Interpreting Middle East Economic News and Analyzing Market Trends

More on the myth of the shale oil miracle…


The above video will give you the most comprehensive evidence on why shale oil is headed for disaster.  We have discussed the problems with shale oil in previous posts, most recently here, here and here.  However, we cannot stress the importance of falling oil prices on current shale plays, even though the financial media seem to believe that the industry can weather the current fall in prices.



A recent article in The Telegraph had this to say about Shale Oil:


Based on recent stress tests of subprime borrowers in the energy sector in the US produced by Deutsche Bank, should the price of US crude fall by a further 20pc to $60 per barrel, it could result in up to a 30pc default rate among B and CCC rated high-yield US borrowers in the industry. West Texas Intermediate crude is currently trading at multi-year lows of around $75 per barrel, down from $107 per barrel in June.

“A shock of that magnitude could be sufficient to trigger a broader high-yield market default cycle, if materialised,” warn Deutsche strategists Oleg Melentyev and Daniel Sorid in their report.

Five years ago at the beginning of what has become known as the US shale oil revolution, drillers started to load up on debt to fund their operations and acquire new acreage as vast areas of North America started to open up for exploration.

In 2010, energy and materials companies made up just 18pc of the US high-yield index – which tracks sub-investment grade borrowers – but today they account for 29pc of the measure after drilling firms spent the past five years borrowing heavily to underwrite the operations. The result of this debt splurge has been a spectacular rise in US oil and gas output.

Latest estimates suggest that by the end of the decade the US will have outstripped even Saudi Arabia and Russia in terms of oil production. The development of new shale resources in North America and the opening up of fields in the Arctic seas off Alaska could see the country pumping 14.2m barrels per day (bpd) of oil and petroleum liquids by 2020, up from 7.5m bpd in 2013.

This rush to pump more oil in the US has created a dangerous debt bubble in a notoriously volatile segment of corporate credit markets, which could pose a wider systemic risk in the world’s biggest economy. By encouraging ever more drilling in pursuit of lower oil prices, the US Department of Energy has unleashed a potential economic monster and pitched these heavily debt-laden shale oil drilling companies into an impossible battle for market share against some of the world’s most powerful low-cost producers in the Organisation of Petroleum Exporting Countries (Opec).

It’s a battle the US oil fracking companies won’t win.

The problem is that much of America’s shale oil is expensive to produce and the industry is comprised of numerous small companies who were forced to leverage their operations with debt to fund the high cost of drilling wells through a process known as hydraulic fracturing, or fracking. Should oil prices fall for a prolonged period of time many who have been forced to borrow at a higher rate could be forced out of business and ultimately default.

According to research from JP Morgan Asset Management, of the 12 largest shale oil basins in the US, 80pc are barely profitable, with prices of oil below $80 per barrel. More worrying is that these projections don’t include interest payments on debt made by shale producers.

Read the full article from The Telegraph.

As the video clearly states, the rise of Shale oil since 2006 is directly the result of a rising price of oil, not because of new technology.  Central banks, such as the Fed, also helped juice the boom by keeping interest rates at record lows for so long.  Wall Street banks and investor searching for higher yields went to riskier emerging markets and riskier industries, such as oil drillers and shale producers. 

Nobody is looking at the current problems in MLPs (Master Limited Partnerships), another exotic name for a junk financial instrument popularized after the collapse of CDOs, CDSs and a host of other Wall Street ‘innovations.’  The Wall Street Journal mentions the falling prices of MLPs, which are mainly used to finance energy infrastructure, storage and transportation, in a recent article here, but fails to say why MPLs are falling.  Instead, the article simply says “it’s not entirely clear why.”  What is clear is that the WSJ does not understand how the industry works and how it has been financed.


The bigger problem, however, is environmental.  With rising prices and rising production it was not appropriate to talk about the environmental damaged caused by Shale oil.  Once production slows or stops as we predict, the environmental damage caused by shale will make headlines.