This Is Just the Beginning of the Great American Oil Bust

“This is going to be a painful period of time,” explained Texas Governor Rick Perry. The oil price plunge is going to make things “very uncomfortable” in the oil patch of Texas. There would be “a bit of belt-tightening in places,” and some areas would “have to make some changes,” he said.

His speech to a conservative forum on Friday in Austin made one thing clear: for Texas, the largest oil-producing state in the nation, the oil bust won’t be easy, even if seen from the perennially optimistic point of view of a politician.

It won’t be easy for any oil-producing state – or the country.

A few days ago, Helmerich & Payne, announced that it would idle 50 more drilling rigs in February, after having already idled 11 rigs. Each rig accounts for about 100 jobs. This will cut its shale drilling activities by 20%. The other two large drillers, Nabors Industries and Patterson-UTI Energy are on a similar program. All three combined are “likely to cut approximately 15,000 jobs out of the 50,000 people they currently employ,” said Oilpro Managing Director Joseph Triepke.

“They all know they’re staring down a cliff, they just don’t know how far it goes yet,” said Dave Anderson, an oilfield service and equipment analyst at Barclays on Friday, according to FuelFix. This year, spending on oil and gas drilling could plunge by $58 billion – or 30% – from last year’s $196 billion, based on a survey of 225 companies in the sector. But it could get even worse: Barclays conducted the survey over the past four weeks, and the price of oil has continued to drop since, and companies will adjust to the new realities.

Small to midsized drillers are making even deeper cuts in drilling to stem the cash outflow. For example, Houston-based Halcón Resources cut its 2015 budget to a range of $375 million to $425 million, down 55% to 60% from its 2014 budget of $950 million. These companies are just trying to hang on. Shares closed at $1.59 on Friday, down 87% from their $12 peak in February 2012, and down 79% from June 2014.

Houston-based Sanchez Energy cut its 2015 drilling and completion budget to a rage of $600 to $650 million, from the $1.15 billion it had first projected last year. But the budget assumed that West Texas Intermediate will average $60 per barrel in 2015 and natural gas $3.75 per million Btu. However, WTI last traded at $46.31 and natural gas at $2.88. Sanchez went public with all kinds of hoopla at the end of 2011. On Friday, its shares closed at $8.88, down 77% since June.

The peak in the number of rigs drilling for oil, according to Baker Hughes’ data series going back to 1987, occurred in the second week of October last year, with 1,609 active rigs. At the time, it was already clear that the oil price plunge wasn’t just a temporary blip. But rigs are contracted for well in advance, and breaking contracts isn’t easy, and changing capital-expenditure plans takes time.

Then late last year, the rig count began to edge down. But on Friday, Baker Hughes reported that oil rigs dropped by 61 to 1,421 rigs. It was the largest week-to-week drop in the data series. In percentage terms (-4.12%), it was the largest drop since the Financial Crisis. When the rig count started plunging like this in December 2008, the stock market was crashing.

And yet, it’s just the beginning


Texas got hit the hardest. Week-to-week, rigs dropped by 29 to 810. The count is now down 95 rigs, or 10.5%, from the peak of 905 rigs on November 21.

North Dakota, the second largest oil-producing state, lost 7 rigs last week. Its 162 rigs are also down 10.5% from its peak in mid-November.

Estimates vary widely as to how far the rig cutting will go. Barclays’ analyst Anderson estimated that at least 500 rigs could be idled in the American oil patch by the end of the year. Raymond James analyst Praveen Narra said that his firm estimated that up to 850 rigs could be idled this year. If 60% are idled, as was the case during the Financial Crisis, it would mean that 965 rigs would be taken out of service. Over the last 10 years, the oil and gas business in the US has become huge, and the unwind will be huge as well.

Yet, even as capital expenditures are getting slashed brutally, companies have not lowered their production forecasts.

And they won’t, at least not for a while; they’ll keep pumping at the maximum rate possible, especially now that revenues from unhedged production are plunging – while the costs of servicing their mountains of debt have remained the same, and rolling over that debt or borrowing even more money has become a lot more expensive. Cutting back on exploration, drilling, and completion stems the cash outflow, but it doesn’t cut production, not until the decline rates of existing shale wells start making a visible dent into it.

