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Special NIA Report: The Fed’s Oil Shale Bubble

The world now produces 77.637 million barrels of crude oil per day, up from 73.944 million six years ago. The US now produces 8.737 million barrels of crude oil per day, up from 4.722 million six years ago.

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US crude oil production has increased by 4.015 million barrels per day over the last six years vs. the rest of the world seeing a 321,000 barrel per day decline in crude oil production.crudeoilgrowthusvsworld

The US is now the third largest producer of crude oil in the world, behind only Russia and Saudi Arabia.

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America’s share of global crude oil production is now 11.25%, up from 6.38% six years ago. America’s share of global crude oil production has surpassed Asia & Oceania (excluding Russia) and Africa. Asia & Oceania’s share of global crude oil production is now 9.71%, down from 10.29% six years ago. Africa’s share of global crude oil production is now 10.46%, down from 13.21% six years ago.

Canada’s share of global crude oil production is now 4.65%, up from 3.56% six years ago. Canada’s share of global crude oil production has surpassed Europe (excluding Russia). Europe’s share of global crude oil production is now 3.62%, down from 5.58% six years ago.

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America’s rapid crude oil production growth has been primarily fueled by the shale boom taking place in Texas and North Dakota. Breakthrough new hydraulic fracturing and horizontal drilling technologies together with the Federal Reserve allowing oil exploration & production companies to easily borrow billions of dollars in the bond market – have in NIA’s opinion created a US oil shale bubble. Take a look at the recent parabolic rise in crude oil production in Texas and North Dakota – to see for yourself how the Fed has created another massive bubble:

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Six years ago, Texas and North Dakota accounted for 27.28% of total US crude oil production, but last quarter their combined US market share hit 50%.

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If we divide the US up into three countries: Texas, North Dakota, and the Rest of the US: Texas is now the world’s 8th largest producer of crude oil – ranked in between Iran and the United Arab Emirates, while North Dakota is the world’s 20th largest producer of crude oil – ranked in between Algeria and Colombia.

largestproducerstxndIf Texas and North Dakota were their own countries, they would by far have the fastest growing crude oil production in the world – followed by Canada, which is also benefiting from the shale boom. Over the last six years, North Dakota has increased crude oil production by 532.33%, Texas has increased crude oil production by 195.21%, and Canada has increased crude oil production by 37.09%.

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For further proof of a massive US oil shale bubble, take a look at this long-term chart of US crude oil production. Daily US crude oil production has increased by 3.52 million barrels over just the last 38 months. Even when US crude oil production exploded to a peak in 1970 of 10.044 million barrels per day, it took a total of 148 months for production to increase by 3.473 million barrels. Incredibly, US crude oil production over the last 3-4 years has been growing at quadruple the pace of the 1960s.

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2014 was a record setting year for US crude oil production growth, with average daily production increasing by over 1 million barrels over 2013. This surpasses last year’s record, which saw average daily production increase by 944,000 barrels over 2012 – and is the third consecutive year of record growth.

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Perhaps the easiest way to show why crude oil prices were overdue for a dramatic decline, is to display the growth of crude oil rigs operating in the US. In May 2009, following the financial crisis, there were only 187 US crude oil rigs in operation – a decrease of 56.1% from 426 in November 2008.  This set the stage for crude oil to rise back to $100 per barrel and remain there until the number of operating crude oil rigs caught up.

Thanks to the Fed’s 0% interest rates and quantitative easing, instead of seeing crude oil rigs rise proportionally to the increase in crude oil prices, crude oil rigs soared from 187 in May 2009 to a peak of 1,609 in October 2014 – for an increase of 740.43% in 65 months. Operating crude oil rigs got way ahead of crude oil prices – resulting not only in oversupply today, but the promise of much greater oversupply in the future if crude oil prices didn’t decline dramatically to end malinvestments and burst the Fed’s shale bubble.

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The post-crisis peak for crude oil of $113.39 per barrel was reached in April 2011, which was when rising crude oil rigs surpassed declining natural gas rigs:

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The latest US crude oil inventory figures were just released for the end of the third week of December 2014. There are now 387.2 million barrels of crude oil in US inventory, which is the highest level (for this time of year) of the last seven years – and exceeds the 7-year average by 11.1%.

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The capital expenditures (CAPEX) of oil exploration & production companies have exploded for the last five consecutive years. The CAPEX of oil exploration & production companies has remained well above their operating cash flow, resulting in six straight years of negative free cash flow.

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Since 2008, total cumulative CAPEX of oil exploration & production companies has surpassed $1 trillion, with cumulative negative free cash flow of nearly $133 billion.

cumulativecapexfcfoilThe total debt of oil exploration & production companies has exploded from less than $181 billion in 2008 to north of $330 billion today – an increase of $149 billion or 82.3% in six years.

debtepDuring the same time period, the total debt of the full energy sector has exploded from less than $699 billion in 2008 to north of $1.677 trillion today – an increase of $979 billion or 140.2%.

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Based on the revenues and operating cash flow margins of US oil exploration & production companies along with average annual WTI crude oil prices, NIA estimates that the average cost to produce crude oil in the US over the last six years has been $62.69 per barrel.

crudeoilproductioncostIt is because of America’s oil shale bubble that the US economy seemingly held up better than the rest of the world during the global financial crisis and had one of the world’s strongest recoveries afterwards. During the 26 month period of January 2008 through February 2010 – Texas and North Dakota added 174,103 new jobs, increasing the total number of employed workers in Texas by 1.56% and in North Dakota by 0.56%. However, during that same time period, the rest of the US lost 8.5 million jobs. Outside of Texas and North Dakota, the number of employed US workers declined by a stunning 7% in just 26 months!

As of today, the US has added a total of 1.65 million jobs since January 2008. Incredibly, 87.5% or 1.443 million of these jobs were created in either Texas or North Dakota. Over the last seven years, the number of employed workers has increased by 13.49% in North Dakota and 12.65% in Texas vs. only 0.19% in the rest of the US!

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In June, the average yield of corporate junk bonds rated CCC or lower declined to a new all time low of 7.91%, but has since exploded to a high this month of 11.95%. Energy companies now account for 18% of total US junk bond debt, up from 9% in 2009. Declining oil prices has caused the junk bond yields of some energy companies to explode north of 20% in recent weeks. This has locked many oil exploration & production companies out of the bond market – and will make it near impossible for them to raise more money without severely diluting shareholders.

junkbondyieldsOil exploration & production companies see a $5 billion decline in operating cash flow for every $1 decline in the price of crude oil. If crude oil remains at $55 per barrel, NIA estimates that US oil companies will have negative 2015 operating cash flow of ($38.45 billion) vs. positive 2014 operating cash flow of $150.75 billion. In 2014, oil exploration & production companies spent $179.715 billion on CAPEX and had negative free cash flow of ($28.963 billion). Even if the average oil exploration & production company dramatically cuts CAPEX by 50%, $55 per barrel crude oil would result in the industry having negative free cash flow in 2015 of ($128.31 billion) – close to their total cumulative negative free cash flow from 2008 through 2014 of ($132.86 billion).

Remember, between 2008 and 2014, oil exploration & production companies issued $149 billion in total debt to cover their ($132.86 billion) in negative free cash flow. With exploding junk bond yields locking many oil companies out of the bond market, if oil prices don’t begin recovering in January – some oil companies will be forced to cut CAPEX by up to 90%. Some of these same companies could be forced to explore asset sales, just to cover interest payments on their debt.

In 2014, oil exploration & production companies had a combined interest expense of $10.187 billion, up 142.5% from $4.2 billion in 2008.

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