Trillion Dollar Disaster

Jim Brown
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The sharp decline in crude prices is on the verge of causing a trillion dollar disaster. Low prices do not just mean lower profits but in many cases higher losses and cancelled projects.

Energy consultant Woods Mackenzie said low oil prices have already cut investment in oil and gas projects by over $220 billion over the last two years. If oil prices remain at the current level this could turn into the delay or cancellation of as much as $1.5 trillion in projects over the next several years.

In the U.S. the Bureau of Labor Statistics, claims more than 108,000 energy jobs have been lost. Private researchers believe the number is much higher at 200,000 to 250,000. When there are mass layoffs concentrated in certain geographic areas, the entire economic system is damaged. Waitresses, plumbers, small businesses, car mechanics, truck drivers, etc, all lose their jobs as well because of the sharp decline in economic activity.

Oil well workers are highly paid with experienced people making $80-$100,000 a year. Even entry-level jobs are in the $60,000 range. That money is then spread around in the community as the worker families go about their daily lives. When a worker loses an $80,000 a year income they cannot just pickup a newspaper and start a new job next week at the same level. Unemployment helps defer the pain but only temporarily and only a small amount. Without an immediate switch to a different high paying profession, which is highly unlikely, the homes are sold or foreclosed, families moved and desolation settles in over the community where thousands of families are impacted. This is just the impact on the economy from the workers.

Add in the decline in tens of millions of local dollars spent by energy companies and the damage is magnified.

The EIA previously projected a shortfall of 43 million barrels per day by 2030 unless hundreds of new projects are discovered, funded and completed on schedule and that was with oil at $85 per barrel. The situation will be dramatically worse at $50 per barrel.

Now take this to the global stage. Hundreds of energy companies are slashing tens of billions in capital expenditures every month. According to Wood Mackenzie more than 46 major energy projects have been cancelled over the last two years. The company estimates that as many as $1.5 trillion in new projects could be cancelled because of low oil prices.

Many projects of $10 billion or more were conceived and sanctioned when oil was over $100. Most deepwater projects have costs per barrel averaging $75 or more. Major companies, banks and investors are not going to throw billions into a project of that magnitude with oil at $45 a barrel. Even the low cost onshore shale producers are slashing drilling and new developments on a weekly basis.

These high dollar projects are simply uneconomic at $45 a barrel. If it costs you $75 a barrel to produce the oil you can't make up the difference on volume regardless of how much you produce.

Historically there have been as many as 50 new multi-billion dollar projects approved every year. Wood Mackenzie expects only six projects to be approved in 2015 and as few as 10 in 2016.

While the U.S. is seeing a period of weak economics as a direct result of the slowdown in the energy sector with only about $100 billion in project cuts, you can imagine what would happen to global economics with a cut of $1.5 trillion. We are talking about more than a million jobs and hundreds of billions in economic impact to the local economies surrounding these projects. This is still not the big picture disaster.

In order to oil prices to remain stable there has to be a continuous flow of new oil coming to market. It takes 5-7 years from conception to production of a new oil project. It does not happen overnight.

If prices remain low and a trillion dollars in projects are cancelled then we are in serious trouble. Chevron said more than 200 billion barrels of new oil must be found and produced between now and 2030 to keep up with oil demand. At $50 oil that is not going to happen. All the cheap oil has been found and produced over the last 50 years. Oil found today offshore is $75 a barrel or more. Shale oil is $65 on average. It would take a return to $100 oil to restart the project flow and many investors and corporations are going to be very cautious before they sanction a new project just because prices returned to $100 for a few weeks.

If the oil industry shuts down as it is doing today, it could take 7-10 years before it could restart and undertake those 5-7 year projects that will produce significant production volumes.

The trillion dollar disaster is going to be the high prices for gasoline once the cycle rebounds. The longer oil remains at $45-$50 the more workers will be retrained and enter other professions. The more rigs will be scrapped and the more engineers will retire. This is not new. This has happened about every 20 years since the 1950s.

In 1998 oil was under $10 a barrel. The active rig count went from 4,350 to 450. The majority of those rigs were scrapped. The workers left the oil patch and took other jobs. When the oil cycle restarted it took 6 years to produce new rigs and hire and train new workers. Oil prices rose to $145 in 2008 as a result. Experienced workers were being given six-month signing bonuses to change jobs. Gasoline went to more than $4 per gallon.

If the current oil glut continues as it appears it will at least through 2016, we could be looking at another complete washout of the energy sector. It will take years to rebuild and years to ramp up production. Consumers may be enjoying low gasoline prices today but we will pay the price when the cycle reverses. We always have. The oil cycle is well documented because of the numerous times it has repeated over the last century.

This time is different because the oil price required to restart the production effort is going to be a lot higher and the resulting high gasoline prices are going to weigh on the global economics for a long time.

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Active Rigs

Active drilling rigs declined -29 to 809 for the week ended on Friday and that is a 10 year low . Oil rigs fell -26 for the week to 614. Active gas rigs fell -2 to 195. Active rigs have now declined -1,113 since the high of 1,931 in September 2014. That is a -62% drop. Active offshore rigs were fell -3 to 30, down -31 from year ago levels.

Oil Inventories

Crude inventories rose +4.0 million barrels to 457.9 million.

Refinery utilization fell from 90.9% to 89.8%. That is down from the high of 96.1% on August 7th.

U.S. production fell -4,000 barrels to 9.096 mbpd, down from the 9.61 mbpd and 40-year high in June.

Cushing inventories fell to 53.0 million from 54.0 million.

Gasoline inventories rose +3.3 million barrels to 222.0 million.

Distillate inventories fell -0.3 million barrels to 151.6 million.

In the graphic below green represents a recent high and yellow a recent low.

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