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Page added on August 29, 2014
A Big Summer Story You Missed: Soaring Oil Debt
Some of the summer’s biggest news stories took place in the bombed schools of Gaza, the abandoned hospitals of the Democratic Republic of Congo, the wheat fields of eastern Ukraine and the bloody mountains of northern Iraq.
But one of the most important made virtually no headlines at all, and seemed to only appear on the website of the U.S. Energy Information Administration.
Last July the government agency, which has collected mundane statistics on energy matters for decades, quietly revealed that 127 of the world’s largest oil and gas companies are running out of cash.
They are now spending more than they are earning. Profits have lagged as expenditures have risen. Overburdened by debt, these firms are selling assets.
The math is simple. The 127 firms generated $568 billion in cash from their operations during 2013-2014 while their expenses totalled $677 billion. To cover the difference of $110 billion, the energy giants increased their debt load or sold off assets.
Given that the gap between earned cash and spending stood at a modest $10 billion in 2010, that’s a significant change for the industry as well as the global economy it fuels.
Mining messy bitumen
The Energy Information Administration doesn’t explain why the world’s major hydrocarbon producers are now spending more and making less. But an August report by Carbon Tracker, a non-profit financial think-tank, provides some possible answers.
Most companies are now investing in high-cost and high-risk projects to mine difficult hydrocarbons such as bitumen or shale oil, according to Carbon Tracker. Hydraulic fracturing, the land equivalent of ocean bottom trawling, adds to the cost of oil, too.
It’s not only the firms deploing fracking that are racking up high debt loads. Chinese state-owned corporations, for example, plopped down $30 billion to develop junk crude in the oilsands over the last decade.
But with a few exceptions, none of the investments are making a good dollar return due to the difficult and costly nature of mining messy bitumen as well as problematic quality of the reserves, combined with huge cost overruns.
By Carbon Tracker’s calculation, bitumen remains the world’s most expensive hydrocarbon. The extraction of this fuel signals that business as usual is over, and mining of extreme hydrocarbons comes with extreme financial and political risks.
Cheap and easy days are over
The Chinese aren’t the only ones facing diminishing returns from high-cost projects in the oilsands.
Most of the world’s oil and gas firms are now pursuing extreme hydrocarbons because the cheap and easy stuff is gone. The high-carbon remainders include shale oil, oilsands, ultra deepwater oil and Arctic petroleum. (Industry now wants to frack the Northwest Territories, too.)
But given that oil demand in places like Europe, the United States and Japan is flattening or declining, many analysts don’t think that high-carbon, high-risk projects (which all need a $75 to $95 market price for oil to break even) make much economic sense in a carbon-constrained world.
“Our analysis demonstrates that a blind pursuit of reserve replacement at all costs or a focus on high expenditure regardless of returns could go against improving shareholder returns,” recently warned Carbon Tracker.
The capital costs for liquefied natural gas (LNG) terminals supplied by heavily fracked coal or shale fields is also rising. Highly complex LNG projects in Norway, Australia and Papua New Guinea have all experienced major cost overruns.
Goldman Sachs now reckons more than half of the oil companies listed on the stock market — are spending five times more than what they did in 2000 chasing extreme hydrocarbons. As a consequence they need an oil price of $120 a barrel to remain cash neutral in the future.
Spending more cash to get less energy has major implications for the global economy, a creature of oil. Whenever nations spend lots on oil, they record crazy exponential growth, like China. And whenever nations spend less on petroleum, like Europe and the U.S., there is stagnation.
Oil’s slavish hold
To explain oil’s slavish hold on the global economy, the Russian physicists Victor Gorshkov and Anastassia M. Makarieva employ a useful metaphor.
Imagine a town of 100 people. Ten own the air, the oil of the modern economy, and they force everyone else to pay to breathe. The other 90 work hard and give the air owners about 10 per cent of their production.
Whenever the price of air goes up quickly (and the cost of extracting oil has increased substantially in the last decade — about 12 per cent a year), then economic growth slows to a crawl. The air owners have killed the growth potential of the workers.
Sooner or later the owners of the air realize they have to lower the price. “As the air price goes down, the workers feel better…. This, in short, is the scenario of the global economic crisis, how it starts and how it develops,” explains Gorshkov and Makarieva. “Curiously, none of the economic analysts relate the world crisis to the abnormally high oil prices that preceded it.”
