Understanding Oil Prices

[explanade]

Note that also the low prices will wring out inefficiencies in the proceedures used in drilling and completing the wells. This will over time reduce the break even price just as directionally drilling multiple wells from one pad has done (once you go directional, one can drill wells in different directions from a single site)

Is there a chance that environmental regulators crack down on the fracking processes, like the proprietary liquids they use, controlling the release of methane, etc. to raise the costs?

 

[aja8888]

Is there a chance that environmental regulators crack down on the fracking processes, like the proprietary liquids they use, controlling the release of methane, etc. to raise the costs?

In very simple terms for those who believe the talking heads in the news:

Oil companies have been "fraccing" wells since the 1940's. The perceived issues have been hyped beyond belief, kind of like Ebola to some extent.

These new wells are upwards of 3 miles under the ground and not hydraulically connected to useable groundwater supplies. Most chemicals used in formation fracturing and completion are high pressure water, sand, and diesel fuel. Controlled expolsive charges are set off in the well bore to initially fracture the formation.

EPA has not found one case in the U.S. of any shale or deep horizontal well that has caused a documented problem with water resources.

For a new shale well (Bakken, Eagle Ford) the cost is about $3-4 MM to drill it and $6-7 MM to frac it and complete the well. These are horizontals.

This is not the wild, wild, west remember.

 

[eytonxav]

Shades of the tech bust thinking circa 2001?

I don't think OPEC will allow this to happen indefinitely, so from my perspective, this phenomena will not become the new normal. Now if an alternate and cheaper form of energy comes along, that would be a game changer, but those developments will slow up if this persists. Anyhow, I am willing to go over weight when an asset class is cheap.

 

[Mulligan]

I don't think OPEC will allow this to happen indefinitely, so from my perspective, this phenomena will not become the new normal. Now if an alternate and cheaper form of energy comes along, that would be a game changer, but those developments will slow up if this persists. Anyhow, I am willing to go over weight when an asset class is cheap.

Why I am still hesitant is while the oil asset is "cheap", I worry the stocks themselves are not (I am referring to the bigger oil producers, not oil equipment and services, etc.). These stocks have not came down nearly as far as oil, so I wonder if there is another shoe to fall when earnings get reported the following quarter. Then I have read many companies have their oil price hedge out through second quarter next year which would cause them to continue current production levels. Clearly you can see where I am heading. Paralysis by analysis and I will miss the buying opportunity waiting for it to fall "just a little bit more".


Sent from my iPad using Tapatalk

 

[Running_Man]

One of the most complicated subjects ever. Trying to understand the reasons why crude oil could drop 45% in less than 6 months is a mind bending exercise.
There are so many factors that influence the barrel price that any five or six that you could pick, would be only a beginning.
Worldwide economic situations on a by-country basis are just a part of the overall price fall, though indicative of the shaky GDP in the largest nations.
While the low price is being touted as a chance to grow the US GDP, the offset in job loss may prove a cure worse than the disease.
China, Russia, OPEC, Venezuela and a score of other countries are in the middle of this change.

This article mentions some of the individual factors:
Ten Reasons Why A Sustained Drop In Oil Prices Could Be Catastrophic

Following the pundits on TV and in the financial media only adds to the confusion. This week, so far, the VIX is up 56%... confirming the uncertainty.

And so we're left to wonder if the $15 we'll save at the pump will be worth it. The noise factor suggests a new $1/gal tax to pay for infrastructure. At the same time, is the worry about leaving the oil in the ground would leave a return to higher prices with higher taxes.

Has anyone here seen a comprehensive explanation that makes sense?

... and yes, I know that there are other threads on the subject of investment in oil stocks. The future of oil as a factor in international economic stability will be extremely important in the near term.

I read the article you linked and do not disagree with his conclusion about this coming as an end to debt financing. Most of the financing for oil production has occurred in the junk bond markets after the conclusion of the subprime mess as the central banker's zero rate interest policies made real assets to be a place you could raise massive amounts of capital these projects required at very cheap interest rates. Russia at the start of the year was at 5% interest rates, toal debt up 25% at the start of this year from Jan 2013 levels and today their central bank raised interest rates to 17 percent.

