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Why The Oil Price Collapse Is The Fed's Fault

Tyler Durden's picture




 

Submitted by Arthur Berman via OilPrice.com,

The present oil price collapse is because of over-production of expensive tight oil. The collapse occurred because of the inability of the world market to support the cost of the new expensive oil supply from shale, oil sands and deep water. Demand was progressively destroyed during the longest period of sustained high oil prices in history from 2010 through 2014.

Since the early 2000s, the price of oil was largely insensitive to the fundamentals of supply and demand as long as prices were less than about $90 per barrel. The chart below shows world liquids supply minus demand (relative supply surplus or deficit), and WTI oil price.

WorldLiquidsSurplus

Figure 1. World liquids relative surplus or deficit (production minus consumption) and WTI crude oil price adjusted using the consumer price index (CPI) to real February 2015 U.S. dollars, 2003-2015. Source: EIA, U.S. Bureau of Labor Statistics, and Labyrinth Consulting Services, Inc.

(click to enlarge image)

In mid-2004 and mid-2005, the relative supply surplus was much greater than it has been during the 2014-2015 price collapse yet prices continued to rise. When oil traders perceive supply limits and rising prices, price below some critical threshold is not an issue. They are willing to carry the cost of storage and interest to hold the commodity in the future when it will be more valuable.

In 2004, the relative supply surplus reached 1.9 million barrels per day and in 2005, it reached 4.1 million barrels per day. By contrast, the greatest supply surplus in the current oil price collapse was 1.7 million barrels per day in January 2015.

During periods of supply surplus in 2004 and 2005, prices were less than $75 per barrel. The average WTI oil price between November 2010 and October 2014 was $91 and for 18 months of that period, prices were more than $100 per barrel.

Oil prices have collapsed three times because of demand destruction: in 1979, 2008 and 2014. In all of these cases, oil prices exceeded $90 per barrel in real 2015 dollars for extended periods. The chart below shows WTI oil price* from 1970 to the present with periods when price exceeded $90 per barrel highlighted in red.

WTICrudeOilPrice

Figure 2. WTI crude oil price adjusted using the consumer price index (CPI) to real February 2015 U.S. dollars. Areas in red represent periods when oil prices exceeded $90 per barrel. Source: U.S. Bureau of Labor Statistics, EIA and Labyrinth Consulting Services, Inc.

(click to enlarge image)

Oil prices were more than $90 in 1979-1981 for 26 months; in 2008-2009, for 13 months; and in 2010-2014, for 33 months. 2010-2014 was the longest period of oil prices above $90 in history. There were other factors at work in all three of these high oil-price episodes and their subsequent periods of price collapse.

In 1979, the trigger for oil-price increase was the Iranian Revolution and the Iran-Iraq war. More than 6 million barrels of oil were removed from world supply. Oil prices rose from $50 to $115 per barrel (in real 2015 dollars) between January 1979 and April 1981. Then, new production from the North Sea, Mexico, Alaska and Siberia flooded the market. By March 1986, prices had fallen to $27 per barrel. OPEC cut production by 14 million barrels per day but oil price was unaffected because of a combination of demand destruction, crippling interest rates, and new supply from non-OPEC countries. Prices did not begin to recover until 2001.

So far, the current oil-price collapse is nothing like this. Surplus production is about 1.0 to 1.5 million barrels per day, interest rates are near zero, and demand recovery appears strong from early data.

The oil-price collapse and Financial Crisis of 2008 were preceded by 11 consecutive months of relative supply deficit and price increase (Figure 1 above). This was largely because of a surge of consumption by China and low OPEC spare capacity. Oil prices approached $150 per barrel in June 2008, the highest price ever reached, and then collapsed below $40 by February 2009.

The record price of oil was an underlying cause of The Financial Crisis. It increased the cost of global trade, produced inflation and higher interest rates that contributed to real estate loan defaults, and caused demand destruction for oil and other commodities.

Weak demand for all commodities and loans remains a chronic artifact of the years since 2008 despite the best efforts of central banks to correct the problem.