But diminished returns from extreme hydrocarbons will do more than slow down productivity and increase price volatility. They will impose lasting and material adjustments on all of us.
In addition to seeing fewer vehicles on the road (a startling U.S. reality already), we shall also see lower wages (except in the hydrocarbon industry), rising food prices, rising personal debt loads, increased demands on governments increasingly short of revenue, explosive inequalities in wealth and rising political conflict.
Our new narrative
We shall also see more of what the U.S. Energy Information Administration dutifully recorded: soaring debt loads to support massive energy sprawl. That means industry will spend more good money chasing poor quality resources. They will inefficiently mine and frack ever larger land bases at higher environmental costs for lower energy returns.
Combined with its twin brother, climate change, this is the great energy narrative that will shape our destiny in the years to come.
Marion King Hubbert, a Shell geologist, predicted this development decades ago and presented the cultural conundrum clearly: “During the last two centuries we have known nothing but an exponential growth culture, a culture so dependent upon the continuance of exponential growth for its stability that is incapable of reckoning with problems of non-growth.”
But why would such a radical development be news in the dog days of summer?
25 Comments on "A Big Summer Story You Missed: Soaring Oil Debt"
markisha on Fri, 29th Aug 2014 9:34 pm
print some money for them . Problem solved hahahahaha
Craig Ruchman on Fri, 29th Aug 2014 9:50 pm
“The math is simple. The 127 firms generated $568 billion in cash from their operations during 2013-2014 while their expenses totaled $677 billion. To cover the difference of $110 billion, the energy giants increased their debt load or sold off assets.” As a investor in a few good stocks who made more in the markets then what my regular job paid, this is the kind of canary in the coal mine news I look for. If this keeps up for a few more years, then I can say with confidence that Peak Oil has arrived.
What ever happened to the kind news when there were record profits such as in 2008?
rockman on Fri, 29th Aug 2014 10:08 pm
Not that the debt burden isn’t significant but the article ignores the fact that the vast majority of wells drilled since Col. Drake poked the first one more then a century ago didn’t recover their costs the first year. It’s not uncommon for a good well with a respectable rate of return to generate cash flow representing just 50% of it’s cost…or less. If I can spend $100 million on new wells that only produce $50 million in revenue the first year it would be considered a successful program: the revenue doesn’t stop at the end of the first year. In fact, if prices are high and I can borrow the entire $100 million it’s an even better deal. I would be paying interest on the loan but remember: I just generated a cash flow stream well in excess of $100 million. IOW who here wouldn’t invest $100 of the bank’s money (and not spend a single $ of their own) to net, say, $30 million after they paid off the principle and interest in a couple of years?
But it is a dangerous proposition. After the price bust of the 80’s hundreds of operators went belly up when they couldn’t even make interest payments let alone cover the principle. No different then an individual borrowing a big chunk of change on the margin to buy a sure-thing stock and then watching that stock tank.
Yous pays your money and yous takes your chances. LOL. Companies are taking the same chances today they did in the 70’s boom. And that didn’t end up well for many of them.
DMyers on Fri, 29th Aug 2014 10:51 pm
This is exactly what we’ve been predicting. The elevated costs are finally breaking through. The mystery of why the breakthrough did not occur sooner is merely dissipated, never solved.
The hand writing is on the wall. You can’t run for long at a loss. Pay more for oil or get less oil, which will mean pay more for oil. That’s the formula I see emerging.
John Doyle on Sat, 30th Aug 2014 1:40 am
An outstanding question is” How much are we prepared to pay for oil?. Our whole existence depends on oil energy so it really is priceless. Clearly we are prepared to pay more when our existence is under threat so the price will vary according to the importance of the need. Holidays and entertainment will not be in the same league as hospitals and food production. I’ve yet to see this discussed. The future is rationing?
MSN Fanboy on Sat, 30th Aug 2014 2:57 am
Great, so peak oil looks like it about to say hello…
You do realise followed behind peak oil is chaos.
But the article makes some good points, but so does Rockman lol
Dredd on Sat, 30th Aug 2014 6:49 am
Going down while destroying civilization and claiming to be honourable businesses.
