Shale: Bubble Burst
Published in Hypothèse
(France) on 13 January 2015
by Jacques Sapir (link to original)
(France) on 13 January 2015
by Jacques Sapir (link to original)
Translated from
by Michael Krimian.
Edited by Nicholas Eckart.
The reduction of the number of drilling rigs dedicated to shale oil has sped up since the beginning of the year. The horizontal drilling rigs have represented more than half of the decrease recorded during the first week of 2015. In fact, we can expect a decrease of more than 30 percent of the number of U.S. drilling rigs in the next 10 weeks. This decrease affects all the extraction ponds: in Texas and New Mexico, where a third of the rigs are located — i.e. 502 out of a total of 1,482 booked in Dec. 31, 2014 — the decrease in the first week of 2015 was 28 rigs. That is 5.6 percent of the total. This phenomenon is massive and can be witnessed on different kinds of ponds.
The Consequences for U.S. Production and Prices
At this date, U.S. production keeps on increasing. It should reach 9.5 million barrels a day, probably by the end of March or the beginning of April. Nevertheless, we know the production cycle is between three and six months. It implies that the fall of the number of rigs, and the effects of the first bankruptcies that will be multiplied in the following weeks could have an impact on production between June and August 2015 — a situation likely to scale up in the second quarter of 2015: a reduction of daily production of at least 10 percent and maybe a lot more by the end of the year. By the end of the third quarter or the beginning of the fourth, we cannot exclude the possibility that U.S. production goes back from 8.2 to 8.6 million barrels a day. The effects on the price of a barrel of oil will be astonishing, and they will be amplified by the considerable speculation that the banks and other kinds of financial companies are running. Hence, a considerable decrease is to be expected; the price of BRENT crude oil could drop to less than $40; and the one of the WTI less than $35, as long as production does not decrease. Nevertheless, as soon as production drops — and when it happens it will be quick and strong — anticipations will reverse. This movement will be all the more brutal since the previous decrease would have been considerable. Nonetheless, it is likely that the most important actors of the oil market will not allow the price to go back up significantly over $70 a barrel. At this price, a large part of the production is not profitable or at the utmost very marginally so.
To sum up, the price drop should carry on until March, possibly April. The “rebound,” consecutive to the anticipations inversion, should happen between May and July 2015, and we should witness a return to a normal pricing — i.e. $70 to $80, coming next November. It must be noted that it is what the CEOs of big Russian oil companies are expecting. This scenario is already acknowledged across the board.
Losers and Winners
Such fluctuations will have many repercussions on different economies, in the U.S. of course but also elsewhere. It is already clear that two countries will profit massively from the decrease of oil prices: Japan and Germany. These two countries do not have oil industries and are big hydrocarbons importers.
In the case of the USA, the picture is a lot more complex. We must take heed of contradictory effects and also acknowledge that these effects will not manifest themselves at the same time:
- There is a beneficial effect in view of the importance of oil price for the population and the low level of taxation of oil. A decrease of production price translates quickly to a decrease of the price at the pump. It also has an impact on companies that heavily consume energy and hydrocarbons — e.g., the chemical sector. This impact is already being felt.
- But we must take heed of the indirect and direct effects of the crisis currently devastating the shale oil industry. Regarding the direct effects, we will see a large number of bankruptcies — happening between April and early November — of companies engaged in the production phase and their different outsourcing activities. As of now, US Steel has announced the closure of one of its production sites ensuing from the brutal decrease of steel demand for the manufacturing of drilling equipment. Besides, the shale industry — oil and gas — represents, directly and indirectly by its impact on consumption and household income, approximately half of the jobs created over the past three years. The expected coming wave of bankruptcies will surely be converted into massive layoffs. These layoffs will have a multiplier effect on service activities — a multiplier effect estimated at 2.3 to 2.7 of linked jobs by directly destroyed jobs. In view of the great U.S. job market flexibility, a part of the terminated people will find another job after six to nine months — depending of their dismissal — but in lower paying employment. In fact, with equal level of qualification, wages in the shale industry are better paid from 15 percent to 25 percent than in the rest of the economy. Between unemployed workers, sensu stricto, and the people forced to accept a low remunerated job, we could see a shrinking of the global U.S. wage bill — from 1 percent to 2 percent — and a considerable drop — from 2 percent to 3 percent — of household consumption because we will witness a paradigm shift — i.e. from a consumerist mindset to a preference for saving, as happens every time one is facing substantial economic difficulties. This phenomenon will last from the end of summer 2015 to summer 2016. Nonetheless, this impact will be combined with the increase in the price of oil. What follows is that the contraction of consumption in the last quarter of 2015 or the first quarter of 2016 could be more important than predicted.
