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Fracking Drill Rig. (grandriver/Getty Images)
Fracking Drill Rig. (grandriver/Getty Images)

A Fracking Good Time

Irwin M. Stelzer

It promises to be a fracking good year in some of our oil producing regions. To understand why, you need to keep four numbers in mind: $100, $25, $50, and $60. The first is the approximate price of a barrel of crude oil in the summer of 2014, the second the price to which it plunged early in 2016, the third the current price after more than doubling last year, and the last the price U.S. frackers are expecting in 2017, now that the OPEC cartel and fellow-traveler Russia have agreed to rein in output.

Fracking technology boosted U.S. oil production to some 9 million barrels per day, right behind Russia’s 10 million and Saudi Arabia’s 11 million. So the Saudis opened their taps wide to drive prices down and American frackers out of business, in the process preventing the hated Iranians from marketing more oil.

In the event, Iran is back in the markets in a big way, and although more than 110 Canadian and U.S. companies did go under, reducing US crude production by about one million barrels per day, others survived. And became more efficient. A round of cost-cutting enables frackers operating in the more prolific areas to make good money with oil at $40, and others to operate profitably at $50.

The big loser was Saudi Arabia, which was forced to borrow money on world markets and cut benefits to its subjects. But the lavish spending of the royal family seems to have been exempted from the new austerity. King Salman bin Abdulaziz, who travels with an entourage of 1,000 and owns a dozen apartments in Paris worth $35 million, a luxury chateau on the Côte d’Azur and a palace in Marbella, added another in Morocco, while his designated successor, prince Mohammed bin Salman, shelled out $600 million on the spot for a yacht that caught his eye during a vacation stroll. Such profligacy combined with austerity for the masses could produce violent regime change, the one thing that could bring back $100 oil.

The big winners from last year’s oil price run-up are the gamblers who bet that prices would recover, and that the more efficient frackers would survive. They snapped up the shares the drillers were forced to sell at distress prices in order to raise cash to pay interest on their loans rather than declare bankruptcy. The Wall Street Journal estimates that shares bought at distress prices have increased in value by a cool $14 billion over the past two years.

As for consumers, they did well during the crude oil price plunge, which saw some gasoline prices at the pump dropping to below $2 per gallon for a time. Even though prices rose to around $2.30 per gallon in 2016, sales of big SUVs — Chelsea tractors — made up the bulk of record vehicle sales in 2016, while more fuel-efficient sedans piled up unsold on dealers’ lots.

So here we are, a new year, and most experts predicting crude oil prices will hit around $60 per barrel, and Lee Cooperman, whose Omega Advisors manages $3.4 billion of its customers’ money, expecting for oil to hit $65-$70 by year-end. Unless they won’t, which is more than a remote possibility.

For one thing, there is a large overhang of unsold inventories that has to be sold before the output reductions bring demand and supply into better balance. OPEC estimates that the overhang is the equivalent of 800,000 barrels a day. If the production cuts it is counting on are realized, that surplus will be reduced by only 100,000 barrels a day this year. Adam Ritchie, director of consultants Petro-Logistics SA, does not believe “people have fully grasped the scale of excess inventory that has to clear….”.

JPMorgan Chase oil analyst Scott Darling estimates that agreed cuts by OPEC and friends total 1.8 million barrels per day. But the OPEC cartel has never been successful in preventing its members from cheating by over-producing their quotas. A good rule-of-thumb is that the group will achieve about two-thirds of the cuts its members agree to, or perhaps 1.2 million barrels per day. Darling also estimates that $60 oil would induce U.S. frackers to step up production by 600,000 barrels, offsetting half the OPED cutbacks by year end. For technical reasons, fracked wells are more easily brought on line than conventional ones, and that process is underway.

And OPEC members-in-good-standing Libya and Nigeria have been exempted from the cuts, and might also increase their output. Nigeria is producing 1.8 million barrels, but could ramp up by some 700,000. Libya has already added 600,000 barrels and is only running output at half its potential level. Add the possibility that Russia, a non-OPEC member, will cooperate only until Vladimir Putin’s need for cash to finance his military adventures overwhelms his desire to honor his commitment to the group. In sum, the agreed cut in output could easily be offset by drawdowns from inventories or increased production from any one of a number of sources.

None of this means that prices will not rise further. But it does mean that such increases are no sure thing. Especially if the demand side of the equation doesn’t cooperate. Which it might not.

  • Citigroup expects demand to increase, but only by 1.1 million barrels a day, compared to 1.9 million in 2015 and 1.4 million last year.
  • Analysts at Bank of America Merrill Lynch say that if the Fed goes through with the interest rate increases it has announced, indebted emerging countries will have to devote more of their cash to paying interest on their debts, and less to growing their economies and buying oil.
  • Energy Aspects, consultants, reckons that China has filled its strategic petroleum reserve, and will cut its purchases for that purpose to 80 million barrels in 2017 from 120 million in 2016.
  • If the already-strong dollar strengthens further, oil, which is bought and sold in dollars, will become even more expensive around the world, curtailing demand.

As is so often the case, what happens in America doesn’t stay in America. More production here means weaker oil prices worldwide, especially if demand growth weakens. $60-$70 oil might be a pipe dream. Fortunately, a fracking good time can be had at $40-$50. Drillers live the life Stephen Sondheim described in his hit musical “Follies”:

Good times and bum times, I've seen them all
And, my dear, I'm still here
Plush velvet sometimes
Sometimes just pretzels and beer, but I'm here.

A presence made more pleasurable by the fact that the Saudis tried but failed to succeed in ridding themselves of these meddling drillers.

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