The Shale Bubble and its conséquences

Note kindly translated by Anne-Marie de Grazia.

The reduction in the number of drilling installations dedicated to shale oil extraction is accelerating since the beginning of the year. Horizontal installations have made up over half of the decrease registered during the first week of 2015. In fact, one can expect a reduction of over 30% of the number of drilling installations in the United States during the coming 10 weeks. This decrease affects all extraction basins. In those of Texas and New Mexico, where one third of the installations are situated (502 of a total of 1482 on December 31, 2014), the drop in the first week of 2015 has amounted to 28 installations, that is 5,6% of the total. This phenomenon is widespread and affects all basins.

Consequences for the American production, and on prices.

For the time being, production continues to increase in the United States. It should reach 9,5 million barrels/day probably at the end of March-beginning of April.  But we know that the production cycle is comprised between 3 and 6 months. This implies that the decrease in the number of installations, as well as the effects of the first bankruptcies which are going to multiply within the next few weeks, could make themselves felt on the production between June and August 2015, and gain in amplitude during the 2nd semester. A reduction of the daily production of 10% at least, and maybe much more, should begin to appear by the end of the year. It cannot be excluded that we will come back towards the end of the 3rd quarter, or even the beginning of the 4th quarter, to a production (in the United States) of 8.2 to 8.6 million barrels a day. The effects on the price of the barrel of oil will of course be spectacular and they will moreover be amplified by the considerable speculative activity which banks and various forms of financial institutions are carrying on right now. So that we can expect a strong decrease, the price of the BRENT might reach less than 40 USD and the price of the WTI less than 35 USD, as long as the production will diminish. But, as soon as the production goes down, and of course the more so the more the decrease is strong and rapid, anticipations will reverse themselves. This movement will be the more brutal than the preceding decrease will have been considerable. Nevertheless, it is probable that the big actors on the oil market will not allow prices to go back up above 70 USD a barrel. At such a price, a large part of the production is no longer cost-effective, or is so only marginally. Ce ne serait pas le contraire?

To summarize, the decrease in price should continue until March, or even April. The “rebound” following the inversion in anticipations should occur between May and July 2015 and we should be reverting to a « normal » price of 70-80 USD around the month of November 2015. We must point out here that this is what the managers of the big Russian oil companies are expecting. The scenario has already been written. The only uncertainty resides in the time period (beginning of June and end of July) and on the size of the rebound (a slow rise towards 70 USD a barrel, or a fast rise occurring because it will arrive later and  after a bigger decrease).

Winners and losers

Such movements will have repercussions on the economies, in the United States of course, but also elsewhere. It is already clear that two countries will be profiting massively from this fall in oil prices, Japan and Germany. These countries do not have an oil industry and are big importers of fossil fuels.

As for the case of the United States, the picture is more complex. We must watch carefully for contradictory effects and especially we must be well aware that these effects will not manifest themselves all in the same time.

