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13 December 2014

Press review 13-12-2014 - A bursting bubble

American energy writer Richard Heinberg entitled his book on petroleum extraction from source rocks "Snake Oil". This title was a sharp choice, possibly in more ways than Richard himself could have anticipated. For a few years the US investment community was completely intoxicated with stories of limitless supplies of fossil fuels and even energy independence. Every day more wells would be drilled, more infrastructure would be sourced, more news of a bright future would be written. And more debt would be issued to feed the beast.

Until one day. It turns out source rocks were not so good after all, relying on wells with lifetimes counted in years, instead of decades. Thousands of millions of dollars were piled up on resources lying at the top end of the supply curve, thus vulnerable to the slightest shifts in the market equilibrium. Today that equilibrium renders source rocks money loosers and battered investors flee the market in hordes. Behind they leave a pile of debt on the verge of collapse, threatening the whole financial system; and not only in the US.

Bloomberg
Fed Bubble Bursts in $550 Billion of Energy Debt: Credit Markets
Christine Idzelis and Craig Torres, 11-12-2014

Since early 2010, energy producers have raised $550 billion of new bonds and loans as the Federal Reserve held borrowing costs near zero, according to Deutsche Bank AG. With oil prices plunging, investors are questioning the ability of some issuers to meet their debt obligations. Research firm CreditSights Inc. predicts the default rate for energy junk bonds will double to eight percent next year.

[...] The Houston-based company’s $700 million of 9.25 percent notes due in June 2021 have plummeted to 53.5 cents from 108 cents at the beginning of September, according to Trace. The debt is rated Caa1 by Moody’s and B- by S&P.

Some borrowers are under pressure just a few months after selling new debt. Sanchez Energy Corp.’s $1.15 billion of 6.125 percent notes maturing in January 2023, issued this year, have tumbled to 77 cents from 101 cents in September, according to Trace. Proceeds from the bonds were partly used to fund a purchase of Eagle Ford shale assets from Royal Dutch Shell Plc. (RDSA)
As the acknowledgement of the burst grows, so grows the the negative outlook on the US bond market. In the article below an analysts puts the size of the energy sector at one fifth of the high-yield (aka "junk") bond market. There will be consequences, and possibly not restricted to the US.
CNBC
Investors are in denial about the energy bust: Glazer
Tom DiChristopher, 11-12-2014

Investors remain in denial about the consequences of lower energy prices, and the market has not yet priced in the negatives associated with them, Larry Glazer, managing partner at Mayflower Advisors, said Thursday.

[...] "If you're a Texas home builder, go back to 1986, the last time you had an energy bust of this magnitude. Those were tough times. It took 10 years to dig yourself out of this hole, and I think that's the story we could have," Glazer said.

"You may not have a pipeline running through New Jersey, but the steel is made in Ohio, so it affects a lot of places," he added.

Asked whether the impacts will be limited to certain U.S. regions, Glazer said 15 to 20 percent of the high-yield debt market is exposed to the energy sector, and many of the bonds Wall Street sold the last two years are now under water.
The mainstream media in the US is now overtly contemplating a "bail-out" to the petroleum industry. It is an hard sell to the public, but without it the US might end up rescuing its banking sector again.
CNBC
Could the US bail out its own oil sector?
Matt Clinch, 10-12-2014

A large number of economists believe the drilling frenzy and huge domestic energy boom has helped the U.S. to recover since the global financial crash of 2008, contributing an estimated 0.3-0.6 percentage points to U.S. gross domestic product. But Jakobsen believes this tailwind could soon become a headwind despite gas becoming cheaper at the pump for U.S. citizens.

"It will subtract 0.5 percent from GDP, bare minimum," he said. "There's a precedent here, back in the 80s we also had an oil crisis and that led to bank recoveries."

He added that oil companies are in for a "massive correction," similar to the downtrend seen in mining stocks, explaining that exploration was getting "hugely expensive" with energy majors having little free cash flow available.
In the alternative media the present state of the US bond market is compared with the conditions that lead to the 2008 crash, then triggered by the housing sector. The potential for contagion is huge, a story that could overwhelm the energy sector worldwide in 2015.
Wolf Street
“Yes, it Was a Brutal Week for the Oil & Gas Loan Sector”
Wolf Richter, 08-12-2014

Yesterday, I discussed how the plunging price of oil is wreaking havoc on leveraged loans in the energy sector. These loans are issued by junk-rated corporations already burdened by a large amount of debt. Banks that originate these loans can retain them on their balance sheets or sell them in various creative ways, including by repackaging them into synthetic structured securities, called Collateralized Loan Obligations.