Iron hearts and minds without conscience is what we really see (Deepwater Horizon Keeps On Killing & Drilling – 3).
Davy on Sat, 30th Aug 2014 7:30 am
John said – Holidays and entertainment will not be in the same league as hospitals and food production. I’ve yet to see this discussed. The future is rationing?
John, it is pretty apparent at least with doomers here contraction is ahead. With contraction I anticipate economic martial law when this contraction reaches a critical point. There will be rationing with all modern vitals because all modern vitals are energy dependent in their production. Robert Hirsch has an excellent chapter on rationing options. None of these options are easy, nice, and all have draw backs. I find it surreal that nowhere are these options discussed. The doomer movement is showing dereliction of duty by not discussing a post PO economy of rationing. This is a primary part of mitigation and adaptation to energy shortages. I have read that a 10% reduction in liquid fuel supplies will cut discretionary liquid fuel usage by 50%. That is an economic devastating number. Retail and leisure are effectively dead in those situations. Economic martial law will have to take over and possibly social and political martial law. Mass bankruptcies and unemployment will make in effect be the end of representative democracy with free and open markets. A society of today at the level of population and complexity will have to have a centralized command and control triaging resources to the necessary and vital. Local and individual trade and barter will go on of course because people live their lives. On a national and regional level there will be a plan and forced implementation. Vital industries will get resources. None vitals will be shut down. People will not argue when faced with hunger. Yet, there is no discussion of these issues even in the abstract. What is wrong with us? I understand the cornies have no interest because the see relative growth and prosperity continuing of course with some hiccups. We “MUST” discuss this and develop good strategies soon or the vital element of time will slip by.
paulo1 on Sat, 30th Aug 2014 8:18 am
What business ever recoups expenses with first year profits? Plus, investing in oil sands projects is not risky with $100 oil, it is simply expensive. You know what is there and you have a good idea what it will cost to produce it. The rest is financing.
That is what accountants and comptrollers are hired for.
Maybe less oil will be produced but will be done by Govt directive for national security. Who knows? There are many ways to skin this cat going forward.
Paulo
steve on Sat, 30th Aug 2014 9:49 am
Davey, I hear you and that sounds great on paper but in reality I think you start out that way but when the reality sets in chaos rears its ugly head and it will be very hard to encourage drilling in the artic….if all it gets you is a piece of bread…
rockman on Sat, 30th Aug 2014 11:04 am
MSN – Which is exactly the point I was trying to make. The oil patch (and any other industry) will borrow beyond it’s cash flow to finance development in good times. $90+/bbl is a good time to invest. Consider the hypothetical: oil drops to $40/bbl. And the “good news” is that companies (shut down the great majority of projects since they aren’t economic at $40/bbl) now have a great profile: generating much more income then they are spending while borrowing very little if any. Is that a scenario the consumers would prefer: companies reaping great profits while adding nothing to the reserve base the economy is dependent upon?
And consider the only likely cause of a low oil prices: a global recession as we had in the 80’s. So even when the economy recovers little new reserves haven’t been developed (as happened in the 90’s when US production tanked) so as demand eventually outstrips production (as happened about 7 years ago) resulting in a price surge. A price urge that eventually leads to a drilling boom (as we have now). A drilling boom that requires extensive borrowing to fund (as has been happening for years now).
A familiar sounding dynamic? LOL. This has been the cyclic nature of the energy industry since Col. Drake poked that first hole over 150 years ago. What’s old appears new to folks who aren’t familiar with our history.
Spending/borrowing more capex in a particular year then the income for that year is not “running at a loss”. It’s running at a negative cash flow. Spending more capex to drill wells then the revenue those wells will ultimately produce is “running at a loss”. Which is the case for some of the shale players for sure. But that has been the situation throughout the entire history of the oil patch. Back in the conventional drilling boom of the late 70’s I worked for a company that spent hundreds of $millions and generated $65 million in total future income. They floated a $100 million bond for part of that capex. Then oil prices collapsed. When the bond came due they couldn’t pay a single $1 back, filled bankruptcy and disappeared for ever. The cycle repeated back then…as it will again eventually IMHO. Obvious there wasn’t a single year in their short existence that income came close to matching expenditures. And they never drilled even one unconventional well.