For me the reason the oil market held up until summer was the market's belief that no matter what OPEC would adjust down production to maintain pricing. Now that the surge in production that is due to begin next year is arriving at the same time as a decline in worldwide oil demand reality is being priced in. It seems obvious that OPEC looked at the present financial vulnerability of the oil producers in North America being in a bubble made possible by cheap financing and have taken a long term view that there may need to be a 1-2 year period where they let oil find it's own price, meaning they don't cut production and eliminate a growing competitive threat. This was not expected and the goal is to bankrupt the competition and stop further production from coming online, which is likely if OPEC does not adjust their production. If production in North America is stopped and these producers go out of business, cheap financing will not be available to make these projects available in the future.

Something to consider is that the price of natural gas for decades was priced very closely to oil in energy equivalence and at recent prices would be at 32 dollar oil.

This oil decline is a highly deflationary move to the economies of the world and the idea that this is stimulative seems incredulous to me how many people truly believe oil declines are good for the economy. A 1.3 trillion dollar per year revenue stream is being taken away at present prices, with oil valuations of earning assets being priced at 3X EBITDA this means an additional decline of 5 trillion in the value of the assets producing the world's oil, whether those are junk financed assets or AAA assets.

This is the reason you are seeing the Ruble, the Candian Dollar and the Kroner fall. This has impacted Emerging market stock markets to fall to where they were in Sep and real effects have not even occured. Russia fell first because oil is laying bare the fact they will not have revenues to pay their debt, Norway has a sovereign fund where they invested their excess oil reserves in stock markets around the world, if the price of oil stays down, their plan is to balance their budgets and social costs by selling their sovereign fund assets, about one trillion dollars in total, these assets support the lifestyle of 5 million people and this fund owns 2 percent of the total stock market of Europe.

Petrobas in Brazil is not even capable of producing financial results for the 3rd quarter, this means you probably have 2 countries with a total of 5 trillion dollars in GDP (Russia & Brazil) that are probably bankrupt as a result of this oil price decline.

The interconnected pieces are to me so much more complex than consumers save 1.3 trillion to pay for other goods. This is an unepected decline built from ironically enough LTCM which required in 1998 as a result of the Russian and Brazil financial collapse not following the Nobel prize winning theory of market implementation. 3.6 Billion from the Federal Reserve was required to save the markets then. The resulting lower interest rates over the following years to prevent financial impairments have led to this point in the debt cycle, we will see if this is really a positive boon for the economy, I sure hope it is and I am totally wrong about the complexity of the transactions being far too complex for any central bank to possibly understand.

 

[imoldernu]

I read the article you linked and do not disagree with his conclusion about this coming as an end to debt financing. Most of the financing for oil production has occurred in the junk bond markets after the conclusion of the subprime mess as the central banker's zero rate interest policies made real assets to be a place you could raise massive amounts of capital these projects required at very cheap interest rates. Russia at the start of the year was at 5% interest rates, total debt up 25% at the start of this year from Jan 2013 levels and today their central bank raised interest rates to 17 percent.

First... thank you for your time to produce this thoughtful analysis. It deserves re-reading.
Watching the central banks and the actions of the governments that are in the most trouble (Japan, Russia, China, Brazil, Venezuela, and a score of smaller countries), indicates a bubble that will not be easily deflated or perhaps reflated.

The common thinking seems to be that as cheap oil becomes available, the more expensive sources of US oil will be temporarily shut down, that OPEC will then raise rates, and the oil market will recover. That remains to be seen.

In any case, the thought that lower priced gasoline will boost the economy and create jobs may be wishful thinking.

The most interesting part of this unusual spike, is the reaction of the financial analysts. Extremes of opinion.

The interconnected pieces are to me so much more complex than consumers save 1.3 trillion to pay for other goods. This is an unepected decline built from ironically enough LTCM which required in 1998 as a result of the Russian and Brazil financial collapse not following the Nobel prize winning theory of market implementation. 3.6 Billion from the Federal Reserve was required to save the markets then. The resulting lower interest rates over the following years to prevent financial impairments have led to this point in the debt cycle, we will see if this is really a positive boon for the economy, I sure hope it is and I am totally wrong about the complexity of the transactions being far too complex for any central bank to possibly understand.

