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 TheStreet Staff May 21, 2013 1:44PM

 Oil derricks copyright Comstock, CorbisBy 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.


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36Comments
May 21, 2013 3:54PM
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Big Oil has gotten savvy enough to manipulate public opinion so that regardless of actual supply, they can always gouge folks at the pump. Until future traders along with Big Oil are held accountable for their corruption, your outlook on bust and boom, won't happen.
May 21, 2013 4:17PM
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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.

May 21, 2013 4:13PM
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Dana    You told us 4 times you went back to Houston in 1984    Enough already    and gas is over 4 Dollars now.  Your daughter goes to school in Kingsville     to bad   Hope you enjoy atlanta    you should be there   not in Texas
May 21, 2013 4:25PM
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Commodity cycles have always been influenced by supply and demand.  OPEC controls a lot the price by simply turning on or off their spigot.  When the prices get too low, they pump less and when it goes up they pump more.  Whether or not new reserves are found, it all depends on not just whats in the ground, but whether or not they choose to it take out.  They close wells because the oil company says it's not profitable to keep it open and then restart the well when prices make it worthwhile to do so.  Until non-oil dependant energy is utilized to a much larger percentage, the oil producers will continue their stranglehold on energy prices.
May 21, 2013 4:35PM
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Like what has happened in Hawaii, where electric companies are losing profits because so many people are producing their own electricity using solar power, power companies are trying to not credit the excess power individuals are producing from their solar arrays.  In CA, they want to increase prices to make up for "lost profits," or charge individual solar power users more fees just to stay connected to the grid.
May 21, 2013 5:14PM
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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,.....

May 21, 2013 4:35PM
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MAJOR fallacies in your "observations" - mistakes most mere "observers" make when they do not grasp the fundamentals.   1)  in 1984 there was constant demand, a glut brought about after the worldwide shortage/embargo in 1973, and the only speculation was in the price.  As such, prices fell and oil industry profits suffered - along with the economy.  The major difference now is that the worldwide demand for oil has grown exponentially ... and the oil industry immediately adapted.  2)  recent fall in demand (or price as you observed) in natural gas.  Natural gas was, primarily, for U.S.S.A. consumption,  When demand fell (or 'price' as you observed)  the oil industry immediately adjusted by making U.S.S.A. natural gas available to other countries,  Equilibrium reached, yet again.
May 21, 2013 5:31PM
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Boom and bust are built into capitalism. So far the government has socialized the busts with the small taxpayer's money, but that can only be a temporary situation.
May 21, 2013 4:22PM
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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.

May 21, 2013 5:57PM
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Oil and oil related investments have been the best asset for me over the last 5 years.  I expect it to continue for another 5 minimum, unless our U.S. Govt screws that up too like everything else.
May 21, 2013 10:10PM
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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"........

May 21, 2013 8:35PM
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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.  

May 21, 2013 6:11PM
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I doubt prices will hit levels they did during the 80's as countries such as China and India are expanding too quickly. Likely if prices dropped the rate of growth would skyrocket. Hard to see the U.S. becoming more self sufficient as any thing but good. Hopefully the authors prediction of growth in renewable areas will come to pass as even with the new technologies energy production will eventually again start to decline.
May 21, 2013 6:10PM
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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?

May 21, 2013 6:09PM
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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.

May 21, 2013 9:46PM
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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.

May 21, 2013 5:41PM
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No worries - Obamaville will just add another tax increase onto the cost of a gallon of gas - Barry needs mo' money to redistribute as part of his Grand Overpromise.  mmm, mmm, mmm!
May 21, 2013 6:10PM
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We will never run out of oil.  The Republicans have decreed it!
May 22, 2013 4:18AM
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Big Oil and their puppets in Congress would sell their first born to make a profit. They are big Friends with those whom most on these boards call our enemies. As long as they play along with Big Oil, they are friends. Once they refuse to play ball, they are the enemy, darn the people hurt in WAR. That's been proven by all the Dictators our Country has supported then brought down over the decades when they refuse to accept Big Oil terms. We pay through the noise for that ongoing deception. That's the dirty little secret that the Main Stream Media refuses to talk about.
May 21, 2013 5:01PM
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if the supply goes up to high they have it rigged oh refinery fire ,oh storms hit the gulf ,it all about price manipulation
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