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Page added on June 25, 2016

Oil, Interest Rates, and Debt

At first glance it is hard to see how oil, interest rates and debt are connected. Two of them are human constructs while oil (fossil sunlight), a gift from Mother Nature, took tens of millions of years to process. Oil is an endowment extracted from a confined underground stock and is now the most dense and versatile energy source known to man.

Figure 1: Chart that shows the development of [extraction] cost of oil and interest rates (US 10 Year Treasuries) has developed since 2000 and a likely trajectory for oil extraction costs.

Both lines are SIGNALS, and most likely plan their future based on only one of them.

The 10 Year Treasury (or similar) rate is the reference used for amongst other things to set interest rate for mortgages. Most now, aware of it or not, base their future plans on the expectations to developments of the 10 Year Treasury.

What is now playing out in the oil market may be described as below;

Low interest rates [stimulates debt growth] => Pulls demand forward => Oversupply => Deflation

How will the interest rate develop in the future?

This is important as the present huge global debt overhang weighs heavily in the consumers’ balance sheets and their affordability for costlier oil. It is also important for oil companies’ long term planning to bring costlier oil to the market.

A lasting, low rate makes higher debt loads manageable. Interest rates works both sides of the demand/supply equation.

A higher interest rate will have serious implications for highly leveraged consumers and oil companies.

The dynamics may be described as below:

Higher interest rate => lowers demand => downward pressure on price [deflation] => makes it harder for [highly leveraged] consumers/oil companies to service their debt overhang => lowers investments to develop costlier supplies

At some point in time the present oil supply overhang will come to an end. This will become reflected in a higher price.

The timing of these events creates uncertainties and the agile and financial strong oil companies will sweat out a lasting low oil price.

Few are aware of that the costs of accessing our real capital (like oil) that runs our economies are rapidly increasing.

What is different this time is that the oil price may remain lower for longer than the estimated full cycle break even costs for new developments.

The suggested path for costs is believed in the near term to come down as oil service companies have reduced their prices to shoulder the burden from the recent price collapse. Over time, the capacities of the service companies will become aligned with the demand for their services and products. At some point, as the oil price recovers and investments pick up, the market mechanisms will bring the prices from the service companies up as the service companies also need to make a profit to stay in business.

In figures 4 and 5 are shown how the combination of lower interest rates and a lasting, high oil price encouraged the oil companies to rapidly take on more debt to develop costlier oil on the expectations that consumers had remaining ability to take on more debt/credit to pay for this, thus allowing the oil companies to retire their debts.

The oil companies’ behavior in the recent decade is reminiscent of group think. Few expected the oil price to collapse, though the oil industry itself repeatedly point out the cyclical nature of the oil price.

The aggregate of developments (primarily driven by an amazing growth in the extraction of light tight oil [LTO]) gradually resulted in a supply overhang that made the oil price collapse.

The costs of extracting real capital, like oil, has been rapidly increasing, yet we are making decisions for the future as if it were decreasing, based on the price of capital (money). This is a short term phenomenon that will last until supply and demand become balanced.

The present situation with an apparent oil glut and low prices is a temporary false signal.

This may also be the case with the low interest rates.

The near future will reveal how the competition for available funds to service a still growing huge global debt overhang fare towards the need to fund developments of costlier oil.

Can an increasingly leveraged global economy handle both higher oil prices and interest rates and still remain on its growth trajectory?

Some energy basics and food for thought

Figure 2: Common for the 8 items in the figure above is that these now (Mid April 2016) sell for $40 – $50 and they all required some energy input and/or used derivatives of crude oil to become commercial objects.
NOTE: The price for several of the items is what was asking price at Amazon.com (costs for handling, shipping and customs may be added).
Primarily refineries buy crude oil to turn it into commercial products like gasoline, diesel, kerosene, lubricants etc.

One of the items in figure 2 is very special, and it is not the rose colored glasses.

CRUDE OIL!

