Christmas Message: Economic Recovery, Bah, Humbug

Contributed by Phil. T. Looker

Albert Finney as Ebeneezer Scrooge
Albert Finney as Ebeneezer Scrooge (source)

These words or something near them were seen in almost every financial newspaper and website today:

“Oil prices have dropped $50 a barrel. That may not sound like much. But when you take $107 and you take $57, that’s almost a 47 percent decline…!”

To certain people not unconnected from this blog who have an easy come, easy go attitude to money this may not sound like a big deal. When the accountants and maths geeks get busy with their scientific calculators, the decline starts to look catastrophic.

The Financial Pundits seem to think so anyway. And even Ian has to agree for one the meths geeks are right. So what’s going on?

Many people who have spent the last couple of years hailing the shale revolution and crowing about the economic boom it would usher in (never mind the serious environmental concerns about fracking). Being traders rather than accountants they failed to understand the downside side of shale’s effect on business. The significance of little things like the fact that much of the day-to-day shale operation was being run on junk bond financing. Thus they had no problem in convincing themselves that in the future every day would be Christmas. Sorry but I have to be Scrooge and tell you the bubble just burst.

The bubble floated well in the zero gravity environment of zero interest rate policy (ZIRP) where investors desperate for “yield” — i.e. a better return than sweet FA on their money — ended up in the bond market’s junkyard. These investors, it turned out, were the big institutional concerns, pension funds, insurance companies, mixed bond investment trust funds. ZIRP was killing them.

In the good old days of the late 20th century boom-and-bust they would see an annual interest rate of between 5 and 10 percent which enabled them to fund their obligations, i.e. pay pensions, settle insurance claims, cover company salaries and have a bit left over for a Christmas jolly.

ZIRP ended all that. In fact zero interest destroyed the most important index in the financial world: the true cost of borrowing money. It also destroyed the entire relationship between borrowed money and the cost-structure of the endeavors it was borrowed for. Shale oil is the prime (or sub prime) example.

The fundamental constraint for investing in shale oil was that the wells were only good for about two years after which they were pretty much fracked,(hence that was the contstraint nobody in the entire fracking world talked about).

So, if you were in that business, and held a bunch of leases, you had to constantly drill baby drill and drill and drill again just to maintain production. Drilling costs between $6 and $12-million per well.
Over the past seven years is that the drillers and their investment bankers, aided and abetted by the kind of scientists who deal in mathematical models, theory, speculation and guesswork hyped the holy shite out of the shale fracking business (the scientists had no qualms about building mathematical models that exaggerated the oil and gas yield from wells by 96% with makes even the climate science fraud look reasonable).

It was not a shale revolution but another Ponzi scheme, it was Enronomics all over again; as long as the money kept rolling in they could pay out the early investors and boost confidence in their scam. In the few short years they drilled the results looked so impressive that to quote the song Evita sings “The money kept rolling in”. It was going to save the American economy, it was going to chain the Russian bear, it was going to put the arabs in their place and restore the status quo.

Sadly the shale oil and gas economic “miracle” was a rerun of the dotcom bubble, the housing bubble, the South Sea bubble, the Tulip bubble (which we generally accept was the first investment bubble). It was deja vu all over again. The frackers sucked so much oil out of the ground in a short period of time that they killed the goose that laid the black, slimy egg; in response to American over production the Arabs cut their prices, demand for oil at a price that made it worth drilling for just dropped away.

The current stage (stage 4?) will see much of the junk financing default, bankers will steer clear of junk financing just as they steer clear of sub prime mortgages now, and a lot of planned wells will be abandoned, meaning that the current crop of wells will crap out within two years, and production will not be replaced by new wells because there is no money in it (it may come as a surprise to lefties but the objective of business is to make a profit. Still, on the bright side, all those wannabe protestors can go home and spend Christmas with their dear old Mum, no point protesting against something that ain’t gonna happen.

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