So investors see blood in the streets. And it’s the signal. The four largest exchange-traded oil-related funds – including the largest oil fund, USO – had inflows of $1.23 billion in December, the most since May 2010, and $110 million during the first few days of January, Bloomberg reported. These investors are betting on a quick rebound of the price of oil. A sign that there isn’t nearly enough blood in the streets yet.

These folks are looking at what happened during the financial crisis, when the price of oil plunged 75% in half a year, but after the Fed started its QE program, oil bounced off its low (along with stocks and nearly everything else) and formed a miraculous V-shaped recovery [read…. Oil Price Crash Triggered by the Fed? Amazing Chart].

The bet is that this may happen again. The Fed may start QE-4. Who knows to what lengths it will go in its efforts to inflate asset prices and transfer wealth! But if this oil bust is anything like classic oil busts, and the Fed sits on its hands, it may take years before this is worked out. Look at the price of natural gas: it has been below the cost of production at most wells for years – and production is still soaring! And that soaring production represses the price further.

In the end, oil goes from boom to bust to boom to bust, creating a lot of enthusiasm, hype, endless possibilities, and wealth for some on the way up, and leaving a lot of debris and anguish in its wake on the way down. The last time, the Fed stepped in. This time, it may not. Instead, the classic oil bust may play out in its drawn-out brutal manner.

And so, in the American Oil Patch and beyond, all heck is breaking loose as the “most reliable profit driver” has “abruptly turned sour.” Read… Oil-Bust Bloodletting: Projects Cancelled, Layoffs Ripple to Other Areas, Default Hits Private-Equity and Pension Funds

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  13 comments for “This Is Just the Beginning of the Great American Oil Bust

  1. Mary says:

    I’ve just started following your website. Full of useful information and analysis delivered in clear prose. Thank you!

  2. Petunia says:

    The last price collapse in WTI oil took us into the Vietnam War, which was fought on an ocean of WTI and created the real fortunes of Texas. This collapse will likely take us into another manufactured conflict somewhere else to be fought on an ocean of oil. Let’s see what the Jeb administration can come up with.

  3. Julian the Apostate says:

    Greetings Mary. Welcome to the Long Porch, a civilized place that actually has dialogues and oratory.

  4. pete says:

    Great stuff Wolf. Bottom when Venezuela squeals, no?…PJS

  5. MC says:

    Personally I think financial markets have become so detached from fundamentals not even an invasion staged by little green men from Mars could stop it from climbing higher and higher. The only thing that could kill them stone dead is an interest rate hike (even a modest one) but that’s not going to happen anytime soon. Or, who knows, it may happen next week. Interpreting central bankers is as an obscure and arcane of an art as predicting the future from the flight of birds.

    Having said that, I strongly suspect Prince al-Walid bin Talal of Saudi Arabia is fundamentally correct in his assessment: nobody knows what the true breakeven for fracking and shale is, not even the companies physically pumping the stuff from the ground. The reason for this is very simple: most of them are so heavily leveraged even a seemingly modest hike in interest they pay on their debt could easily add $10-15/barrel to their breakeven overnight. The present figures daily trotted out by Wall Street are based on the assumption interest rates will stay stable through all 2015 and beyond… and that foreign oil won’t become so cheap as to become more tempting for refineries than it already is. Saudi Arabia has already sent signals in that direction by lowering crude prices for the European market.
    A combination of oil prices in the $65-75/barrel ballpark midterm and slightly higher interest rates could cause far more damage than the present burst because most small and middle sized fracking and shale companies were bred and raised in a very high oil price/very low interest rates environment. They lack the experience and leadership of Exxon and Chevron for dealing with different situations.

    A year ago I mused if there ever was so to be a burst of the fracking and shale industries, it would have ended in tears and a bailout. Now I only see the tears.
    Exxon, Chevron and large foreign companies such as BP, Talisman and Shell can not only weather the storm but profit from it mid to long term: somebody will have to buy the assets of all those small oil companies that will inevitably go burst. They aren’t robot traders buying the dip: they can wait for prices to go down a long way and States such as North Dakota and Texas to become really desperate. They have the political clout to keep at bay demands by politicians to “buy now” to save their districts from financial ruins. Most of all, they are financially solid enough to not only weather, but profit (though not at present levels) from reasonaly priced oil.

    In a way this could end up a bit like the Zaitech Burst in Japan. The three largest and most solid keiretsu (Mitsui, Sumitomo and Mitsubishi) ended up being strengthened by being able to scoop up assets from the other Big Three and the plethora of smaller conglomerates at rock bottom prices.