Adding to the general confusion is the not-well-understood difference between inflation, deflation and disinflation. The time differential in disinflation could mask a long term negative change in international markets. The recent addition of the rollback of parts of Dodd Frank, may well serve to extend a hiatus of debt reconciliation. The mind of the FED is either inscrutably wise, or exceptionally naive.
(my opinion only)

 

[target2019]

This oil decline is a highly deflationary move to the economies of the world and the idea that this is stimulative seems incredulous to me how many people truly believe oil declines are good for the economy.

A lot of what comes from the media is repeated as if it were researched and discussed. It's mostly short-term thinking, though. There probably was an immediate boost to consumer spending, but the effect as we get months into the oil price reductions will not play out as "they say."

 

[Fermion]

If the price of cheap oil comes at the collapse of the US shale industry, I think the working joe will find he has cheap gas but no job to drive to.

 

[aja8888]

If the price of cheap oil comes at the collapse of the US shale industry, I think the working joe will find he has cheap gas but no job to drive to.

Construction jobs....building more Walmarts and Costcos to move the cheap Chinese goods even more. Where we live north of Houston, there are 7 Super Walmarts in a 10 mile radius and a new Costco just went up in two months (next to the new Mercedes dealer).

The shale oil and gas industry won't go away. We still need lots of gasoline in this country and also natural gas. The price to obtain leases and drill new wells will decrease to bring on new wells. This always happens.

 

[Fermion]

Construction jobs....building more Walmarts and Costcos to move the cheap Chinese goods even more. Where we live north of Houston, there are 7 Super Walmarts in a 10 mile radius and a new Costco just went up in two months (next to the new Mercedes dealer).

The shale oil and gas industry won't go away. We still need lots of gasoline in this country and also natural gas. The price to obtain leases and drill new wells will decrease to bring on new wells. This always happens.

Great. So our trade deficit becomes even larger as we import more Chinese goods for our superstores and import more oil because it is cheaper to import than produce ourselves.

If you play the very long game, I don't see how that is a positive for the USA.

 

[aja8888]

Great. So our trade deficit becomes even larger as we import more Chinese goods for our superstores and import more oil because it is cheaper to import than produce ourselves.

If you play the very long game, I don't see how that is a positive for the USA.

I agree.

 

[audreyh1]

I don't think the shale oil industry is a big enough part of the US GDP to cause a great deal of harm. I don't believe it will "collapse" either, just slow down quite a bit. Yes, we will lose some jobs there, but we may gain jobs in another places as a result of lower oil prices benefitting other industries. A shock of this nature always has ripples, but I believe they will eventually settle.

 

[REWahoo]

...import more oil because it is cheaper to import than produce ourselves.

If you play the very long game, I don't see how that is a positive for the USA.

Any merit to saving our petroleum resources and using up the other guy's first?

 

[dallas27]

This oil decline is a highly deflationary move to the economies of the world and the idea that this is stimulative seems incredulous to me how many people truly believe oil declines are good for the economy. A 1.3 trillion dollar per year revenue stream is being taken away at present prices, with oil valuations of earning assets being priced at 3X EBITDA this means an additional decline of 5 trillion in the value of the assets producing the world's oil, whether those are junk financed assets or AAA assets.

Lower prices on any commodity are ultimately positive for society. When prices>production cost, that means the producer is restricting supply and maximizing profit at expense of the consumer. "Social Surplus" is NOT maximized.

Yes the companies margins are higher (becuase they have market power and are influencing the market at the expense of the consumer), but consumers are not getting as much product as they can use.

As we push the price closer to the equilibrium of supply and demand, social surplus increases. Yes the oil companies run tight on profit, but society overall gains, from a basic microeconomic viewpoint.

In real life, change hurts, so this is a messy transistion (or even temporary), not a simple set of line equations. If lower prices do stick around, there will be winners and loser, but overal, mankind benefits. (I'm ignoring all pollution externalities, that's another conversation)

 

[Chuckanut]

What I find fascinating is the number of people who think lower oil and energy prices are going to hurt the economy. Certainly, there will be winners and losers. But overall, I expect far more winners than losers.

This should be a huge boost for our economy and may even help get our anemic recovery up to speed.