Earlier today, I discussed how the current generation of leveraged loans in general compares to the leveraged loans issued at the cusp of the Financial Crisis. Spoiler alert: by almost every metric, they’re bigger and crappier now than they were in 2007.

So here’s a chart of S&P Capital IQ’s energy-sector leveraged-loan index for the latest week, and it was such a doozie that it caused leveraged-loan focused LCD News, a unit of S&P Capital IQ, to tweet: “Yes, it Was a Brutal Week for the Oil & Gas Loan Sector.”
Euan Mearns reflects on what 60 $/b means to the world's largest petroleum exporters. While this market can not possibly be good for Saudi and peers, the challenges they face are completely dwarfed by what is to come in the US.
Energy Matters
The OPEC Conundrum
Euan Mearns, 08-12-2014

When OPEC met on 27th November they decided to leave production unchanged and to not meet again until June 2015. This at a time of volatility in oil markets and plunging price that leaves many OPEC member states facing budget deficits, some large and unmanageable.

In this post I take a look at the oil production and consumption history of OPEC and find that historically OPEC has been as much controlled by markets as to be in control of them.

Jeff Rubin offers some insight on the present petroleum market, defending the idea that present prices are here to stay. At this stage I see long term stability of petroleum prices as an highly unlikely scenario.
Financial Sense
Jeff Rubin: Falling Oil Prices "Harbinger of What's to Come"
10-12-2014

“[...] I'd argue that oil prices are really throttling the path that has already been blazed by coal. As dramatic as the declines in oil prices have been, they are a fraction of what’s happened in coal. We've gone from a world of $140/ton thermal coal prices to less than $70/ton, and that's shut-in coal plants everywhere from Australia to British Columbia, but coal hasn't rebounded and I'm not sure oil will either. I guess there are two issues to address: one is that economic growth, pretty well everywhere you look around the world, has downshifted into a much lower gear and since hydrocarbons are about 80% of the energy input behind global GDP, it's not a mystery while demand has slackened off. And I think the other big issue is that while investors in coal or oil stocks have comforted themselves every night before they go to sleep with the notion that there is still no global carbon agreement and unlikely to be one in the foreseeable future, that doesn't mean that actions taken by individual countries haven't been just as hurtful to those areas as a global agreement would be. And when I talk about specific countries I include the two most important coal-burning countries in the world, China and the US, both of whom would disagree vehemently about their respective roles in controlling global emissions but both of which have taken for different reasons unilateral actions that have been very hurtful to coal stocks and soon I think to high cost oil stocks like shale oil and bitumen."
Here in Europe the big story is now Belgium. Our life style is far more fragile and dependent than most would admit. And can quickly change to less comfortable arrangements.
EUObserver
Belgium asks for solidarity to prevent electricity blackouts
Peter Teffer, 09-12-2014

Across the country, posters ask people to try and reduce energy demand, by switching off lights when they are not needed, washing clothes at lower temperature and cooking using fewer pans.

The campaign has a friendly nature and there was no sense of panic in Antwerp on a recent Friday (5 December).

Tourists and locals alike wander the city wearing hats and gloves, but the temperature is moderate: about five degrees Celsius.

If temperatures go too low, however, then a combination of events could spell trouble for Belgium, the European Network of Transmission System Operators for Electricity concluded in its annual Winter Outlook analysis.

“Apart from the holiday period, all weeks can potentially be critical depending mainly on the meteorological conditions in Belgium and neighbouring countries,” the report says.
Norway has been again in the news this week, a country that has a lot on the line over petroleum. The high prices of recent years had so far masked the decline in extraction (and consequently exports), but low prices mean first of all that exploration is coming to an halt, with a clear short term impact on employment.
UPI
Statoil suspends rig operations in rough market
Daniel J. Graeber, 05-12-2014

Current market conditions are making it difficult to sustain drilling operations in Norwegian territorial waters, a procurement director at Statoil said Friday.

The bear market for crude oil has forced some in the industry to scale back on their near-term investment forecasts. Brent crude oil prices traded near the $69 per barrel mark Friday for the January contract.

Statoil procurement head Jon Arnt Jacobsen said the company was suspending contracts for four rigs because of lower profitability.
Long term, this price rout means that Norway's petroleum bonanza is coming to an end. Arctic waters are completely out of the question, and for now the continental shelf is shut in. The economy of this country is bound for an overhaul if petroleum prices remain this low for a significant span of time.
OilPrice.com
Norway’s Oil Decline Accelerating
Nick Cunningham, 07-12-2014

[...] Energy analysts have explored in detail how the ongoing decline in oil prices – down 40 percent since June – might affect oil exporting countries like Russia, Iran, Venezuela, and other OPEC members. But even Norway, the model for using natural resources to build a modern wealthy economy, is not immune to the price fall.

