The Fracking Bubble

At an oil price of $50 a barrel, money is burned daily in Texas and Dakota. Yet the Saudis’ rumored price war is fiction.

Maybe the price of oil has now finally hit bottom. After a seven-month downward trend, it is breathing relatively steadily just under the $50 mark. A loss of 60 percent since the summer—no one thought that possible. Such a spectacular fall invites world observers to paint geopolitical conspiracy theories and sinister plots.

Saudis against Americans, Saudis against Iran, everyone together against the Russians. If one only has banal explanations for the price decline – falling demand, high supply, plus gambling of the speculators – then one just imagines a story suitable for the drama of the great oil price war.

The most recent version alleges that helped by low oil prices, the Saudis want to extinguish the momentum of the U.S. fracking industry. Therefore the kingdom adamantly refuses to curtail its production in order to stop the price decline with an artificially short supply.

Behind this is the old image of the shifty oil sheikh who is playing games “with our oil.” Saudi Arabia is closely connected to the U.S. and dependent upon its protection; the kingdom cannot risk an open attack on the U.S. energy industry. Saudi Arabia is simply faced with the choice of keeping its production stable and thereby earning less because of the tumbling oil price, or actually curtailing its production substantially, but thereby escalating a loss of revenue and at the same time also losing market share.

The decision is clear. That the competition, producing oil with expensive high tech and fracking, is currently experiencing huge losses is a pleasant windfall gain for the Saudis, but not a targeted strategy. The country has been producing at a steady level and at the time of higher oil prices, undertook absolutely nothing to drive the price into the cellar and attack the competition.

Saudi Arabia is readily designated as a swing producer that can supposedly regulate its output at will. Yet exactly this is becoming more and more difficult because the pressure in very old oil fields is sinking and must again and again be artificially maintained by constant infusions. The geological conditions are complicated, and optimizing output is becoming an increasingly more technical challenge; any decrease or increase threatens the delicate framework.

Collapse of the Fracking Industry

Astonishingly, no one poses the obvious question of why the U. S. doesn’t actually curtail its production. After all, it has created the excess by hefty increases of 4 million barrels a day since 2008, and thereby substantially contributed to the plunging price of oil. While some U.S. media and blogs smirk that the price of oil is now backing rogue nations like Venezuela and Iran as well as the hated Putin into a corner, the fact that the domestic fracking industry is also collapsing is overlooked.

Texas fracking company WBH Energy has already had to file for bankruptcy, the first firm to do so. The number of drilling platforms in fracking regions registered the sharpest drop since counting began: from 1,609 in October to only 1,366 at present.

The respected U.S. market watcher Arthur Berman estimates the break-even point for fracking at $80 to $85 a barrel. Continental Resources, the number one petroleum liquids producer in the so-called Bakken formation, the most important fracking region in the U.S. and Canada, already turned in abysmal numbers in the third quarter of 2014 at an oil price of $90 a barrel. Now the price has slipped below $50! And it appears to be making itself comfortable there. One doesn’t need to be an economist to predict the consequences. Every day more money is being burned. And at some time or another it will be quitting time.

Declining Oil Investments

To prevent a panic among investors and bankers, the fracking industry is demonstrating coolness. It was said in the fall, one could live with an oil price of $70 a barrel. Then the profit and pain threshold sank to $60, analogous to the trundling price of oil. But now we are under $50. The break-even point is becoming modeling clay that is fitted to every further price drop – because one must keep the situation calm.

The fracking bubble is being financed by the usual voodoo economics, primarily with high yield bonds: bonds with high interest rates for firms with dim creditworthiness. How long can one still service the bonds? “Most fracking firms would long since have been bankrupt according to German law,” said energy expert Jörg Schindler. But if the fracking bubble bursts, it will also jeopardize the U.S. economic recovery.

Staggering Tempo

In the meantime, both of the most important institutes for energy studies, the International Energy Agency of the OECD and the American Energy Information Administration, have corrected their prognosis. They anticipate a slight drop in fracking in the second half of the year and a moderately declining oil supply worldwide. Yet the investments in the oil business are currently being driven back at a staggering tempo.

Shell alone has cut its investments until 2018 by $15 billion; likewise, Chevron, BP and Total up to a third of their projects. If, however, all step on the brakes at full tilt and at the same time, a soft landing is not possible. The worldwide oil production and supply could suddenly nosedive in a time lag of two or three years just like the price of oil now. Then it [price of oil] would learn to fly again.

Predictions of price developments are, however, dubious because every single event in the producing regions, every new crisis, changes the starting point right away. Only one thing is certain. The production of conventional, that is, easily accessible “normal” oil has been declining for almost ten years. The expensive high tech oil is supposed to fill this gap. That cannot function at a price of $50 a barrel.