Art Berman : Shale Plays Will Not Cause the Next Financial Crisis

Here are the latest musings from Art Berman.  You may or may not agree with some of the views presentented here, but I definitely recommend taking the time to read his article in full.

Shale Plays Will Not Cause the Next Financial Crisis

Many think that debt and negative cash flow by U.S. shale companies will crash the global financial system. I believe the opposite is more likely, that a developing financial crisis may crash oil prices and test the survival of shale plays.

In The Next Financial Crisis Lurks Underground, Bethany McLean argues that the U.S. energy boom is on shaky ground because of excessive debt and failure to show profits after a decade of drilling. This thoughtful op-ed raises concerns that many have expressed since the advent of tight oil production.

The problem with her thesis is that debt from the U.S. oil sector is just not big enough to crash the global financial system. Losses and bankruptcies in that sector in 2015-16 were substantial and yet, did not threaten the stability of world financial markets. In the improbable worst case scenario, the U.S. government would step in as it did for the auto industry in 2009.

Higher oil prices are inevitable at some time sooner than later because of under-investment over the last several years of low prices. This is compounded by lack of big discoveries and ever-present geopolitical supply interruptions and outages.  ...

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What is just barely alluded to by Art Berman is the situation in Turkey.  It is my view that Turkey, with its collapsing currency, will become a spot barren of capital as capital not invested in hard assets will leave  (or flee, take your pick).  Turkey will end up in an economic depression, and parallel to that, personal consumption of oil and oil products by the Turkish population outside of the areas militarily controlled by the Kurds will collapse.  That in turn will have a spiral effect on oil demand. 

There have been comments here on Oilprice that there is limited substitution for oil.  That is only partly true.  For example, in the US Northeast, where cold weather is common in Winter, millions of homes have oil heat.  That oil is burned in small furnat=ces of simply design, basically a motor blowing air through a coupled fan, and a little oil pump that forces some oil through a nozzle (to get droplets) and an igniter consisting of two probes setting a high-voltage spark across them, to ignite the oil drops.  The heat then goes into the house indirectly via water pipes and a water jacket in the furnace, or directly via heating of a jacket of air which is pumped by a fan through the house.  These simple machines don't cost all that much, figure a replacement starts at $4,000, and nobody is going to go replace that with some fancy system using say electric heat pumps, that costs way too much. 

However, those oil furnaces have a direct substitute: the cast-iron stove.  A top-of-the-line cast iron stove will set you back about $3,200 retail, and you can burn wood pellets (increasingly popular), cord wood  (basically log pieces split at 16 inches length), and even coal.  Now coal is out there in abundance, top quality anthracite coal at 50% carbon content is selling retail in New York State at $110/ton.  That is plenty cheap, and you can even buy it bagged in 50-lb bags for a price premium.  The coal dealers will deliver the stuff to you, so don't underestimate the possible switch to coal. 

If (when?) Turkey collapses I predict a large switch to coal. And even more so, I  predict a switch to coal in India, which has large deposits of the stuff.  India is fragile enough, now has its steel facing import duties of 25% to the US market, and I anticipate devaluation of the currency to compensate. But that makes dollar-denominated oil imports expensive, again pushing back to the use of coal. 

Other factors that will continue to grind away at oil consumption in the USA is the expansion of natural gas, which is so super-abundant that it is getting flared at the wellhead due to lack of pipeline capacity to remove and sell the stuff.  You also have the continuing removal by demolition of old, obsolete, energy-hog housing stock and its replacement with modern, energy-tight housing - in some cases, by net-zero housing.  And you see folks building trombe walls on their South-facing houses, and even packing in windows on the North Face for the winter, all chipping away at oil demand. While oil pricing is a traders' market, with these guys in the pit yelling at each other and trying to out-guess each other,  over the longer term consumption will fall as the various effects described above kick in.  And that in turn will panic those traders that are on the wrong side of their margin trading bets, and down comes the price of oil. 

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40 minutes ago, Jan van Eck said:

What is just barely alluded to by Art Berman is the situation in Turkey.  It is my view that Turkey, with its collapsing currency, will become a spot barren of capital as capital not invested in hard assets will leave  (or flee, take your pick).

Related:

We May Be Facing a Textbook Emerging-Market Crisis

The textbook recipe for an emerging-market crisis requires a large dose of debt and an associated domestic credit bubble, including misallocation of capital into uneconomic trophy projects or financial speculation. Then add: a weak banking sector, budget deficits, current-account gaps, substantial short-term foreign-currency debt and inadequate forex reserves. Season with narrowly based industrial structures, reliance on commodity exports, institutional weaknesses, corruption and poor political and economic leadership.

Based on these criteria, the number of emerging markets at risk extends well beyond Turkey and Argentina. Like Tolstoy’s families, each nation has different sources of unhappiness.

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