demand for oil, they have to give money to the poor, and we all know that they are not EVER going to do that.

      I have some reading for you, M. Rains, and this ought to be required reading for every individual who believes that the west can hurt Russia with low oil prices:

      http://en.wikipedia.org/wiki/French_invasion_of_Russia

      Some people just never learn …..

  5. NotSoSure
    Jan 22, 2015 at 5:08 pm

    Time for war?

  6. williamwilliam
    Jan 22, 2015 at 5:45 pm

    Layoffs are almost always followed by more layoffs. Corporations are structured to shrink by dropping mid-management levels and increasing the number of reports to each manager. It’s referred to as flattening. But it happens in stages. One layoff, then another, then another. American layoffs are the easiest. Overseas, they get complex and have to be more carefully handled.

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