The Oil Bubble

From Charles Hugh-Smith via Tyler Durden:

Since 2009, central state/bank authorities have backstopped the private banking sector and the sovereign debt market with everything they’ve got. The Federal Reserve alone threw something on the order of $23 trillion in guarantees, loans and backstops at the private banking sector, and the other central banks have thrown trillions of yuan, yen and euros to shore up the banking sector and sovereign debt.

They did this because they identified the banking sector and sovereign debt as the sources of systemic risk. Now that they’ve effectively shored up these two risk-laden sectors with the full weight of the central state and bank, they presume the systemic risk has been eradicated.

They could not be more wrong. As I often note, risk cannot be disappeared, it can only be masked or transferred. The systemic risk will not manifest in the heavily protected banking sector or the sovereign debt market–risk will break out of sectors that are considered ‘safe”–like oil.

Yesterday, I described how The Financialization of Oil has followed much the same path as the financialization of home mortgages in the 2000s: a “safe” sector has been piled high with highly profitable and highly risky debt and leverage.


We just had a conversation an hour or two ago about what declining oil prices might do to Vlad Putin’s Russia, but Russia isn’t the only country at risk of financial ruin. Before we get to that though, a brief word about the Saudis.

The Saudis don’t enjoy so much control over the price of oil just because they have so much of it, although that is a part of their control. The other part is that their oil is the highest quality (light, sweet), easy to get to (scratch the sand and the oil comes forth), and easy to market (the oil fields are right there on the coast). So the Saudis can sell oil at a profit at prices which drive higher-cost producers out of business.

The fracking revolution has done wonderful things for our economy, but fracking is far from a low-cost method of oil production. See this from an October Reuters report:

“We estimate $73 as the weighted average breakeven point for
U.S. supply.”

Eagle Ford Liquids Rich $53
Wolfcamp North Midland $57
Bakken Core $61
Niobrara Extension $64
Eagle Ford Oil $65
Niobrara Core $68
Wolfcamp South Midland $75

Bakken Non Core $75
Texas Panhandle $81
Mississippi Lime $84
Barnett Combo $93


At the time of this writing, crude oil is trading at under $70.

Much of our present recovery, lame as it is, is due to the revolution in fracking. The jobs pay well, the work requires lots of expensive equipment, and those benefits plus the benefits of cheaper energy ripple through the rest of the economy. So it’s great to watch Putin squirm as the rug is pulled out from under his imperial ambitions, but if Hugh-Smith is right, the US economy could be looking at an oil bubble ready to pop — a bubble every bit as big as the real estate bubble of 2007-08. The ripple effects we’re enjoying now could easily become the giant sucking sound of trillions of dollars leaving the economy.

Can we afford for the Fed to inflate its balance sheet by several additional trillions? Can we afford another trillion-dollar stimulus? Can we afford seven trillion more in debt? Can we afford negative interest rates?

Which begs further questions still.

Where would the Fed’s newly-minted trillions go? Who would be the beneficiaries of Washington’s renewed largess? Who would buy our debt? What happens to an economy when banks become the Fed’s enlarged syphons of middle class savings?

I’m not sure there’s ever been First World economy as dependent on the production of extraction wealth as ours has become under Obamanomics. We’re in uncharted waters here, but its plain to see for anyone willing to look that they are treacherous.


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