JuanP on Sat, 30th Aug 2014 11:10 am
I’m with Davy on this one. Great comment!
JuanP on Sat, 30th Aug 2014 11:13 am
Rock, do you think oil prices have been falling because of global economic growth slowing down or for some other reason?
shortonoil on Sat, 30th Aug 2014 1:43 pm
“Rock, do you think oil prices have been falling because of global economic growth slowing down or for some other reason?”
Some one dump 300,000 long positions in one second day before yesterday. There are a lot of people who don’t want to see higher oil prices. To name one, look to the US refineries. A $10 increase in the cost of oil puts them $73 billion per year behind in raw material costs.
“The Energy Information Administration doesn’t explain why the world’s major hydrocarbon producers are now spending more and making less.”
But the Etp model does. What it says is that from the usable energy half way point (2000 by our calculations) the cost of production will begin to increase faster than the price can increase. The petroleum industry, that has seen 150 years of expansion, will begin to contract, and this will show up as tighter margins. When asked what to invest in we tell tell them buy production costs. Forget the Wall Street meme “reserves, reserves, reserves”. The producer who can pump at $40/barrel with limited reserves will outlast the $85/barrel producer with massive reserves. The high cost producer will see their margin disappear before the low reserve producer runs out of oil.
http://www.thehillsgroup.org/
rockman on Sat, 30th Aug 2014 2:33 pm
Juan – Here’s my basic smart ass answer: the price of crude oil falls/increases because that’s what the refiners in that market are willing to pay. LOL. The produces have almost no say in what they sell for. They have but two options: shut their wells in (very rarely ever happens) or find a buyer who is willing pay more. But due to transport costs sellers are limited to what market they can reach. I’ve been selling my oil from the upper Texas coast to a buyer that barges the oil to a La refinery where the price is benchmarked to LLS and not WTI. I get a better price but it’s still a price set b the buyer…not me. In no case am I going to shut my wells in to wait for a better price: cash flow is almost always King for the oil patch…not profit margin.
So now the essence of your question: why are the refiners offering lower prices? I don’t know. The answer probably varies between refiner. But in general the refiners look at their potential profit margins which is typically controlled by the supple/demand dynamic. If the refiners are holding in a rather high inventory while expecting lower demand they would offer a lower price. Remember a refiner only needs to buy enough oil to crack enough product to supply it’s market at an accessible margin. So between inventory and demand expectations the refiners don’t always need to buy their max refining capacity. Unlike the Rockman and the others producers that need to sell our max production.
Of course when inventories get low and there’s expectations of growing demand it’s still a buyers market but now the pressure is on the refiners to be competitive on pricing since in addition to creating a profit they also want to max cash flow.
So there you go: see if there’s an answer in my ramblings that makes sense to you. Good luck…you’ll need it. LOL.
JuanP on Sat, 30th Aug 2014 2:34 pm
Thanks, short.
JuanP on Sat, 30th Aug 2014 3:25 pm
Thanks, rock.
Perk Earl on Sat, 30th Aug 2014 7:01 pm
Rockman my impression is you figure this is no big deal. Just another up & down cycle working it’s way through the system. Is that how you see it, i.e. no difference this time?
So your thinking on this is expenditures may exceed profit now, but only initially, then in subsequent years profits pile up, rinse, repeat. Does that mean you view this as not peak oil, but rather a new cycle leading to a new peak later and so on?
Perk Earl on Sat, 30th Aug 2014 7:47 pm
“But the Etp model does. What it says is that from the usable energy half way point (2000 by our calculations) the cost of production will begin to increase faster than the price can increase.”
That is a daunting stat short, but makes sense that at some point it isn’t just another boom & bust oil cycle, but rather, finite limits bump into global economic affordability.
Makati1 on Sat, 30th Aug 2014 8:29 pm
“Down” rarely lasts for long … unless it is the over-all economy of our future.
rockman on Sun, 31st Aug 2014 3:06 am
Earl – The boom/bust cycle is a big deal for consumers and producers. Has been throughout the history of the fossil fuel age.