One barrel of crude oil (159 liters) contains about 5.7 Giga Joules (GJ) energy or about 1,640 kilowatt hours (kWh) of available energy/work. (Conversions as proposed in the BP Statistical Review for 2016.)

A human doing hard manual labor produces 0.07 – 0.08 kW. For a workday of 8 hours this amounts to about 0.6 kWh.

One barrel of crude oil has the potential to substitute for about 22,000 hours of hard manual labor. Some refer to fossil energy as our fossil energy slaves that are available 24/7 and which never complains, strikes, takes sick leaves, etc. In recent years, these slaves have been asking for wage increases and are destined to continue to do so.

Mother Nature took tens of millions of years to process fossil sunlight into crude oil and we humans gradually figured out ways both how to locate and wrestle it from the deep underground and to use it to improve our living standards.

These fossil energy slaves are endowments from the distant geological past, by many referred to as our real capital.

ENERGY is hard to distinguish from MAGIC, as energy cannot be seen, only the effects of its workings are observable.

Energy should not be confused with technology!

We are conditioned to look upon the monetary/financial system as what runs our world.

Every product and service in our economies require an energy input, which makes energy the real power that runs our complex societies.

Energy is THE invisible hand of our complex economies.

Money is a claim on energy.

Development in our energy consumption

Figure 3: Chart shows global development in energy consumption split on energy sources since 1800 and as of 2015.

The Industrial Revolution was in reality a Fossil Fuel revolution which started in the 1800’s as coal increasingly was introduced into the energy mix. This likely reversed the trend of using wood as primary fuel and slowed deforestation. Meaningful growth in the use of oil and natural gas started after World War 2. The chart also illustrates that as new energy sources were introduced in the energy mix some substitution took place, but globally the new sources were added to growth from the existing ones.

As from the 1980’s increasingly more debt was used both to grow energy consumption and for the extraction of fossil fuels and in the recent years, technological improvements allowed to add more repeatable methods for energy harvesting, like solar and wind.

Oil companies’ growth in debt

Figure 4: Figure from BIS report [link below] on growth in debt for energy companies.

Figure 4 has been lifted from the speech “Credit, commodities and currencies” of February 2016.

Since 2006 the oil companies increasingly turned to external funding by primarily debt as the oil price moved above $60/bo (ref also figure 5) in a bid to grow supplies.

Figure 5: Brent oil price since Jan 2000 [rh scale] together with growth in energy companies outstanding bonds since Jan 2006 [lh scale].
NOTE: The lines for energy bonds are not stacked.

Higher oil price allowed to use oil reserves as collateral and allowed to rapidly take on more debt in a bet that oil prices would remain high. Figure 5 illustrates that the oil companies apparently based their future on sustained oil price around $100/bo.

The energy sector in both US and EMEs grew their outstanding bonds by a factor of 5 from early 2006 to early 2015.

That is an average compounded annual growth (CAG) of close to 20%.

Oil companies regularly underlines the cyclical nature of the oil price which begs the question why did they rapidly grow their debt levels on the expectations that an oil price of $100/bo was sustainable which would ensure orderly retirements of their debts?

This happened while total global debt grew strongly.

Debt funded growth works if the financial income grows fast enough.

The collapse of and sustained low oil price has forced many companies into restructuring their balance sheets due to the debt overhang.

As figure 5 illustrates some deleveraging has recently taken place. Most of this deleveraging is now driven by bankruptcies [bankruptcy is one way to deleverage], a process which now has picked up speed as this recent presentation from HaynesBoone illustrates.

Figure 6: The figure above shows developments in Statoil’s gross interest-bearing financial liabilities, net income and development in equity volumes split on liquids and natural gas in Norway and international.
Statoil reported a net negative income of 37.3 GNOK in 2015 due to lower prices and impairment losses.
NOTE: Equity volumes are higher than entitlement volumes.

Figure 6 illustrates that growth in inorganic CAPital EXpenditures (by growth in debt) has had small effects on production and this during a period where most of the time the oil price was high.

