January 15, 2015

$40 oil, or why Glenn Hegar could be even wronger than rain

I've already dissected how I think Texas Comptroller Glenn Hegar's biennial budget estimate is probably $2 billion too high, if not more. (See new poll on right to vote on where you think oil will be on March 31.)

That said, that was based on the possibility that oil would not get above the low $50s in the first half of this year, and not break the middle $60s before the end of the year.

Well, what if even THAT was too optimistic?

What if oil sits in the low-mid $40s for 4-6 months, and doesn't break a flat $60 on a regular basis until the end of the year? That's especially if market psychology (as well as general first-quarter lulls) says  "keep it there."

The EIA has also weighed in, expecting the average 2015 price to be about $55.

What if even THAT is too optimistic. What if, per new estimates by British Petroleum, oil stays below $60 for three years?

Oops in spades. And that's the starting point of this post and some speculative thinking.

Add in that even more flush U.S. shale oil operators may not have money to buy out the weakest, at least not right away. Add in that major banks, both Texas-based and even bigger national players, are likely to tighten lending wallets, especially on "market mentality."

Add in that it, per the first link, with more info here, could take 4-6 months to soak up most the current excess supply.

That's especially true when, per the first link, nobody in the US has actually started sopping up any excess yet:
Oil output, however, is still at a record level. In the week that ended on January 2, when the number of rigs also dropped, it reached 9.13 million barrels a day, more than ever before. Oil companies are only stopping production at their worst wells, which only produce a few barrels a day – at current prices, those wells aren't worth the lease payments on the equipment. Since nobody is cutting production, the price keeps going down; today, Brent was at $US47.43 per barrel and trends are still heading downward.

So, yeah, 4-6 months is probably the correct time frame, for, let's say, mid-40s prices. Well, the state of Texas, Glenn Hegar, and even more so, the one responsible adult running Texas government, Speaker Joe Straus, had better hope that 4-6 months — and not something worse — is the correct time frame.

Because we haven't tackled one last point. 

And, the biggest issue. Financial reserves, not monetary ones.

The petrostates of the Middle East, in general, are flush with cash and can afford to burn money for some time. And, Saudi Arabia can really afford that much burning. Plus, some of the Gulf states have lower per-barrel prices than it.

Russia is also a petrostate, but cannot afford such money-burning.

The US is not a "petrostate," even if it's producing as much or a bit more oil than Saudi Arabia.

Publicly traded companies have shareholders to whom to answer, and debt to service to third parties — those Texas and national banks. Privately traded companies still have debt to service.

Yes, both of them also have leases to keep active. But, smaller companies, per my note above, may have to take a hard look at their lack of financial reserves, and negotiate lease buyouts.

Or, like subprime home mortgage holders facing balloon notes, some of the smaller oil companies may have to swallow even harder and do the equivalent of tossing the front door keys on the kitchen counter or in the mail slot.

That's what could be afoot. And, if that's what's up?

Well, in that case, Hegar's biennial revenue estimate could be off by $3 billion, not $2 billion. Beyond a deepened loss of oil and gas revenue will be lost sales taxes from oilfield-related businesses. And, there will be new unemployment claims, as the layoffs are already starting. And less retail, dining and entertainment spending.

Meanwhile, a note to the American Petroleum Industry: now is not the time to be greedy on a wish list.

That said, I'll end this with one last thought. Older Texans remember the savings and loan debacle of the 1980s. I'm not saying that this will be anything like that. But, as compared to previous oil price slumps, because shale oil requires more investment, political leaders should not bank on any "rosy scenarios" offering easy relief. And, they should doubly not bet on frivolous tax cuts that are based on "rosy scenarios."

POSTSCRIPT: What if what I wrote above is itself still too optimistic? There are summer 2015 futures contracts out there, already, for $20/bbl oil.

Meanwhile, Boone Pickens, per this piece, either has a "trick oil knee," or onset of some age-related mental decline or something else, if he really thinks oil will get back to $100 within 18 months, let alone 12.

Pickens has probably also been trumped by the biggest drop in active rigs in six years. The fact is that this is different than 2009, where the Great Recession cratered economies. Yes, there seems to be new signs of slowing growth in both Europe and China. But, not THAT slow. This is still mainly due to an industry-created surplus that's been building for six months. It's going to take 3-4 months to cut the spigots back enough to where that surplus can be mopped up over another likely 6-8 months. So, that's 9-12 months out before we're back to June 2014.

And, Texas Monthly is now weighing in, saying there's a fair possibility of a 1980s-style full oil bust.


PDiddie said...

Well reasoned. I similarly think it's going to be worse than anyone thinks going forward, just because that's how it's been for the last 6-12 months. I was amazed to learn that Gov. Ross Sterling once ordered the Texas National Guard into the oil patches to limit continuing oversupply. (I must have missed that part in Yergin's The Prize). The world of law enforcement has changed a bit since then... but not the law of supply and demand.

Gadfly said...

Yeah, that was right before the formation of the RRC to regulate something besides railroads.