The US Oil Slick is Getting Wider: Oil Boom Going Bust

The Saudis are keeping production high to kill off the US fracking industry

oil boom going bust
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By David Haggith:

Only about a week ago, one reader scoffed at me because oil prices had stabilized (or so the market theory d’jour went). The big stock market crash I had predicted had run its course, he thought. The Saudis and Russia had entered a deal on oil, and Iran was coming on board; the stock market was back up as a result. Everything was normalizing again. Whew! He could write off the doom-and-gloomers.

It was a wet, oily dream — a dream I listened to with detached amusement as oil prices and stock prices rose to support his hopes. How silly, I thought, that these investors all hear exactly what they want to hear. What a bunch of lemmings.

Here is what they should have heard as I would have written the news last week:

The Saudis and Russians agreed this week not to reduce production of oil for months to come but to freeze in place the current high production rates that are crippling the US fracking industry. They also conditioned their freeze at these high production rates on all other suppliers keeping their production rates frozen. In so doing, the Saudis and Russians implied that, if others like the US continue to boost production, they will, too. The price war continues full force.

Iran this week said it might become a party to this deal after it gets its own production rates up to the market share it enjoyed before sanctions. For now it is concentrating on boosting production and sales back to that old level.

That was the upshot of all parties agreeing “to talk.” The real news was clear for anyone with ears to hear if people would just start to listen to things they don’t want to hear: No one is budging. Oil producers are going to keep pumping supplies up at the same high rate for as far as the eye can see, and Iran is going to continue to ramp up production until it gets back to where it was in its pre-sanction days.

There was no good news there at all — not a drop — but people lapped it up as if there was because that’s what they wanted to believe. It’s strange to see so many people crowded around pools of spilled oil surplus, lapping it all up like it tastes good.

The resulting rise last week in speculative oil pricing was beyond silly. The stabilization of the stock market based on seeing oil prices rise shows that investors are running on the thin fumes of mere wishes now. Their heads are filled with carbon monoxide so that they think through a sleepy fog. They bobble like balloons with every little wind of change that blows.

This week, however, we see reality sinking back in as their heads clear a little to see that everything continues exactly as it did before the Arabs and the Russians got together. That, of course, is exactly how I have been saying it is going to continue.

Let’s get down to it: We’re in an oil boom bust

Saudi Arabia’s oil minister says production cuts to boost oil prices won’t work, and that instead the market should be allowed to work even if that forces some operators out of business…. (NewsMax)

You see that? “Production cuts won’t work” means “they’re not going to happen!” So get over it, investors. You’re dreaming of blue skies that are far, far, far away. I don’t see blue. I see seemingly endless fountains of oil, clouding the desert skies for months to come until the spine of the fracking industry in the US lies broken and quivering on the sand with the vultures picking at its meat.

That’s the reality of the US oil industry right now … if you’re willing to step outside of economic denial and see things as they are.

The producers of these high-cost barrels must find a way to lower their costs, borrow cash or liquidate,” Naimi said. “It sounds harsh, and unfortunately it is, but it is the more efficient way to rebalance markets.”

He means fracking companies in the US, which have a high cost of production compared to the cheap Saudi costs of extraction, are going to have to buck up. They can either keep borrowing more cash until they and their banks die from bad loans or just liquidate now. Saudi Arabia’s oil minister admits that sounds tough, and it is tough. What he’s saying, in other words, is, “This is capitalism, so GET USED TO IT! The problem will only be solved when the weak perish! We’re not cutting production in order to help them survive. This problem of oversupply will be settled by the high-cost frackers liquidating. That is the efficient capitalist way.”

And he’s right, but we live in a world that doesn’t understand economics anymore. They think things should happen the way they want them to. The US stock market and the oil speculators last week forgot all about how ruthlessly capitalism works when it corrects speculative boom cycles. The Saudis quite simply are not about to keep trimming back their market share just to help us get richer at their expense. They can produce oil a lot more cheaply than the booming US fracking industry can, so they are going to keep on pumping and drive the US fracking industry largely out of business.

Anybody who believed anything else for one second just was not thinking. Those weren’t sparks of thought that brought the market up. They were just short circuits — brains fried from things that don’t compute after years and years of free Fed money.

Naimi disputed a common view in the industry: that Saudi Arabia has kept pumping oil to protect its market share and undercut shale producers. “We have not declared war on shale or on production from any given country or company,” he said.