Oil prices rebounded fairly quickly after 2008 because of a 4.2 million barrel per day production cut by OPEC in January 2009 (Figure 1). Another reason for increasing oil price was the devaluation of the U.S. dollar by the Federal Reserve Board by lowering interest rates and increasing the money supply. The chart below shows Federal Funds interest rates and the price of oil.

FederalFundsInterestRates

Figure 3. Federal funds interest rates and WTI oil price in 2015 dollars, January 2000 – January 2015. Source: Board of Governors of the Federal Reserve System, EIA, U.S. Bureau of Labor Statistics and Labyrinth Consulting Services, Inc.

(click to enlarge image)

Oil prices rose with a weak U.S. dollar and interest rates near zero in 2009. Other factors, notably the Arab Spring uprisings in the Middle East, also contributed to the price increase.

As prices passed $80 per barrel in late 2009, tight oil production began in earnest. Low interest rates forced investors to look for yields better than they could find in U.S. Treasury bonds or conventional savings instruments. Money flowed to U.S. E&P companies through high-yield corporate (“junk”) bonds, loans, joint ventures and share offerings. Although risk was a concern, these were investments in the United States that were theoretically backed by hard assets of oil and gas in the ground.

 

In the first half of 2012, flagging demand caused a relative supply surplus of 3.5 million barrels per day (Figure 1 above). WTI oil prices dropped below $90 but by early 2013, prices returned to the high $90-to-low-$100 per barrel range.

Tight oil boomed after late 2011 when oil prices moved higher than $90. An endless flow of easy money was available to fund spending that always exceeded cash flow. The table below shows full-year 2014 earnings data for representative tight oil E&P companies.

2014TightOilEarnings

Table 1. Full-year 2014 earnings data for representative tight oil exploration and production companies. Dollar amounts in millions of U.S. dollars. FCF=free cash flow; CF=cash flow; CE=capital expenditures. Source: 2014 10-K filings, Google Finance and Labyrinth Consulting Services, Inc.

(click to enlarge image)

These companies out-spent cash flow by 25%, spending $1.25 for every $1.00 earned from operations. Only 3 companies–OXY, EOG and Marathon–had positive free cash flow. Total debt increased from $83.4 to $90.3 billion from 2013 to 2014. Debt must be continually re-financed on increasingly poorer terms because it can never be repaid from cash flow by many of these companies.

The U.S. E&P business has, in effect, become financialized: investment in this class of company has become the sub-prime derivative of the post-Financial Crisis period. There is no performance requirement by investors other than the implicit need to maintain net asset values above debt covenant trigger thresholds.

These terrible financial results reflect a year when average WTI oil prices were more than $93 per barrel. First quarter 2015 earnings will make these results look good.

The immediate cause of the present oil price collapse is found in increasing production and, to a less obvious extent, decreasing demand that began in January 2014 as shown in the chart below. Markets react slowly and it was not until June 2014 that prices began to fall.

WorldLiquidsSupplyDemand

Figure 4. World liquids supply and demand, July 2013-February 2015: Source: EIA and Labyrinth Consulting Services, Inc.

(click to enlarge image)

This was the manifestation of longer-term demand destruction following nearly 3 years of oil prices above $90. The chart below shows the same world liquids data as in Figure 1 but with demand (consumption) expressed as a percentage of supply (production).

WorldLiquidsConsumption

Figure 5. World liquids demand (consumption) as a percent of supply (production) and WTI crude oil price adjusted using the consumer price index (CPI) to real February 2015 U.S. dollars, 2003-2015. Source: EIA, U.S. Bureau of Labor Statistics, and Labyrinth Consulting Services, Inc.

(click to enlarge image)

Figure 5 shows that demand as a percent of supply was generally increasing until about September 2007 and has been generally decreasing since then. Especially weak demand since early 2014 is merely the most extreme expression of a trend that has been active for more than 7 years.

The present oil-price collapse is, therefore, because of long-term high oil-price fatigue. It reached a crescendo in mid-2008 when oil prices exceeded $140 per barrel but was not specifically recognized as more than another of the factors that contributed to the Financial Collapse that followed. It is now clear that oil price was a central cause of that collapse.

