Watching Oil Big Boys Drown The Competition


If there is one sure bet in all of commodities trading, it is that oil speculating is an art of observation balanced against the power players.  That being the case, $40 per barrel (or thereabouts) crude oil for months, was, well, expected even if some legends missed it.

Despite T. Boone Pickens’ prediction that oil would bounce back to $70ish sometime in 2015, oil is still in the $40s after being there for a couple months, and is showing no sign of budging.  Pickens seems to think this is because Saudi Arabia and OPEC want to remain in power.  Maybe so.  But about a year ago, the speculation was that sometime in 2015, oil would be at $40 a barrel for quite a while in order to drive out the start-ups and the newer frackers in the American marketplace – and that wasn’t coming from OPEC watchers so much as it was people who keep tabs on Big Oil in the United States.

The USA might have one of the largest stores of petroleum in various forms still in the ground, but can’t let too many people profit from it, you know.

The idea behind $40 oil was to hold the price there long enough to drive the small fish to sell out or out of business altogether as that’s roughly the break even point.  In West Texas, this reality is playing out with painful results:

From oil and gas companies to municipalities that depend on oil tax revenue to Wall Street firms that issued debt to drillers, many parties are watching the Permian Basin’s players—especially smaller, newer ones—closely.

Larger, more cash-flush players are already quietly gobbling up assets from smaller, private, harder-hit companies that have hedges expiring and debt payments coming due. In many cases, it’s not a merger or acquisition, but the sale of operating assets—active wells—that is the focus of deals.

The expectation is that there will be bankruptcies—and if crude stays low, maybe a large number of them. A credit crunch is already beginning to take root as debt payments come due and financiers remain skittish about extending more credit. Many operators have key hedges expiring next year, or for those better-positioned, in 2017. If the Federal Reserve begins raising interest rates, that will take its toll as well—not only making debt more expensive, but likely adding more strength to the dollar, which in turn will continue to weigh on commodity prices.

When crude prices were high, the little fish spent other people’s money.  Now that the wells are drilled and operational (even if not all are operating at this point), and the major expenses are out of the way, but the loans still need to be paid back, the big boys are buying up the work that’s already been done since the product price is too low for the entrepreneurs to actually afford the loan payments.  (Tell me if you’ve heard this before.)  Just like was predicted.

What is interesting about this is that Saudi Arabia, specifically, is still producing oil to the tune of a million barrels a day.  Traditionally, the Saudis have played the role of stabilizer pulling back production during times of too much of the black, sticky stuff being available, and going to the other extreme when there isn’t enough to keep prices affordable.  This role is called “swing producer” and with all the alternative ways to bring petroleum to market developed here – and that it is illegal to export US oil – the United States is sliding into that spot…all while thinning the herd as it were with oil prices being low enough that the little guys are being forced to sell out, and their production is gradually taken offline, and exploration comes to a halt.

Indeed, we should expect an even sharper reduction in U.S. energy output as persistently low prices increase the pressure on domestic producers. From the shutdown of additional rigs to the curtailment of new investment in exploiting shale resources, the U.S. will likely experience a fall in its absolute energy production, as well as in its share of world output.

So, is this really Saudi Arabia trying to maintain power, or, as was predicted last year, is it the U.S. producers drowning their competition in oil in order to buy up assets at bargain basement prices like George Soros did with coal.  Interesting question.  And even more interesting that in the process of keeping oil at $40 a barrel both effects are panning out just like the more nasty predictions said.

About the Author

Cultural Limits
A resident of Flyover Country, Cultural Limits is a rare creature in American Conservatism - committed to not just small government, Christianity and traditional social roles, but non-profits and high arts and culture. Watching politics, observing human behavior and writing are all long-time interests. In her other life, CL writes romance novels under her nom de plume, Patricia Holden (@PatriciaHoldenAuthor on Facebook), and crochets like a mad woman (designs can be found on Facebook @BohemianFlairCrochet and on Pinterest on the Bohemian Flair Crochet board). In religion, CL is Catholic; in work, the jill of all trades when it comes to fundraising software manipulation and event planning; in play, a classically trained soprano and proud citizen of Cardinal Nation, although, during hockey season, Bleeds Blue. She lives in the Mid-Mississippi River Valley with family and two cute and charming tyrants...make that toy dogs.