It’s critical to understand that the expenditure to cash flow is not indicative of profitability. Real life example: my first hz well in that “depleted”. It cost $2.2 million and netted $1.8 million the same year. So was it an unprofitable effort if the capex spent that year exceeded income? The second year the well will net about $1.4 million. The third year about $0.9 million. And will continue netting positive cash flow for a number of years. So in just the first 3 years that &2.2 million investment will return $4.2 million. IOW almost doubled the money in just 3 years…and that’s not counting revenue beyond the first few years. Has anyone here made 2X their investment in just 3 years?
That’s the only point I was trying to make: evaluating a company’s profitability based on the ratio of capex to income on any given year is a waste of time IMHO. A very old trick a pubcp can do is slash capex to the bone during a year (often by not only reducing drilling but also cutting the staff) and…Ta Da!…suddenly Sent from my iPhone
We’ve been doing about 3’/hr. Only have 40 hrs on the bit but given the hardness of the shale we might consider tripping for a bit before we cut the CR IV instead of doing it after opening it up. There’s no chance of getting to a logging TD without tripping so it’s going to happen sooner or later. Trip now and we can lay down the directional assembly and eliminate that liability. their income greatly exceeds the outgoing. A metric many erroneously classify as “profit”. It isn’t profit…it’s net cash flow. So one company with greater revenue than capex during a year might be losing their ass and another (like the Rockman) might be spending more them he ‘s taking in that year and in reality making his $billionaire owner even richer.
Now you know why I’m his favorite geologist…at least for the moment. LOL
Boat on Sun, 31st Aug 2014 7:57 am
Wells and getting oil to market costs more but there is still profit to be made or they would stop doing it. This isn’t a bubble of finance, just spending what it takes to make a profit.
Our cheap nat gas price along with CHP tech lets our US refineries have a significant price advantage.
Of course some of us cornucopia minded folks think renewables will become cheap (comparable) after a couple more of the price hikes to oil in the future and our energy sources will become much more diverse.
Nony on Sun, 31st Aug 2014 8:14 am
Rock: I don’t see how you can attribute 20 years of cheap oil on a single recession at the beginning of the 1980s. For one thing, global consumption increased over that period of time. So how do you explain the pricing as a demand function only?
Perk Earl on Sun, 31st Aug 2014 9:38 am
Thanks for getting back to me on that Rockman. Gees, I’ve been in the wrong business all these years – lol. Although my wife and I should not complain as this next project we do will allow us to retire in style.
Must be exciting from the standpoint of not knowing exactly how much oil or NG will come out of all the upfront geologic and other work to extract. You have some idea it’s there, but exactly how much probably lends some fun, yet risky uncertainty to the process.
That’s for the same reason I like to do experiments not knowing exactly how it will turn out.
shortonoil on Sun, 31st Aug 2014 10:02 am
“That is a daunting stat short, but makes sense that at some point it isn’t just another boom & bust oil cycle, but rather, finite limits bump into global economic affordability.”
Petroleum is a commodity with a unique characteristic that is overlooked by economists. Petroleum is a commodity that is capable of driving its own demand:
http://www.thehillsgroup.org/depletion2_012.htm
Its ability to do this is determined by its energy content, and the maximum amount of petroleum that can ever be extracted is also determined by its energy content. As time progresses the energy cost of producing petroleum, and its products increases. We see this as increasing dollar cost of production. Wells get deeper, water cut increases, and now we are attempting to squeeze oil out of rock with almost no permeability. This increases energy, and the dollar cost of producing it (energy, and dollar costs are closely related).
http://www.thehillsgroup.org/depletion2_008.htm
The benefit of petroleum is, however, finite. There is a point where its cost can no longer be justified by the end consumer. The maximum theoretical price is about $400/barrel, but the point where the consumer begins to cut back on their usage appears to be in the $100/barrel area. It is a good guess that from this point forward petroleum will be used less, and less for non critical applications, and constrained to production of items such as food, and goods transport. This, of course, has huge implications for many areas of the economy, such as retail, and for the concept of globalization.
Of course the consumer is constrained by the price of oil. Mother Nature is not, and production costs will continue to increase as long as the commodity is extracted, and used. We are now firmly in the decline phase of petroleum production. This will manifest itself as ever declining margins for its producers!
http://www.thehillsgroup.org/