- The indirect effects of this crisis, notably in the banking sector, will also be considerable. The estimated net indebtedness of the companies specialized in shale oil production amounts to $200 billion. If we add the outsourcing companies, but also the indebtedness of the companies whose main activities are not based on shale — yet is an important activity — this indebtedness amounts to $310-$330 billion. Finally, if we add derived products and linked activities financed by shale oil industry incomes — such as housing construction projects to face the housing bubble happening next to drilling sites — we reach $420-$450 billion. Of that amount, at least approximately $300-$350 billion will become, in the coming months, “bad debts.” Since these debts are securitized, the impact on bank balance sheet will be considerable. It is clear that it will influence the Federal Reserve's policy, which will have to be extremely cautious regarding its interest rate governance.
- In the longer term, we must expect a decline of the dollar and therefore a return of dollar-to-euro change rate at around 1.25/1.30, beginning next year at the latest. The downward trend of the euro could be nullified by the last quarter of 2015, which would compromise the still very shy — and very fragile — questionable euro rebound.
All these parameters substantiate the idea that U.S. growth will last until the end of the first quarter of 2015, followed by an ever increasing deterioration, starting in the third quarter.
The Situation in Russia
In this context, attention should be paid to the Russian economic situation. First, it must be noted that the global break-even point of petroleum activities — linked activities included — is 3,000 rubles a barrel. It means that if the BRENT goes under the $50 per barrel, the ruble-to-dollar rate cannot go over 60 against 1. In fact, the changing rate is expected to range from 60 to 70 rubles for $1 if the price of a barrel keeps on declining. Nonetheless, the prospects are not bad in the medium term.
On the other hand, with the price of a barrel going back up around $70, the ruble-to-dollar exchange rate should go back up around 45 to 1, at the latest at the end of this year. Furthermore, the repayment decline that Russian companies must honor to nonresident financial institutions will considerably loosen the situation on the currency market.
Nevertheless, the Russian quarterly trade surplus reaches at least $40 billion. Hence, it is worth noticing that the trade surplus — exports-imports — will largely cover the financing needs of Russian companies. From this point of view, it is clear that the Russian financial situation will improve in 2015, particularly from the 2nd quarter with the likely surge in the price of oil. Russia actually appears to be only slightly vulnerable to a momentary decline in oil prices. On the contrary, the shale oil bubble burst that emerges could have dire consequences for the U.S. economy.
The Consequences for U.S. Production and Prices
At this date, U.S. production keeps on increasing. It should reach 9.5 million barrels a day, probably by the end of March or the beginning of April. Nevertheless, we know the production cycle is between three and six months. It implies that the fall of the number of rigs, and the effects of the first bankruptcies that will be multiplied in the following weeks could have an impact on production between June and August 2015 — a situation likely to scale up in the second quarter of 2015: a reduction of daily production of at least 10 percent and maybe a lot more by the end of the year. By the end of the third quarter or the beginning of the fourth, we cannot exclude the possibility that U.S. production goes back from 8.2 to 8.6 million barrels a day. The effects on the price of a barrel of oil will be astonishing, and they will be amplified by the considerable speculation that the banks and other kinds of financial companies are running. Hence, a considerable decrease is to be expected; the price of BRENT crude oil could drop to less than $40; and the one of the WTI less than $35, as long as production does not decrease. Nevertheless, as soon as production drops — and when it happens it will be quick and strong — anticipations will reverse. This movement will be all the more brutal since the previous decrease would have been considerable. Nonetheless, it is likely that the most important actors of the oil market will not allow the price to go back up significantly over $70 a barrel. At this price, a large part of the production is not profitable or at the utmost very marginally so.
To sum up, the price drop should carry on until March, possibly April. The “rebound,” consecutive to the anticipations inversion, should happen between May and July 2015, and we should witness a return to a normal pricing — i.e. $70 to $80, coming next November. It must be noted that it is what the CEOs of big Russian oil companies are expecting. This scenario is already acknowledged across the board.
Losers and Winners
Such fluctuations will have many repercussions on different economies, in the U.S. of course but also elsewhere. It is already clear that two countries will profit massively from the decrease of oil prices: Japan and Germany. These two countries do not have oil industries and are big hydrocarbons importers.