This is worrisome because with a lasting, low oil price (below $60/bo) debt management has now moved to the top of management’s agenda and dictate how future income becomes allocated between new developments, debt services and dividends.

A combination of lasting, low oil price and declining production makes it harder to access more and/or roll over debt.

With a lasting, low oil price the oil companies have become entangled in a CATCH 22 dynamics; More debt is required to grow their production, but as production declines (due to reserves depletion) so does their debt carrying capacities and the resulting deleveraging will reinforce the downward trend in production as CAPEX is cut.

This will challenge the existing business models (based on financial growth with high debt leverage) of the oil companies and may prompt them to reinvent themselves. Proceeds from asset sales used for debt retirement is one way to deleverage as described in this article.

Figure 7: The chart above shows development in US commercial stocks of petroleum, by some products, since Jan-14 [stacked areas, rh scale] together with the development in the oil price (WTI) [black line, lh scale].

During the last year US total petroleum stocks have grown at an annualized average rate of about 0.3 Mb/d. This is one of the fundamental metrics I follow as it gives valuable feedback about the petroleum supply situation and thus one of the fundamentals that affects the oil price.

This article has also been about how the oil companies responded to a higher oil price and how their growth in debt (stimulated by the decline in interest rates) was used to grow CAPEX in a bid to grow supplies of costlier oil for an expected growth in consumption that could sustain a high oil price.

The other side of the equation is the demand (consumption) as lower interest rates also allowed consumers to expand their balance sheets (take on more debt) to afford higher oil prices and grow consumption.

The recent lower oil price predictably stimulates more consumption, but as more consumers will continue to struggle with their balance sheets, they are now more sensitive to considerable increases in the oil price.

This creates for an interesting situation; the price a growing number of consumers find affordable may be lower than what the oil companies need to go after the costlier oil and retire their debts in an orderly way.

FRACTIONAL FLOW by Rune Likvern

22 Comments on "Oil, Interest Rates, and Debt"

makati1 on Sat, 25th Jun 2016 9:29 pm

Pretty charts saying nothing useful. We are in a permanent contraction mode. The debt tsunami is building up as it recedes from the shoreline of sustainability. Anyone ignoring this sign of what is coming deserves all that they will suffer. Prepare now. You do not know what tomorrow may bring.

JuanP on Sun, 26th Jun 2016 12:34 am

I’ve reached a point when I hardly ever read articles like this anymore. I have read so many for so long that I don’t see the point. What difference would it make? We are FUCKED! There’s no two ways about it. I am focused on prepping, I no longer read stuff like this as much as I did in the past. My research these days is mostly focused on practical matters like water, food, shelter, and protection. All these writers sound like broken records to me!

Truth Has A Liberal Bias on Sun, 26th Jun 2016 12:57 am

You fucking retards couldn’t read a chart to save your life. You doom porn circle jerk dipshits should have tried sticking it out in high school instead of dropping out. Maybe then you might understand future trends based on data. You losers are into the collapse of society because it’s your revenge against a community of people who make you feel insignificant and weak. Revenge of the nerds meets Mad Max. Losers.

JuanP on Sun, 26th Jun 2016 1:05 am

Thalb, You are so stupid you can’t even tell how stupid you are. You can go to school all your life if you want, but you will NEVER stop being stupid! You were born stupid and you will die stupid!

marmico on Sun, 26th Jun 2016 4:41 am

WTF Likvern. 2016 gasoline spending by U.S. households is near record lows.

https://fred.stlouisfed.org/graph/?g=3QNb

U.S. households leveraged up because of the rising price of the outstanding stock of residential real estate not because it cost them 25 bucks to fill up the jalopy.

http://tinyurl.com/hog2bjq

The financial obligations ratio of U.S. households is near record lows.

https://www.federalreserve.gov/releases/housedebt/

makati1 on Sun, 26th Jun 2016 7:03 am

JuanP, I agree. There seems to be an unlimited number of authors writing for a paycheck and saying nothing new. Most of the articles should at least start with “Once upon a time…”. Then you would know not to bother. They almost always end with some hopey, feely, “IF ONLY..” that will never happen and they know it. I often read the headline, jump to see the source and move on.