Statoil, the mostly government-owned oil company, has seen its share price cut in half since July 2014. It is idling several offshore rigs as oil prices drop. Three rigs – the COSL Pioneer, Scarabeo 5, and Songa Trym – will be suspended until the middle of 2015 because of lower profitability. “These measures are necessary due to the overcapacity of rigs compared to the assignments we are prioritising. This situation is unfortunate, and we are doing what we can to minimise the extent of the suspensions,” Statoil procurement head Jon Arnt Jacobsen said in a statement.

[...] The decline in investment is already pinching the labor market. Around 10,000 Norwegian oil workers have been laid off as the industry pares back spending, accounting for 10 percent of the sector’s total workforce, the Wall Street Journal reports. Oil workers are threatening to strike unless the government steps in to stem further losses.
At these prices, even scrapping old infrastructure in the North Sea becomes a problem. Governments might eventually have to foot the bill if the owners and operators of this infrastructure go bust.
Bloomberg
BP Weighs Future of Aging Norwegian Fields Amid Oil Crash
Mikael Holter, 09-12-2014

BP is currently deciding on plans for the five fields it operates in Norway in a study to be completed in the first half, said Jan Erik Geirmo, a Stavanger-based spokesman.

“Falling oil prices, lower production and more demanding operations, in addition to significant costs for shutting down and removing old installations and platforms, are continuous challenges that may have an impact on the lifetime of some of our fields,” Geirmo said in an e-mailed reply to questions.

What goes for BP also goes for an industry hit by squeezed margins even as the government demands it meet commitments to keep investing to ensure resources are exploited in full. Faced with a 40 percent drop in crude prices since June, costs that have surged for a decade and a surprise tax increase last year, Royal Dutch Shell Plc (RDSA) last month said it may close its Draugen field more than 10 years ahead of target. Statoil ASA (STL) on Dec. 1 delayed plans to pursue development of the Snorre 2040 project and Total SA (FP) said Dec. 4 it may postpone spending in the North Sea.
Details are slowly surfacing on the accident in one of Ukraine's nuclear reactors a couple of weeks ago. With both gas and coal supplies constrained, Ukraine has been running its nuclear park at full steam, thus increasing the risk of accidents.
OilPrice.com
Nuclear Incident Leaves Doubts Over Ukraine’s Energy Security
Andy Tully, 04-12-2014

Sometimes it seems Ukraine and energy just don’t mix. Its relationship with Moscow, maintained today only for the sake of buying desperately needed Russian gas, is patchy at best. And recently Russia has halted coal shipments to Ukraine.

And then there’s the worst nuclear disaster in history: Chernobyl in 1986, back when Ukraine was a Soviet socialist republic.

There was another nuclear accident in Ukraine on Nov. 28, though by all accounts it was much less dangerous. Yet its effects are being felt in a nation already short of fuel and fighting well-armed Russian-backed rebels in its east.

The latest accident wasn’t acknowledged until Dec. 3, when Prime Minister Arseniy Yatsenyuk, presiding over the first meeting of his new cabinet, asked Energy Minister Volodymyr Demchyshyn to report on the accident. It was Demchyshyn’s second day on the job.
Recent weeks have been prone in new pieces of information indicating Israel as one of the supporters of the Sunni Caliphate wreaking havoc in the Near East. Below is just one of various news where Israel is reported either backing the Sunni or directly engaging the Shiites.
McClatchy DC
Suspected Israeli war jets strike near Damascus airport
Mitchell Prothero, 07-12-2014

Suspected Israeli aircraft bombed a military complex on the outskirts of Damascus’ international airport Sunday in what Syrian state television said was an attack on warehouses housing an advanced Russian-made anti-aircraft system.

The attack would be consistent with repeated Israeli pledges that it would not allow Syria to deploy the S-300 anti-aircraft missile system and raised the question of whether Russia had sent new components of the system to Syria, perhaps in violation of an August pledge not to complete delivery under terms of a United Nations arms embargo.

The Israeli military offered no comment on the report.

The government-operated Syrian Arab News Agency blamed Israel directly for the strikes and said they targeted “two safe areas in the Damascus countryside in al Dimas and near Damascus International Airport.”
Money will continue to flee energy stocks and bonds, dragging down markets at large. There is a new cease-fire in Ukraine and next week could be crucial in determining its long term fate. Have a pleasant weekend.