The artificial low interest rates that have been imposed by central banks since the Collapse have weakened the U.S. dollar and pushed the price of oil above $90 per barrel for the longest period in history.

The quest for yields in a low interest rate world led investment banks to direct capital to U.S. E&P companies. Capital flowed in unprecedented volumes with no performance expectation other than payment of the coupon attached to that investment. Tight oil boomed despite poor financial performance.

The current oil-price collapse is because of expensive tight and other unconventional oil and the market’s inability to support its cost. $90 per barrel WTI price appears to be the empirical threshold for demand destruction. Only the best parts of core areas of the Bakken and Eagle Ford shale plays make some profit at $90 per barrel and almost nothing makes money at present oil prices.

Low price will eventually cure weak demand. At the same time, the effect of reduced oil and gas spending on the U.S. economy is unclear but a weaker economy could lower demand despite low prices. Allen Brooks and Euan Mearns have explained the case for demand destruction in excellent detail.

The present oil-price collapse is severe because of the accumulated, long-term price fatigue that has existed since late 2007. Although the immediate cause of the collapse is over-production of tight oil, the key to recovery is demand.

Demand is more difficult to cure than over-supply so that is where efforts must be directed. Over-production of non-commercial tight oil must slow and eventually stop before the market can balance itself. I am more optimistic than most that this is already underway but it distresses me to see increased capital flow thus far in 2015 to what Christopher Helman aptly calls “zombie” companies.

The problem is structural and systemic and firmly rooted in the irresponsible funding of under-performing U.S. tight oil companies since at least 2010. The first step to price recovery is the severing of capital supply to companies that could not fund their operations from cash flow when oil prices were more than $90 per barrel. If this does not happen, we could be in for a long period of low oil prices.

 

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Tue, 04/07/2015 - 21:42 | 5969146 buzzsaw99
buzzsaw99's picture

i gotta call bullshit on the demand destruction angle. if anything artificially high prices brought on by the fed gangsters and their henchmen the speculators caused overproduction. if the fed had storage tanks the price would probably be double what it is today.

Tue, 04/07/2015 - 23:13 | 5969449 chilli sauce
chilli sauce's picture

I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... www.globe-report.com

Tue, 04/07/2015 - 23:44 | 5969471 TruthInSunshine
TruthInSunshine's picture

Oil is going to $25, maybe $20 for the exact reasons cited by this article, a d just about every other asset class pumped full of cheap, EZ central bank (plural) fiat/debt/credit - from bonds to art to collectible cars to equities to whatever - is going to do a bubble-bursting cliff dive.

It's inevitable & guaranteed.

p.s. - I'm on a tablet now, but did anyone else get an oilprice.com certificate pop-up and then OS issues after permitting the certificate?

Wed, 04/08/2015 - 01:03 | 5969679 rocker
rocker's picture

You got to love it. Peak Oil. Peak Oil. Peak Oil. Peak Oil. .......... WOW     

"In 1979, the trigger for oil-price increase was the Iranian Revolution and the Iran-Iraq war."

Step 1.  Yes, it was a big trigger. Tax breaks for the rich at a time of "Made up Wars".  Deflate the dollar.

Step 2.  A 10 year war using and burning up all excess oil supplies and reserves. Make Texas and the Koch bros Rich.

Step 3, Create a sludge fund to charge the government for overpriced, no bid contracts for the same Oil.  Can you say Haliburton.

Step 4. Create a new government department because you don't want the CIA, FBI or Secret Service to find you out. Can you say, "Homeland Security"

Oh yes, it was a trigger to never be told by the MSM who worships "The Powers To Be" scared of.   "Mission Accomplished".  

Wed, 04/08/2015 - 01:55 | 5969729 greyghost
greyghost's picture

sometimes you just have to ask.......is this author trying to baffel people with bullshit? for crying out load how many figures/numbers can one article contain? not even counting the shit in the charts!!!!! TOO MUCH OIL IS BEING PUMPED OUT OF THE GROUND.......NOT ENOUGH PEOPLE HAVE JOBS TO BUY SAID PRODUCTS EQUALS ONE MASSIVE SHIT LOAD OF OIL......SIMPLE REALLY

Wed, 04/08/2015 - 03:05 | 5969786 anonymice
anonymice's picture

All the time I hear people saying: "All this talk about Peak Oil is bullshit. We've never produced so much oil as now"

That is exactly the definition of Peak Oil: we've never produced so much oil as now.