We as individuals have no chance of making a difference. All we can do is prep as best we can to ease the pain, make the choices that seem best for ourselves, and enjoy what time we have left. THAT is all we actually control. Ourselves.

marmico on Sun, 26th Jun 2016 7:32 am

We as individuals have no chance of making a difference.

Speak for your self, otherwise known as anecdote.

You are an innumerate barefoot U.S. expatriate tax dodger living the Walter Mitty life on your $1,100 month social security stipend in a third world country which increased its energy consumption by 10% in 2015. Pathetic!

shortonoil on Sun, 26th Jun 2016 9:48 am

What could possibly be the purpose of publishing such an incredibly, and obviously flawed analysis. Likvern is making claims that are so absurd that they not worth mentioning. By comparing his estimates of production costs, which were digitized from the graph above, we compared them to the price of crude for the years 2000 thru 2012.

Year… Prod$.. Price/b..Profit%

2000.. 10.35…26.72…258%
2001.. 10.70…21.84…204
2002.. 11.05…22.51…204
2003.. 11.75…27.56…235
2004.. 14.56…36.77…253
2005.. 17.72…50.28…284
2006.. 22.28…59.69…268
2007.. 28.60…66.52…233
2008.. 30.70…94.04…306
2009.. 31.93…56.35…176
2010.. 33.68…87.49…260
2011.. 35.79…71.21…199
2012.. 43.85…94.05…214

The author’s claim is that the average 13 year profit on Gross Sales for crude extracted was 238%. That is a totally unrealistic. The average profit on Gross Sales is way less than 10% for US corporations in general. The Congressional Research Service put 2007 profit on sales for US petroleum producers at 8.16%.

http://fpc.state.gov/documents/organization/103679.pdf

How anyone who was preparing this report could miss such a blatant contradiction is beyond us. Was it done with some other purpose in mind?

http://www.thehillsgroup.org/

JuanP on Sun, 26th Jun 2016 11:50 am

Marmi “Speak for your self, otherwise known as anecdote.”

Please tell me your plan to save humanity from itself, moron! You are one deluded arsehole!

Apneaman on Sun, 26th Jun 2016 12:41 pm

marmi, I was going to suggest that the record breaking heatwave has damaged your brain, but you have always been a fucking goof, so it can’t be that. Jalopy eh? Subprime (7 year terms) jalopy bought by a Stanford Phd working at Starbucks. His cousin has a masters in “marketing” and is living in his jalopy. When the repo man finds him he’ll be just one more statistic living in the ever growing number of homeless camps. As stupid as most mericans are, the only reason they pay any heed to a retard like Trump is because they are broke or soon will be. If the jobs and income were there they would not think of throwing their vote away on him……but when you have nothing left to lose??? That’s who Trump supporters are – the losers. The flotsam and jetsam of globalization. All that manufactured statistical woo woo you present as evidence of how awesome things are just doesn’t have the same effect as it once did. Your entire country is like Missouri now – “show me”. Of course nothing and no one can bring back the good ole days, so expect big trouble when the honeymoon wears off if Trump wins. If skank Hillary wins expect trouble right away. Ok now run along and go play your Milton Freidman “every thing is awesome” board game by your friendless and womanless self. We’ll call you when it’s time to run and hide – promise.

Boat on Sun, 26th Jun 2016 1:34 pm

ape,

All that manufactured statistical woo woo you present as evidence of how awesome things are just doesn’t have the same effect as it once did of how awesome things are just doesn’t have the same effect as it once did”

America isn’t anything other a large group of people. Our system of government isn’t as good as a few small countries mainly because we are much less flexible. For a large system it has worked rather well compared to other systems.
Most if not all of “All that manufactured statistical woo woo you present as evidence “are just what it is and how it it is. Just correcting off the wall statements by haters who are to lazy to look up the facts. In other words, responding to dumbasses.