 

[dallas27]

I think what we can all agree on is STABILITY is best for business. High or low prices, uncertainty stalls progress/investment.

 

[Lsbcal]

What I find fascinating is the number of people who think lower oil and energy prices are going to hurt the economy. Certainly, there will be winners and losers. But overall, I expect far more winners than losers.

This should be a huge boost for our economy and may even help get our anemic recovery up to speed.

Maybe the ones who will be disproportionately hurt will loose jobs or large dollar investments. They are the ones who are most exposed to the energy industry. Their stories might be played up in the press a bit more.

For each one of these there are many more who will have a few bucks more for spending. I don't know what that ratio is, but it's probably more then 10:1.

 

[Brat]

Here is my take: the price of oil is purely a supply and demand issue. Right now the suppliers are willing to produce notwithstanding the fact that lower demand is driving the price down, precipitously. Who am I to understand the production why.. it just is.

What will be the impact of this precipitous price drop? Russia and Iran, perhaps ISiS, depend on oil revenues. They will see significantly less income which might contribute to political instability/deal making. In North America many new producers will be in a price squeeze... loans based on higher prices are in jeopardy as is the exploration infrastructure. [reflect for a moment on the big bank deal just cut in the funding legislation. Think they saw that coming?]

Refiners, to the extent that they don't have a lot of contracts based on old crude costs, will do fine. Consumers will be happy. Natural gas prices are lower but most utilities have existing contract rates so the consumer won't see a drop in the near term but natural gas utilities will keep the spread.

Messy fall out: Russia from a political, not global economic POV; higher yield bonds in the US. The rest, in the US, will be a difficult shakeout in oil service companies.

My $0.02.

 

[explanade]

Gov. Cuomo bans fracking in NY state due to health concerns.

Some economically depressed communities in the state had been pushing for it, so that they could reap the economic benefits.

But Cuomo had faced challenges from the more liberal part of his party over the issue:

http://www.nytimes.com/2014/12/18/n...-new-york-state-citing-health-risks.html?_r=0

 

[aja8888]

Gov. Cuomo bans fracking in NY state due to health concerns.

Some economically depressed communities in the state had been pushing for it, so that they could reap the economic benefits.

But Cuomo had faced challenges from the more liberal part of his party over the issue:

http://www.nytimes.com/2014/12/18/n...-new-york-state-citing-health-risks.html?_r=0

Reading the above article doesn't specify or provide a link to the the testing data that has confirmed health concerns? Am I missing something here?

 

[explanade]

I think it's mostly about the political aspect.

Sounds like their health dept. issued a separate report.

Guessed the telling thing is, would you want to live where fracking is occurring. Some NY residents in the area near the PA border stood to make over a million from fracking rights, while 3 miles across the border, some people made out well.

 

[ERD50]

Reading the above article doesn't specify or provide a link to the the testing data that has confirmed health concerns? Am I missing something here?

Maybe they updated it, I saw this link:

http://www.nytimes.com/interactive/2014/12/18/nyregion/new-york-state-fracking-report.html

Haven't read it yet, so can't comment on content, but I thought this was interesting wording:

The Cuomo administration decided to ban hydraulic fracturing after concluding that the method posed inestimable public-health risks. DEC. 17, 2014.

inestimable? They can't estimate the risks? Hmmmm.

-ERD50

 

[aja8888]

Gosh, pages 11 & 12 (Conclusions) really tell the story on the quantified risks. I can't copy it so you will have to read it online.

I've done oil & gas work all over western NY and also northern PA and western Ohio. NY only has stripper wells in most western areas that are near end of life. No real need to do anymore drilling there as the communities are small and do count for many votes in NY.

On the other hand, Ohio is going gangbusters with production in the Utica Shale. No complaints there and lots of new gas and jobs.

BTW, these plays are mostly gas and very little oil.

 

[imoldernu]

A different view:

In September, Kerry visits the Saudi's...
The win-win scenario:
Saudi's worried about their neighbors Syria and Iran...
Saudi's have virtually unlimited oil..
Russia cozy with Iran and Syria.
US worried about a China collapse.
Saudi's sell oil below market $50 to China.
This destroys Russia and Iran economy.
Stops the Iran bomb threat
Gives China a lifeline.
US wins!

 

[Brat]

Works for me.