Tue, 04/07/2015 - 21:42 | 5969152 HedgeAccordingly
HedgeAccordingly's picture

Well the ECB had a hand in this oganic appreciation of the dollar .. but also cash has no where to go as bonds are inflated yields in the piss hole and stocks at all time highs still while the economy is sputtering like a 2 dollar hooker after her blow runs out... 

http://hedgeaccordingly.com/2015/04/frank-wolak-the-end-of-expensive-oil...

Tue, 04/07/2015 - 21:53 | 5969194 Seasmoke
Seasmoke's picture

Time for all the cash to buy Gold and silver.

Tue, 04/07/2015 - 21:43 | 5969154 Smuckers
Smuckers's picture

I don't understand - to get back to $90, why don't they just hedonically adjust by using bigger barrels.  Solved, no?

 

/sarc

Tue, 04/07/2015 - 22:05 | 5969236 Savyindallas
Savyindallas's picture

My first thought was no way  - but after reflecting for a while, why not? I think it would work. It's more honest than the bull the Fed and gov Ministry of Truth give us. Probably good for at least a hundred points on the S&P. 

Tue, 04/07/2015 - 21:43 | 5969155 Dr. Engali
Dr. Engali's picture

A long period of low oil prices? How awful. The average Joe gets a break and it's the worst possible thing that could happen to Wallstreet........ Fuckers.

Tue, 04/07/2015 - 21:55 | 5969203 Redneck Hippy
Redneck Hippy's picture

If low oil prices are the fault of the Fed, hooray for Bernanke.  Maybe they actually did something right.  Nothing that's happened in the last six years has been more beneficial to poor bastards like me that have to drive to work every day.

Anyway, its bullshit that shale companies can't make money at less than $90 a barrell. Hello--the price has been cut in half and we just had the biggest inventory build on record.  

Maybe they'll leave some in the ground until pricing improves, but I'm guessing that is years away with the world economy at stall speed.

 

Tue, 04/07/2015 - 22:09 | 5969252 sun tzu
sun tzu's picture

It's more likely Bernanke cause the $100 oil prices with QE. When QE ended was when oil prices went back to normal. 

The shale companies are all hoping the be the last ones eaten by the debt crocodile. Those monthly interest payments have to be made no matter what the price of oil. For the Bakken companies, spot prices are at $36 right now. It was closer to $30 for most of the first quarter. I figure the cost per barrel has to be down to $30 for them to survive. If oil stays around $50 for the next two years, half of them will be gone. 

Tue, 04/07/2015 - 21:56 | 5969208 ukspreads
ukspreads's picture

Except the average Joe is in the market for gas, not barrels of oil and the former hasn't come down proportionally

Tue, 04/07/2015 - 22:29 | 5969316 Dr. Engali
Dr. Engali's picture

I'll take paying $2.00 a gallon over paying $4.00 any day.

Tue, 04/07/2015 - 22:34 | 5969334 Augustus
Augustus's picture

The price for the gasoline has come down.  Taxes imposed by govt. are a large part of pump price and have not changed.

 

Tue, 04/07/2015 - 21:53 | 5969195 post turtle saver
post turtle saver's picture

ha ha lol

Tue, 04/07/2015 - 22:04 | 5969233 disabledvet
disabledvet's picture

BWHAHAHAHAHAHA!

 

OVERPRODUCTION OF DEBT HAS NOTHING TO DO WITH IT! MOVE ALONG DUMBASS!

Tue, 04/07/2015 - 22:15 | 5969269 sun tzu
sun tzu's picture

Most of the shale companies are nothing more than ponzi schemes, especially in the Bakken region. All of their cash flow goes right back into leasing more land because of the depletion rates. They will never have enough cash flow after investing activities in order to pay dividends. Even with oil at $100 they still had negative cash flow after operating and investing activities. 