Apneaman on Sun, 26th Jun 2016 2:20 pm

Boat you the dumb ass from tex-ass who lives in the middle of a permanent disaster zone (one that was predicted) and yet all you can come up with are incoherent ramblings (see above). Like when I brought up climate change with you last year (or 2-3 Houston disasters ago if you like) your response was “they’re exaggerating”. Sure tell that to the newly wiped out/homeless and to the families of the dead soldiers and others. People remember what you say boat even if you don’t or pretend you did not say it.
Try rereading what you just wrote – all those words and you did not make one damn point. Do you have a friend or a woman who proof reads your comments and tells you they’re clever or is it just you? Kruger-Dunning indeed. No one around here has provided more laughs without trying to be funny than you boatmister.

Boat on Sun, 26th Jun 2016 2:57 pm

ape,

You know what’s happening in Houston in the flood zones? They are rebuilding.

Like when I brought up climate change with you last year (or 2-3 Houston disasters ago if you like) your response was “they’re exaggerating”.

Now you’re doing a mak and lying out your ass. I even gave you links of the flooding history of Houston. This is your problem ape. To many of you doomers distort the truth to make a point when there is no need to.

Do I personally think it is wise to build in a flood zone? No Will those rebuilding get flooded more often with increasingly stronger storms? Yes

Get this ape, not all Americans live in flood zones. Some of us do due diligence when buying a home.

PracticalMaina on Mon, 27th Jun 2016 12:35 pm

Boat, the federal government encourages it though, threw subsidies flood insurance, and it will continue to cost us. It used to be the best farmland was in low lying flood plane-delta type areas. Now when the floods do come, they will have so much force, that it will probably wipe all nutrients out to sea, helping algae and nothing else.

marmico on Mon, 27th Jun 2016 1:38 pm

Global cereal supply prospects for 2016/17 improve further notwithstanding the doom porn meteorologists masquerading as climate scientists.

http://www.fao.org/worldfoodsituation/csdb/en/

Apneaman on Mon, 27th Jun 2016 3:18 pm

marmi, what are your prospects for getting laid in 2016/17?

Sorry, didn’t mean to depress you – wasn’t thinking. By all means go back to digging up obscure graphs and using them to misrepresent their real purpose. It will help keep your mind mind off your permanent celibacy.

Apneaman on Mon, 27th Jun 2016 3:44 pm

Sounds familiar, like Syria a few years back.

Drought migrants flee to India’s cities

“Water in the Penna River has completely dried up,” Manikamma said. “We got drinking water in our homes only once a week. Had I not left … my kids would have died of starvation.”

Parts of the country have been in the throes of drought for two years, which has caused a wave of migration as crops fail. After months of high temperatures and dry weather, the monsoon rains have finally arrived, although they have yet to reach some drought-stricken areas in central India. And the past two monsoon seasons have been too weak to stave off the drought.”

https://www.irinnews.org/news/2016/06/27/drought-migrants-flee-india%E2%80%99s-cities

Apneaman on Mon, 27th Jun 2016 4:29 pm

I’m not the only one to make the India – Syria drought and migration comparison.

Robertscribbler paints a fairly accurate big picture here, but he is hopey dopey naive if he thinks there is a snowballs chance in hell of the humans ever cooperating on the level needed to advert disaster. I see that 2nd half 20th century, global level of cooperation as an extension of the techno oil age and like the age itself, it was a one time endowment and it’s well on it’s way down the back slope.