In the case of the USA, the picture is a lot more complex. We must take heed of contradictory effects and also acknowledge that these effects will not manifest themselves at the same time:
- There is a beneficial effect in view of the importance of oil price for the population and the low level of taxation of oil. A decrease of production price translates quickly to a decrease of the price at the pump. It also has an impact on companies that heavily consume energy and hydrocarbons — e.g., the chemical sector. This impact is already being felt.
- But we must take heed of the indirect and direct effects of the crisis currently devastating the shale oil industry. Regarding the direct effects, we will see a large number of bankruptcies — happening between April and early November — of companies engaged in the production phase and their different outsourcing activities. As of now, US Steel has announced the closure of one of its production sites ensuing from the brutal decrease of steel demand for the manufacturing of drilling equipment. Besides, the shale industry — oil and gas — represents, directly and indirectly by its impact on consumption and household income, approximately half of the jobs created over the past three years. The expected coming wave of bankruptcies will surely be converted into massive layoffs. These layoffs will have a multiplier effect on service activities — a multiplier effect estimated at 2.3 to 2.7 of linked jobs by directly destroyed jobs. In view of the great U.S. job market flexibility, a part of the terminated people will find another job after six to nine months — depending of their dismissal — but in lower paying employment. In fact, with equal level of qualification, wages in the shale industry are better paid from 15 percent to 25 percent than in the rest of the economy. Between unemployed workers, sensu stricto, and the people forced to accept a low remunerated job, we could see a shrinking of the global U.S. wage bill — from 1 percent to 2 percent — and a considerable drop — from 2 percent to 3 percent — of household consumption because we will witness a paradigm shift — i.e. from a consumerist mindset to a preference for saving, as happens every time one is facing substantial economic difficulties. This phenomenon will last from the end of summer 2015 to summer 2016. Nonetheless, this impact will be combined with the increase in the price of oil. What follows is that the contraction of consumption in the last quarter of 2015 or the first quarter of 2016 could be more important than predicted.
- The indirect effects of this crisis, notably in the banking sector, will also be considerable. The estimated net indebtedness of the companies specialized in shale oil production amounts to $200 billion. If we add the outsourcing companies, but also the indebtedness of the companies whose main activities are not based on shale — yet is an important activity — this indebtedness amounts to $310-$330 billion. Finally, if we add derived products and linked activities financed by shale oil industry incomes — such as housing construction projects to face the housing bubble happening next to drilling sites — we reach $420-$450 billion. Of that amount, at least approximately $300-$350 billion will become, in the coming months, “bad debts.” Since these debts are securitized, the impact on bank balance sheet will be considerable. It is clear that it will influence the Federal Reserve's policy, which will have to be extremely cautious regarding its interest rate governance.
- In the longer term, we must expect a decline of the dollar and therefore a return of dollar-to-euro change rate at around 1.25/1.30, beginning next year at the latest. The downward trend of the euro could be nullified by the last quarter of 2015, which would compromise the still very shy — and very fragile — questionable euro rebound.
All these parameters substantiate the idea that U.S. growth will last until the end of the first quarter of 2015, followed by an ever increasing deterioration, starting in the third quarter.
The Situation in Russia
In this context, attention should be paid to the Russian economic situation. First, it must be noted that the global break-even point of petroleum activities — linked activities included — is 3,000 rubles a barrel. It means that if the BRENT goes under the $50 per barrel, the ruble-to-dollar rate cannot go over 60 against 1. In fact, the changing rate is expected to range from 60 to 70 rubles for $1 if the price of a barrel keeps on declining. Nonetheless, the prospects are not bad in the medium term.
On the other hand, with the price of a barrel going back up around $70, the ruble-to-dollar exchange rate should go back up around 45 to 1, at the latest at the end of this year. Furthermore, the repayment decline that Russian companies must honor to nonresident financial institutions will considerably loosen the situation on the currency market.
Nevertheless, the Russian quarterly trade surplus reaches at least $40 billion. Hence, it is worth noticing that the trade surplus — exports-imports — will largely cover the financing needs of Russian companies. From this point of view, it is clear that the Russian financial situation will improve in 2015, particularly from the 2nd quarter with the likely surge in the price of oil. Russia actually appears to be only slightly vulnerable to a momentary decline in oil prices. On the contrary, the shale oil bubble burst that emerges could have dire consequences for the U.S. economy.