He may be a little disingenuous there, but what he’s saying is, “We’re not targeting anyone because of who they are or whether they frack.” The Saudis are, however, protecting market share. They’re just not specifically targeting frackers or the US because they’d love to see Iran crippled, too. What they are targeting is their share of the market and saying, “We’re going to keep producing this amount of oil to fill this share, come hell or high oil supplies, and whoever that takes out … that’s their tough luck. It might be harsh, but that’s the way this is going down!”

And that’s how everyone should have understood the Russian and Saudi agreement in the first place. It’s how I immediately understood it. It’s what I said would happen even before they met. All they really said is that they are not going to expand to try for an even larger share … so long as no one else does.

Why OPEC is taking down the US oil boom

The OPEC rationale is simple. Back in the days when OPEC countries were the main players on the oil sands, they could all agree to cut back production in equal proportions in order to raise oil prices. Now that the US is producing as much oil as Saudi Arabia and is continuallyincreasing its production, any cutback by OPEC is a low spot in the market that US oil just flows right into.

Every time OPEC would cut back in order to increase prices, the US would increase its market share by just continuing to ramp up more production. The US did not, in other words, ever participate in the cutbacks. It just sucked up the slack created whenever the Saudis pulled back on production.

The Saudis saw where that was going and essentially said, “That’s the end of that. We’re not cutting back at all anymore more — not this year, not next. We’re going back to the production we were at and will let normal market dynamics solve the oil supply glut. So, may the best nation win.” Thus, as the oil minister continued to say,

Cutting low-cost production to subsidize higher-cost supplies only delays an inevitable reckoning.

Give up your oil pipe dreams, America, that make you think the Saudis are ever going to trim back production. “The way production will be trimmed,” they are plainly saying, “is by others whose costs are higher going out of business! It’s an inevitable day of reckoning because those with much higher costs will over time certainly be the ones to die out.

The Saudi oil minister concluded that this is just another inevitable oil boom-and-bust cycle. The boom is over; the bust is here. So, don’t even ratchet up your glee a tiny bit just because the Saudis and Russians have agreed not to increase production further so long as no one else does. That only means, they’re not going to make things worse than already are, but they are not going to flex an inch to make anything better either. So get ready for a long, hard ride. This is a war of attrition, and the people with bigger mouths to feed will be the first to die. That is the US fracking companies, starting with the smaller, less diverse companies.

As this news was finally digested, we saw oil prices plummet again this week. Anyone who entered bids in the stock market based on the notion that oil prices had risen and would stabilize a little higher was a wishful thinker. Reality is a harsh task master.

As the real meaning of the Saudi-Russian agreement sank in, oil prices went right back down into the tar pit. I’ve said consistently that is where oil prices are staying for awhile. In fact, with Iran’s production coming on, they are bound to go even lower. And then, when all the tanks in the world are full, crude prices could really go bust because who wants to buy any oil for immediate delivery when they have nowhere to put it? The only boom left is kaboom!

So, give up on the idea that oil prices are going to improve. It’s a Keystone pipe dream that isn’t going to happen. When the market goes up on such news, it just shows how far from reality market thinking is and how desperate for hints of favorable economic news. Those who believe it, wind up looking silly … and poor.

See the original article at The Great Recession.

© Copyright by David Haggith, 2016. All rights reserved.

David Haggith
About David Haggith 52 Articles
David Haggith started writing about the economy after he predicted The Great Recession half a year before it hit and was puzzled as to why no economists or stocks analysts saw it coming. In the months after the crisis broke out, he started to write humorous editorials in a series titled “Downtime,“ which chided the U.S. government and bankers who should have seen the economic collapse coming but whose cronyism, greed and ineptitude caused them to run the world into a ditch. These articles were published in The Hudson Valley Business Journal, The Valley City Times-Record (North Dakota), and The Daily Herald in Tennessee. He is dedicated to regularly criticizing the daily news — not just the content but the uncritical, unthinking nature of almost all of the reporting. Haggith now writes his own blog, The Great Recession Blog, to break down the same news as an equal-opportunity critic toward both Republicans and Democrats / Conservatives and Liberals … since neither kind of politician has done anything worthwhile to help plot a better economic course. His articles are now regularly carried by several economic websites. He has also been the guest on many national and international radio programs.