  1. There are beneficial effects, considering the importance of fuel prices for the population and the small level of taxes levied on these prices. The fall in price at production rapidly translates into a decrease of the price « at the pump. » It also has an impact on the industries which are big consumers of energy and fossil fuels (such as the chemical industry). This impact is already making itself felt.
  2. BUT, we must take into account the direct and indirect effects of the crisis which is at present hitting the shale oil industry. From the direct point of view, it will translate into numerous bankruptcies (which will occur between April and early November) of companies involved in the production and of their sub-contractors. Already, US Steel has announced the closure of a production site because of the rapid decrease in the demand for steel to make drilling equipment. Moreover, it must be said that the shale oil (and gas) economy represented, directly or indirectly through its induced effects on consumption and through the income of households working in it, approximately half of the jobs created during these past three years. If we are to witness, as can be expected, a wave of bankruptcies, they will translate into massive job losses. These job losses will have a multiplying effect on the service activities (a multiplier which can be estimated at 2.3/2.7 associated jobs for each job destroyed). Given the very high flexibility of the job market in the United States, part of the dismissed persons will find a new job within 6 to 9 months following the loss of their job, but not at the same level of salary as before. In fact, salaries paid in the shale oil industry are higher, at the same level of qualification, by 15% to 25% than in the rest of the economy. Between the unemployed “strictly speaking,” and persons forced to accept a less well paid job, one might see a drop of 1% to 2% in the mass of the global payroll of the United States, and a considerable decrease (2% to 3%) in the consumption of households because there will be a shifting towards savings, as happens every time one is confronted with considerable economic difficulties. This phenomenon will spread itself from the end of the Summer of 2015 to the Summer of 2016. But the impact will combine with the rise in oil prices. As a result, the contraction of consumption in the 4th quarter of 2015 or in the first quarter of 2016 could be greater than expected.
  3. The indirect effects of this crisis, particularly in the banking sector, will be important as well. It is estimated that the net indebtedness of companies specialized in the production of shale oil amounts to 200 billion dollars. If we add to this the sub-contractors, and also the indebtedness of companies for which shale oil is not the main, but an important activity, this indebtedness reaches 310-330 billion. If one finally adds derived goods and activities financed by the incomes of the shale oil industry (such as the construction of housing to face up to the real estate boom occurring in the extraction basins) we reach amounts of 420 to 450 billion dollars. Of this amount, about 300 to 350 billion at least will become “bad debts” in the coming months. The impact on bank balance sheets will be very noticeable, for these debts are heavily financiarized. It is clear that this will last heavily on the actions of the FED which will have to display extreme prudence in managing interest rates.
  4. In the longer term, one must expect a decrease of the Dollar and a return to an exchange rate USD/Euro at around 1.25/1.30 between now and the beginning of the next year. The downward trend of the euro could find itself reversed as a result during the 4th quarter of 2015, which would jeopardise yet more the timid (and very fragile) “recovery” one seems to be noticing in the Eurozone.

All these factors make one expect a persistence of the growth context in the United States during the first quarter of 2015, followed by a reversal and ever increasing deterioration in the 3rd and 4th quarter.

The situation in Russia

In this context, we must then consider the economic and financial situation of Russia. First of all, we must know that the level of all-around cost-effectiveness of oil (and associated) activities is at 3000 rubles per barrel. This means that if the price of the barrel of BRENT goes below 50 USD a barrel, the exchange rate of the ruble cannot be above 60 rubles per dollar (on an inverted scale). In fact, we must expect exchange rates to reach levels comprised between 65 rubles and 70 rubles for one dollar if the price of the barrel continues to plummet. Still, perspectives are not bad in the middle term.

On the other hand, with a price per barrel which should climb back up to around 70 USD, the exchange rate of the ruble should rise back up to around 45 rubles for one dollar by the end of the year. Moreover, the decrease in the repayments to be made by Russian companies to non-resident financial institutions will considerably pacify the situation on the currencies market.

Table 1

Amount of repayments by Russian companies to non-residents

(in billion dollars)

Q3-2014 Q4-2014 Q1-2015 Q2-2015  Q3 2015  Q4 2015  Q1 2016  Q2 2016
Interests

7,438

7,121

6,65

5,911

5,678

5,42

5,475

4,828

Capital

59,165

47,105

31,833

23,545

18,256

27,983

15,893

21,276

TOTAL

66,603

54,226

38,483

29,456

23,934

33,403

21,368

26,104

Source : Central Bank of Russia

However, the quarterly trade surplus of Russia amounts to at least 40 billion dollars. We can see that the trade surplus (Exports min. Imports) will largely cover the financing needs of Russian companies. From this point of view, it is clear that the financial situation of Russia will improve during the current year, particularly from the 2nd semester on, with the very probable increase in the price of the barrel. In reality, Russia appears to be a country with little vulnerability to a temporary decrease in the price of oil. In the contrary, the bursting of the“shale oil bubble” which is now profiling itself on the horizon could have consequences on the American economy which are otherwise more serious. (correct, mais un peu special. Vous pouvez mettre: quite a bit more serious).

 


Jacques Sapir

Ses travaux de chercheur se sont orientés dans trois dimensions, l’étude de l’économie russe et de la transition, l’analyse des crises financières et des recherches théoriques sur les institutions économiques et les interactions entre les comportements individuels. Il a poursuivi ses recherches à partir de 2000 sur les interactions entre les régimes de change, la structuration des systèmes financiers et les instabilités macroéconomiques. Depuis 2007 il s'est impliqué dans l’analyse de la crise financière actuelle, et en particulier dans la crise de la zone Euro.

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