Britain Succumbs to Fear — Europe Shattered by Deteriorating Physical and Political Climate

“It’s a repeat of a scene that happened in Syria during 2006 through 2010, but on a much larger scale. A scene that will repeat again and again. In Bangladesh and the other low lying coastal and delta regions of the world, hundreds of millions will be uprooted by sea level rise. In the US Southwest, India, Africa, South America, the Middle East and Southern Europe hundreds of millions more will be uprooted by drought. All because we, as a global civilization, failed to work together to halt fossil fuel burning soon enough and prevent a temperature increase great enough to wreck cities, states, and regions and start to destabilize human civilization.”

“The Need For Global Unity and Equality in the Face of Severe Climate Externalities”

“Brexit — The Culmination of Greed, Fear, and Climate Change”

“The Dark Consequences of Economic Systems Engineered to Optimize Wealth Concentration and Externalize Harm”

https://robertscribbler.com/2016/06/27/britain-succumbs-to-fear-europe-shattered-by-deteriorating-physical-and-political-climate/

There is no going back now – not from a physics stand point and not from a human psychological one. Everything is in motion and nothing can be stopped – inertia is a real bitch.

marmico on Mon, 27th Jun 2016 5:09 pm

The doom porn meteorologist needs to go under the augmentation knife to titillate the bored tribal viewers during sweeps rating week.

Apneaman on Mon, 27th Jun 2016 6:15 pm

marmi, robertscribbler ain’t no doomer. If you actually read his writing it quickly becomes apparent that he is still filled with hopium in spite of all evidence to the contrary, which is funny because he one the those doing a great job of explaining said evidence. Of course, I have previously demonstrated that is simply how the human mind works. It tells you the lies you need to hear or else why bother getting out of bed? It’s simply another survival tool evolution provided the humans with.

Brain imaging reveals why we remain optimistic in the face of reality

“In a study published today in Nature Neuroscience, researchers at the Wellcome Trust Centre for Neuroimaging at UCL (University College London) show that people who are very optimistic about the outcome of events tend to learn only from information that reinforces their rose-tinted view of the world. This is related to ‘faulty’ function of their frontal lobes.

People’s predictions of the future are often unrealistically optimistic. A problem that has puzzled scientists for decades is why human optimism is so pervasive, when reality continuously confronts us with information that challenges these biased beliefs.”

http://www.eurekalert.org/pub_releases/2011-10/wt-bir100611.php

Your brain won’t allow you to believe the apocalypse could actually happen

http://io9.gizmodo.com/5848857/your-brain-wont-allow-you-to-believe-the-apocalypse-could-actually-happen

There are very few real doomers and I can only guess why they slip through the cracks so to speak – I only became one a little less than a decade ago. I once thought it was depressive realism, except, I’m not depressed nor are many of the doomers I’ve come in contact with. Who knows? I figure they will string us up as the great unraveling continues – you know, shoot the messenger and all that. Told ya bahahahaha. That’s my last words.

Global Warming 25% Faster Than Thought!!!

https://lokisrevengeblog.wordpress.com/2016/06/27/global-warming-25-faster-than-thought/

shortonoil on Tue, 28th Jun 2016 8:36 am

Considering the weapons development that has occurred over the last century, and the fact that deteriorating economic conditions often result in war, the end for humanity is much more likely to come about from direct human action than climate change.

A mushroom cloud over Houston is going to have much more immediate impact than a flood, or unusual heat wave. The degradation of the world’s fossil fuel resources are leading to a high probably that humans will engage in one last battle. Concern over global warming will be incidental after we have converted the planet into a smoking ruin!

Dustin Hoffman on Tue, 28th Jun 2016 10:06 am

Shortonoil….precisely the sentiments expressed by Admiral Rickover

): You’re looking for easy solutions. The trouble with you is you want easy answers, but you don’t know the proper questions
….CONGRESSMAN: What do you think is the – is the – is the prospect, then, for nuclear war.

AD RICKOVER: Well I think we’ll probably destroy ourselves. So what difference will it make? Some new species will come up that might be wiser than we are. I do not believe in divine intercession. In the eyes of the Lord, we are not the most important thing in the universe

http://www.analytictech.com/mb021/rickover.htm

Oil, Interest Rates, and Debt

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