When the oil boom turns to bust
New sources of supply in the US and overseas will inevitably take a toll on the market.
By Dana Blankenhorn
The present recovery is fueled by, well, fuel.
Fracking has uncovered huge pools of oil in Texas, Ohio and North Dakota, creating an economic boom in those places that has trickled down to the rest of the country.
A Texan may have no more incentive than an Arab to give you a better price on his oil, but he does spread the wealth around, as I saw on a recent trip to Kingsville for my daughter's graduation (TheStreet).
But every oil boom carries within it the seeds of its own destruction.
I have seen this movie before.
After leaving Houston for a daily newspaper job in 1981, I returned in 1984 to see the boomtown I had known transformed into something out of the Great Depression. Billboards advertised churches, roads were empty and buildings see-through. Friends who had graduated from Rice University with high hopes a few years before were taking blue-collar jobs from which they would never recover.
What caused that bust was a precipitous fall in oil prices, begun by Fed Chairman Paul Volcker's tightening of the money supply to choke off inflation. President Reagan also had the Saudis open their oil spigot wide, causing Russian commodity prices to crash and leading to the victorious end of the Cold War.
The cause this time will be different, but the result could be the same.
Renewable energy doesn't look like much right now. It may replace just 1% of demand this year. But it's in the nature of technology that 1% quickly becomes 2%, 2% becomes 4%, and 4% becomes 8%. Even if you think solar and wind energy are government-created frauds -- and financiers no longer think that, as Gigaom's Katie Fehrenbacher notes -- efficiency isn't. Getting more work from less fuel, over time, means less demand.
So what happens then? The high-cost streams are priced out of the market first. Canada's "oil sands" (formerly the Alberta tar sands), deep fracking and deepwater drilling cost more than re-tapping fields in Arabia and Iraq, or fracking for gas closer to markets in Europe and China.
Environmentalists may smile over this, but there's an economic knock-on effect as well. When prices fall permanently, it means the value of "proven reserves" goes down. That makes production loans harder to get. People start losing money. There's a negative wealth effect across the oil patch. That was what I saw in my 1984 visit to Houston.
There was a price collapse quite recently in the natural gas market, although through careful management -- and no small amount of flaring in the Bakken -- the crash in prices there was reversed last year. Prices are now approaching $4/mcf, and CME Group (CME) futures contracts show this firming through year's end.
The oil industry has found many ways to manage falling prices over the last few years, but once the value of reserves starts to drop the retreat could become a rout.
If what's in the ground is seen by a banker as being worth less than what you're pumping now, you're going to want to pump now. New fields in countries that haven't seen an oil boom before are going to be exploited, regardless of price.
All this will take careful political and financial management, over several years, to work through. That time will be called a recession.
But when I returned from my Houston trip in 1984, I found that my new home in Atlanta was seeing a great economic improvement, a real recovery based on its status as a trading center and airline transfer point.
For investors, this means you shouldn't become wedded to your energy investments, especially in U.S. exploration companies that based their valuation, in part, on proven reserves. Make sure you're diversified, even if your oil profits are gushing today. Don't get caught out when the boom inevitably turns to bust.
At the time of publication the author had no position in any of the stocks mentioned.
More from TheStreet.com
This analysis misses the key parameters driving supply and demand, assuming it will bust because it has before. New supplies are much more expensive to develop, so as cost drops so will supply. Aggregate demand is no longer dominated by the US, in a globalized world, dampening any effects of an american recession/drop in demand. As for renewables, get real, come back in 10 years. And analogy to NG in terms of reserves makes no sense at all.
The biggest flaw with this arguement is that the supply of oil is finite,.....making it harder and harder, thus more expensive to procure,......thus putting upward pressure on pricing,.......despite potenitally lower demand,....which hasn't started yet,......more people world wide are driving,.....pricing of oil will continue to rise,.....
Kinda the same thing in Denver, many of those boys, closed a lot of Office space there..
After the similar build-up..
But I won't elaborate and tell you how many times I've been there.
Crazy...We can make jokes about what the Government or even "current Administration" is willing to spend on or invest in...?
You didn't get home today, without using one of them...
You can't look out your window in the morning without seeing one of them..
I grew up watching much of this my entire life, and of course seeing somethings on old film.
InterStates even the road in front of your house/home.
Dams and Power Grids, the electric that runs your Computer.
Satellites and Communications,TV broadcasting, Cable TV, and yes even the Internet.
Our Education systems, except for the Old one-room Schools..Local People built them.
Mining of Iron, Copper and Coal to name a few.
**edited..Oh yeah Oil/Gas exploration and fruitation. Almost forgot what the Article was about.
The "greatest and most expensive" Military in the World.
Yes, Solar power and Wind Generators, not now but back in the 70s-80s..
No the "FreeMarkets" didn't build any of this without subsidies or outright support of Cost.
The Government was responsible for "most" of all of this...
FreeMarkets and Capitalist, IMPROVED and made money on it, in most cases.
"We the People"........
Price drives the drill bit, always has, always will regardless of BIG OIL OPEC conspiracies. I just got back from W TX NM, grew up in the industry, dont know everything but am old enough to have seen boom and bust cycles several times.What is different this time is that with China, India and other emerging economies, oil istruly a global product. I see what $16 billion/yr does for a regional economy as in the Permian basin, not without growth problems but it is far preferable to have to manage growth than recession and poverty.
As long as we are supporting enourmous military assets to protect oil supplies from our enemies, any price up to $150/barrel is a bargain not to mention the human capital we expend. Develop our own resources, pull our troops out of the middle east and leave them stuck in the 7th century.
Not one drop of my son, or daughters blood is acceptable payment for a million barrels of oil from our enemies.
your concern centers around this statement in your column:
"If what's in the ground is seen by a banker as being worth less than what you're pumping now, you're going to want to pump now. New fields in countries that haven't seen an oil boom before are going to be exploited, regardless of price."
I don't know if I agree with that statement. It is contrary to what oil companies would be inclined to do, which is curtail production and raise prices I believe. I'd have to hear if a few bankers in the industry agree with you on what they would want to see happen. Any oil industry bankers here?
Years ago I remember when there was a drive on to put Nat Gaslines into many areas..
Then eventually all new plats had "common bury" or in close proximity of Electric, Telcom, CATV and NG.
I'm hoping there will be another push as such to higher populated rural areas, to put in Ngas lines and eliminated all "the Bombs" people have in their yards...Which are petroleum based.
And let the Government fund the pipeline laying, charging back in a long term hidden miniscule tax.
For recovery of cost for 20-30 years...Then it will get done and provide jobs.
Another point to make about Bankers and Investors, if there is a drop of money (in this case oil) to be made...They will be there writing checks or bringing bags of cash...
If not, all that money dries up and they invest in the next "soft ice cream" or "toilet paper" elsewhere.
Copyright © 2014 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
Investors are anxious to see if hiring can maintain its strong pace in the second half of the year.
VIDEO ON MSN MONEY
Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.
Contributors include professional investors and journalists affiliated with MSN Money.
Follow us on Twitter @topstocksmsn.