Tue, 04/07/2015 - 22:28 | 5969313 Herdee
Herdee's picture

It's political as well.Iran's huge storage supply will come onstream shortly.They'll sell to China first,undercutting Saudis' higher price.35 million barrels just for starters,all loaded in supertankers ready to go and the country will be open for business to everyone.And what about the Saudis?Well,they and their terrorist organization feel like they got stabbed in the back with a big butcher knife by the worst President in U.S. history-  Obuma.Top it off,they're going to have a big propaganda party in Washington and give John Kerry a big hero ceremony for his effort.What a load of horseshit.

Tue, 04/07/2015 - 22:42 | 5969356 Augustus
Augustus's picture

The correlation mentioned in the article are just not correcct.

Production increases since 2009 had little to do with interest rates.  The tech was not available until about then.  Once it got started with the long horizontal legs it just got better.  In 2009 going 1000 ft horizontal was a miracle.  Now the lateral legs can go out 7000 ft.  Fed rates had nothing to do with it.  High prices encouraged the increase in tech capability as there were huge profits.  Of course low rates were a slight contributor but it was high profits that drove the revolution.

The author is proposing that if interest rates had been low enough in 1978 there would have been a similar increase in production from lots of independent oil producers.  That is nonsense.

Tue, 04/07/2015 - 22:54 | 5969398 BoPeople
BoPeople's picture

Now wait a darn second! The charts in your article do not support your thesis.

A. There has been no evidence of demand destruction, There may be excess supply, but as you said investors are willing to hold that until the price rises.
B. Taking almost three years for price to decline from over $90/barrel shows no evidence of a correlation of price to supply and demand.
C. Money has been cheap and easy since 2009. Why would it take until late 2014 for cheap money to destroy price
D. Dropping price is not increasing or decreasing demand. Therefore demand is not related to price and there is no reason to lower price based on supply and demand if investors are willing to hold inventory.

I think the more simple answer is correct. It has to do with the move to eliminate all monarchies (at least in the Middle East) and the Brookings Institute's "Which path to Persia". The drop in oil price appears to be a direct attack on the Saud. The Saudi's did not take the bait and reduce production ... the new conflict with Yemen seems to confirm that this is all a betrayal of the Saudi Arabian monarchy and an attempt to overthrow it and send Saudi Arabia in to chaos like Libya.

Tue, 04/07/2015 - 23:31 | 5969524 weburke
weburke's picture

are you sure the saudi royals are not going to stay in charge? they are related at the top -with- the top. they are not random tools. (despicable, evil, yes)

Wed, 04/08/2015 - 00:09 | 5969614 adr
adr's picture

It costs the Saudis $5 to pump a barrel of oil. If oil drops to $15 they still get to triple their money. You can't topple Saudi Arabia by dropping the price of oil.

There is a thing called demand. If a product sells for $50 but you can only find two people to buy it, you get $100. If your costs go down and you sell the same product for $20, you might find more buyers, maybe five. Guess what, you still brought in $100 even though the price was 60% less.

Wed, 04/08/2015 - 00:04 | 5969604 adr
adr's picture

Prices for oil rose because of the Commodity Futures Modernization Act and the subsequent massive speculation once Glass Steagall was repealed, period. We have had a greater supply of oil over the past twenty years than any other time in history, yet prices rose. There is no free market rationale for this. The supposed mega demand from China and India never materialized and the drop in consumption from developed economies has been larger than the increased demand from developing nations. Oil above $60 causes massive demand destruction. If oil stabilizes at $60 and gas prices drop to the $1.85 per gallon that price represents, the economy may recover.

As it is global consumption numbers are total bullshit. Manipulated statistics in the same vein as Chinese industrial production and BLS job numbers.

The Bernanke funny money era added fuel to the fire and once HFT took over post 2009 the entire commodity market has been based on greater fool theory, mostly whatever idiot will buy into a oil tracking ETF. 

Oil trading has turned into fucking Beanie Baby mania.