  6. Financiers are living in a dream world, where they are the only ones who matter, a world where they can ‘pick up assets on the cheap’ and profit after ‘the market recovers’. They assume their hand-picked sock-puppets who run central banks and governments control outcomes, that reducing interest rates or charging more/less for reserves will solve the problem of falling oil prices (a trend that is exacerbated by near-zero interest rates, btw … )

    The shift of wealth … an astute observation … has been underway since the 1970s: on one hand, wealth flows to the garbage dump on an industrial scale as we strip-mine our resources. At the same time wealth (purchasing power) flows from workers to their bosses. These ‘managers’ look @ oil as an investment asset, workers are obviously looking @ oil as something that can be done without … either by choice or by necessity,.

    Prices cannot go up unless the workers become wealthy, themselves. In a consumption economy this is impossible. Any gains on the part of workers are immediately spent, the goods they buy become garbage with their funds being spent toward the bosses. At the end of the day the workers are as broke as they were when the day began.

    • VegasBob says:

      I think Steve is pretty much on target.

      Absent a labor shortage, there can’t really be a lot of upward pressure on wages.

      And at this point, the banksters really can’t extend more credit to the masses to boost consumption without risking massive writeoffs of consumer bad debt. So the Fed’s efforts to gin up inflation are pretty much useless.

      Perhaps the Fed-sponsored malinvestment bubbles will begin to explode, starting with oil and followed by subprime auto loans, regardless of further Fed manipulation. That would certainly prove the idiocy of trying to manipulate an economy through Central Banking voodoo such as ZIRP and money-printing (QE).

  7. Vespa P200E says:

    Be careful what you wish for…

    All these chatters about lower gas prices result in boosting the consumer spending and the economy is likely wishful thinking. The disappearance of good paying mfg jobs and its impact on the overall economy (so many jobs tied to each well paying mfg job) may outweigh the temporary low gas price hoopla extra discretionary income.

    I recall the survey done years ago near tail end of GW Bush term when he gave “away” the money via tax break to boost the economy and general consensus was that most people’s 1st choice to sock it away followed by pay down the existing debts rather than go and spend the money.

  8. LeftCoastIndependent says:

    Hmmmm, do you think Putin will ditch the dollar and get paid in Euros when selling to Europe? That would be really interesting.

  9. NY Geezer says:

    “The peak in the number of rigs drilling for oil, according to Baker Hughes’ data series going back to 1987, occurred in the second week of October last year, with 1,609 active rigs. At the time, it was already clear that the oil price plunge wasn’t just a temporary blip.”

    I assume that most operators were smart enough to maximize their hedges by the 2nd week of last October. Their dumb money lenders certainly would not have been smart enough to require long term hedges when the loans were originated. The real hurt to the operators will occur when the hedges expire. We will have to wait for the next quarterly reports to find out.

  10. Michael Gorback says:

    Why is Rick Perry hanging black crepe? I thought he created the whole Texas economic boom with his amazing leadership skills. Why doesn’t he just come up with another great plan?

    The fracking problem is just a symptom of a far worse disease: global economic slowdown. demand has fallen precipitously. Anyone who thinks this will be domestically contained to the oil patch is delusional (ask the folks who just got laid off at US Steel in Ohio), as is anyone who thinks we can decouple from the rest of the world (CAT and KO just announced layoffs).

    Lance Roberts published an interesting chart recently. It broke down job growth in the US since 2000 by quartiles, with and without Texas. Without Texas, the bulk of job growth was at the extremes – top and bottom quartiles. Texas was responsible for the vast majority of job growth for the middle income quartiles.

    Those jobs are going to disappear. Unemployment, average wages, and GDP are not going to look pretty in 2015.

  11. Cameron says:

    The V-shaped recovery last time was due to demand recovery. The difference this time is that it’s both the falling demand as well rising supply. The tremendous over-investment/overproduction in the oil industry in recent years will keep oil prices depressed for a lot longer than most people believe or want to believe. All oil producers are now trying to maximize profit mass (or minimize losses) so they’ll continue to pump as much as they can. No V-shape recovery this time.
    2015 will be one helluva year.

  12. Vespa P200E says:

    Well the whole commodities sector across the board has taken a hit in last few months. Heck even gold and silver are crawling near the bottom. The pseudo pent up demand by China no more not to mention global slow down in general.

    And we have global stock markets in all time high… It is not going to end well…

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