Monday, August 10, 2015

The Christmas ghost of fracking past, present, and future

Peak Oil was generally supposed to mean ever escalating prices as the demand for oil pushed oil/gas/energy exploration further into the sphere of the remote and exotic: aka nuclear power plants to steam the water to melt the tar sands sufficiently to get them to poor.

The current Chinese bubble popping asset collapse has made for an interesting example of reality conflicting with expectations.  Trying to hold both ideas at the same time gets you into cognitive dissonance territory. Holding onto two incompatible beliefs at one time.

So why the fracking boom, and the cheap gas if we are going into peak oil.

Wolf Richter, Wolf Street, 15 March 2015
The boom in US oil production will continue “to defy expectations” and wreak havoc on the price of oil until the power behind the boom dries up: money borrowed from yield-chasing investors driven to near insanity by the Fed’s interest rate repression. But that money isn’t drying up yet – except at the margins.
Companies have raked in 14% more money from high-grade bond sales so far this year than over the same period in 2014, according to LCD. And in 2014 at this time, they were 27% ahead of the same period in 2013. You get the idea. 

So the lesson would be: "In the short run financial bubbles trump the normative pricing mechanisms of supply and demand."  And holding interest rates at zero percent will go a long way toward inducing a leveraged buying boom: the leverage (borrowing) is needed to make up for the insanely low rates of return. A $1 return on a $100 investment might be worth it if you only have to put $1 of your own money down and borrow the rest.  Of course if your $100 investment's value collapses to $50 before you can get sell out, Whoops! You now just lost 50x (rather than 1/2) your capital investment. So when leveraged investments get ugly, they get real ugly.  And they are getting ugly:

Wolf Richter, Wolf Street, 4 August 2015 (hat tip: NC)
Oil plunged again on Monday, with West Texas Intermediate down over 4%. At $45.17 a barrel, it’s just a hair away from this year’s oil-bust low. During 8 weeks in a row of relentless declines, WTI had plunged 26%. July’s 21% drop was the largest monthly decline since the Financial Crisis collapse in 2008.

The idea that Iran's oil production will be legit on the global market, isn't helping.  But Mr. Richter goes on to tell a story of various investment folks throwing good money after bad.  Not really seeing the scale of the Chinese collapse for what it is, they were banking on a return to the previous pricing levels. There doubling-down on their bets kept the money flooding into the supply side of the market. So far that plan hasn't looked so good.

So what does this really mean visa vi "Peak Oil."  It means that a bunch of people have blown a lot of money, and that in the process they have developed a bunch of techniques that should not have been economically feasible at current "normative" demands for oil.  For folks sitting on the sidelines, this is not always a bad deal. It's how fiber optic networks, the airlines, and railroads all were able to expand as rapidly as they did.  The problem is that catastrophic investment collapses (bubbles popping) tend to be highly deflationary.  Market transactions become unprofitable to those holding the assets, so they tend to hold onto them as long as possible.  If it all gets cleared out, eventually normal economic activity starts at a lower, more realistic level.  It's why holding cash during a collapse has often worked very well.  Your cash is now worth more.

So the real question is: If we are going to have to pay a more realistic proportion of our wealth toward energy consumption, what level does all of this "reset" at?


James M Dakin said...

$150 a barrel was NOT unrealistic. But since everything is built on cheap and free flowing oil ( and that everything includes politics and economics, cultural institutions as well as physical machinery ), at that price everything crashed. $100 a barrel was realistic for fracking, barely, or at least barely sufficient to inflate the bubble, and that was bad enough for the rest of the economy. Since there is no right answer, everything that is tried just makes things worse.

PioneerPreppy said...

Not all Peak Oil experts said it would equal steadily rising prices. As Gail over at "Our Finite World" said peak oil would create a roller coaster of ups and downs with higher peaks and lower valleys as it goes along. It makes sense too as the users adjust to high prices demand drops but the producers just keep right on pumping creating gluts and surpluses because they cannot afford to slow down.

$85.00 is commonly assumed to be the break even point of tight oil plays but that varies. Anything under $100.00 a barrel typically makes those companies begin to hemorrhage cash and that will eventually catch up to them.

russell1200 said...

James: And to make it even more fun, the price wasn't even all that particularly high when it crashed. The price of West Texas Intermediate (WTI)hasn't been over $100 since August of 2011.

Pioneer: Some of the oddness of sunk costs can create some strange effects. The sunk costs of farming (seed) will cause farmers to (logically) produce after the marginal return has begun to drop. Add into the various loan covenants that the oil folks are locked into and it makes sense for them to keep going - at least for a while.