Wed, 04/08/2015 - 04:44 | 5969844 JenniferS
JenniferS's picture

There is one other factor that I did not read in this article. That of a global economic slowdown. Demand is down. Contrary to what the talking heads and stock and equities salesman posing as experts tell us, there is a global economic slowdown. The worry for central bankers is that it will slip into global recession. Then oil may be in for a long pull back up. I really this article about oil prices. It's very interesting to read. Google news normally comes up with the usual reuters, wjs or financial times 2 sentence nonsense in every single article and then dozens of articles about the fact that UK payday lenders online offer financial help.

Wed, 04/08/2015 - 09:02 | 5970145 Stained Class
Stained Class's picture

Great story. It may have been interesting to see what the historical Crude Storage figures looked like over the period from 2000 onward, relative to the direction of prices. Or maybe not, and that's why it was omitted. What is clear is, whoever parked oil in storage prior to 2014 is losing over half their shirt in value.

Wed, 04/08/2015 - 08:55 | 5970169 gcjohns1971
gcjohns1971's picture

"The artificial low interest rates that have been imposed by central banks since the Collapse have weakened the U.S. dollar and pushed the price of oil above $90 per barrel for the longest period in history."

 

This statement is central to the argument.  The main evidence for this proposition - correlation of monetary easing and oil price - is in chart number 3. 

But chart number 3 doesn't show any correlation.  Those two lines don't seem to be moving either in tandem or in opposition....and that leads inevitably to the conclusion that the oil price isn't directly attributable to monetary policy.

You are surprised? 

Why?

It is a cartel.  The ability to avoid the discipline of the market is the whole point of being a cartel.

Wed, 04/08/2015 - 10:20 | 5970529 wrs1
wrs1's picture

The current oil-price collapse is because of expensive tight and other unconventional oil and the market’s inability to support its cost. $90 per barrel WTI price appears to be the empirical threshold for demand destruction. Only the best parts of core areas of the Bakken and Eagle Ford shale plays make some profit at $90 per barrel and almost nothing makes money at present oil prices.

 

Not sure where the above is justified.  The OPEC countries increased production by 3mmbbl/day since 2010 which is close to the extra supply coming from tight oil.  I don't think these peopl that write the articles really have the first idea what tight oil really costs and what it's production price really is.  In the good plays like the Wolfcamp, a profit can be made at $40/bbl wellhead which equates to what we were getting at the lowest point in January.  As the infrastructure issues are addressed, the price at the well head will increase as shipping costs and ability to send oil where it's needed instead of where it's not, i.e. Cushing, will help producers with profits.  The oversupply will work itself out due to less new wells being drilled and less supply being brought online from OPEC, unless of course OPEC really is out to hurt itself as well.  Those players all need high oil prices to run their countries and that has to be figured in their cost of production. Libya is a perfect case in point that if you don't have a stable country, you can't exploit your resources and so stability in the producing region is a cost of production.  Saudi Arabia is raising prices because they are having to address stability in Yemen and it's costing them more than they expected.  This is definitely resulting in a reduction in the WTI / Brent spread and making higher prices for producers here in the US.  

 

Wed, 04/08/2015 - 13:14 | 5971501 SweetDoug
SweetDoug's picture

'

'

'

'Gaz Prices Excuses!

1)    A hurricane is coming!
2)    A hurricane is here!
3)    A hurricane might be coming!
4)    A hurricane was here!
5)    There was a fire in the refinery!
6)    The refinery was down for maintenance.
7)    The gas prices today are the oil prices from 6 months ago! They’ve got to ‘go through’ the system!
8)    It’s winter gas production time! (Ignore the fact that you’re using the summer gas that was made last winter.)
9)    It’s summer gas production time! (Ignore the fact that you’re using the winter gas that was produced last summer)
10)    There’s a war over in the middle east!
11) There might be a war over in the middle east!
12)    Somebody blew up an oil well over in the middle east.
13)    Somebody might blow up an oil well over in the middle east.
14)    Brent crude is going up!
15)    The Brent/WTI ratio!

16)  Fear of inability to store oil

17) The input costs of the more expensive Balkan oil to refine into gas. (CBC Lang Exchange April 7th

 

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