US Oil Price Shenanigans Are Coming Home to Roost

With a vengeance. The low prices are threatening to collapse the US oil boom, take away jobs, drag down finances

Wed, Jan 7, 2015
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If it was deliberate it was pretty stupid

This is an excerpt from an article that originally appeared at CounterPunch


“If undercharging for energy products occurs deliberately, it also effects those who introduce these limitations. Problems will arise and grow, worsening the situation not only for Russia but also for our partners.” – Russian President Vladimir Putin

It’s hard to know which country is going to suffer the most from falling oil prices. Up to now, of course, Russia, Iran and Venezuela have taken the biggest hit, but that will probably change as time goes on.

What the Obama administration should be worried about is the second-order effects that will eventually show up in terms of higher unemployment, market volatility, and wobbly bank balance sheets.

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That’s where the real damage is going to crop up because that’s where red ink and bad loans can metastasize into a full-blown financial crisis.

Check out this blurb from Nick Cunningham at Oilprice.com and you’ll see what I mean:

“According to an assessment from the Federal Reserve Bank of Dallas, an estimated 250,000 jobs across eight U.S. states could be lost in 2015 if oil prices don’t rise.

More than 50 percent of those job losses would occur in Texas, which leads the nation in oil production.

There are some early signs that a slowdown in drilling could spread to the manufacturing sector in Texas…

One executive at a metal manufacturing company said in the survey, “the drop in crude oil prices is going to make things ugly… quickly.”

Another company that manufactures machinery told the Dallas Fed, “Low oil prices will drive reductions in U.S. drilling rigs, which will in turn reduce the market for our products.”

The sentiment was similar for a chemical manufacturer, who said “lower oil prices will adversely impact margins.

Energy volatility will cause our customers to keep inventories tight.”

States like Texas, North Dakota, Oklahoma, and Louisiana have seen their economies boom over the last few years as oil production surged.

But the sector is now deflating, leaving gashes in employment rolls and state budgets.” (Low Prices Lead To Layoffs In The Oil Patch, Nick Cunningham, Oilprice.com)

Of course industries lay-off workers all the time and it doesn’t always lead to a financial crisis.

But unemployment is just one part of the picture, lower personal consumption is another. Take a look:

“Falling oil prices are a bigger drag on economic growth than the incremental “savings” received by the consumer…..

Another way to show this graphically is to look at the annual changes in Personal Consumption Expenditures (PCE) in aggregate as compared to the subsection of PCE spent on energy and related products. This is shown in the chart below.

Lower Energy Prices To Lower PCE (Personal Consumption Expenditures):

See? So despite what you might have read in the MSM, lower gas prices do not translate into greater personal consumption or more robust growth.

Quiet the contrary, they tend to intensify deflationary pressures and reduce activity which is a damper on growth.

Then there’s the knock-on effects that crashing prices and layoffs have on other industries like mining, manufacturing and chemical production. Here’s more from Oil Price:

“Oil and gas production makeup a hefty chunk of the “mining and manufacturing” component of the employment rolls. Since 2000, when the oil price boom gained traction, Texas has comprised more than 40% of all jobs in the country according to first quarter data from the Dallas Federal Reserve…

The majority of the jobs “created” since the financial crisis have been lower wage paying jobs in retail, healthcare and other service sectors of the economy.

Conversely, the jobs created within the energy space are some of the highest wage paying opportunities available in engineering, technology, accounting, legal, etc.

In fact, each job created in energy related areas has had a “ripple effect” of creating 2.8 jobs elsewhere in the economy from piping to coatings, trucking and transportation, restaurants and retail….

The obvious ramification of the plunge in oil prices is that eventually the loss of revenue will lead to cuts in production, declines in capital expenditure plans (which comprise almost 1/4th of all capex expenditures in the S&P 500), freezes and/or reductions in employment, and declines in revenue and profitability…

Simply put, lower oil and gasoline prices may have a bigger detraction on the economy than the “savings” provided to consumers.” (The Gasoline Price Myth, Lance Roberts, oilprice.com)

None of this sounds very reassuring, does it? And yet, all we hear from the media is how the economy is going to reach “escape velocity” on the back of cheap oil. Nonsense. This is just more “green shoots” baloney wrapped in public relations hype.

The fact is, the economy needs the good-paying jobs more than it needs low-priced energy. But now that prices are tumbling, those jobs are going to disappear which is going to be a drag on growth. Now check out these headlines I picked up on Google News that help to show what’s going on off the radar:

  • “Texas is in danger of a recession”, CNN Money.
  • “Texas Could Be Headed for an Oil-Fueled Recession, JP Morgan Economist Says”, Wall Street Journal
  • “Good Times From Texas to North Dakota May Turn Bad on Oil-Price Drop”, Bloomberg
  • “Low Oil Prices in the New Year Are Screwing Petrostates”, Vice News
  • “Top US Oil States Are Taking A Hit From Plunging Crude Prices”, Business Insider

Get the picture? If oil prices continue to fall, unemployment is going to spike, activity is going to slow, and the economy is going tank. And the damage won’t be limited to the US either. Get a load of this from the UK Telegraph:

“A third of Britain’s listed oil and gas companies are in danger of running out of working capital and even going bankrupt amid a slump in the value of crude, according to new research.

Financial risk management group Company Watch believes that 70pc of the UK’s publicly listed oil exploration and production companies are now unprofitable, racking up significant losses in the region of £1.8bn.

Such is the extent of the financial pressure now bearing down on highly leveraged drillers in the UK that Company Watch estimates that a third of the 126 quoted oil and gas companies on AIM and the London Stock Exchange are generating no revenues.

The findings are the latest warning to hit the oil and gas industry since a slump in the price of crude accelerated in November when the Organisation of Petroleum Exporting Countries (Opec) decided to keep its output levels unchanged. The decision has caused carnage in oil markets with a barrel of Brent crude falling 45pc since June to around $60 per barrel.” (Third of listed UK oil and gas drillers face bankruptcy, Telegraph)

“Carnage in oil markets,” you say?

Indeed. Many of the oil-drilling newcomers set up shop to take advantage of the low rates and easy money available in the bond market.

Now that prices have crashed, investors are avoiding energy-related junk bonds like the plague which is making it impossible for the smaller companies to roll over their debt or attract fresh capital.

When these companies start to default en masse, as they certainly will if prices don’t rebound, the blowback will be felt on bank balance sheets across the country creating the possibility of another financial meltdown. (Now we ARE talking about a financial crisis.)

The basic problem is that the banks have bundled a lot of their dodgy debt into financially-engineered products like Collateralized Loan Obligations (CLOs) and Collateralized Debt Obligations (CDOs) that will inevitably fail when borrowers are no longer able to service the loans.

The rot can be concealed for a while, but eventually, if prices don’t recover, a significant number of these companies are going to go under which will push the perennially-undercapitalized banking system to the brink once again.

That’s why Washington’s plan to push down oil prices (to hurt the Russian economy) might have made sense on a short-term basis (to shock Putin into submission) but as a long-term strategy, it’s nuts.

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