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Page added on June 6, 2016
Cheap Money Helped Inflate Energy Balloon
Count the intensity of the shale oil boom — and its severe bust — as one of the unintended consequences of the Federal Reserve’s efforts to buttress the economy.
The hydraulic fracturing (fracking) method of extracting oil and gas from shale rock has been around for decades, but it didn’t really take off until right after the financial crisis, when a confluence of events meant smaller drillers and speculators had access to billions and billions of dollars of relatively cheap financing.
In late 2008, the Fed embarked on an unprecedented stimulus program to lower borrowing costs with the goal of igniting growth. While its easy-money policies succeeded in bringing the U.S. out of a recession, they also created an environment in which yield-hungry investors pushed into riskier U.S. assets, particularly the junk-bond market, which has nearly doubled in size since the end of 2008.
With willing lenders coupled to a worldwide commodities boom, some of the biggest beneficiaries were speculative U.S. energy companies, which tripled the amount of their debt during that period.
The increase in debt went hand in hand with a drastic increase in U.S. fracking oil production.
Correlation itself isn’t causation, and shale was proving itself as a profitable way for the U.S. to become more independent from overseas oil. But fracking wouldn’t have gained so much momentum so quickly without so many profligate lenders. It would have probably followed a slow, steady trajectory upward, with companies proving themselves to investors one at a time.
As it was, the spigot of cash flooding into junk bonds, master limited partnerships and other energy investment vehicles was so great it enabled both stable and shaky companies to obtain easy financing. U.S. output of oil and natural gas swelled by 42 percent from 2008 to 2014, helping create a glut that eventually overwhelmed demand.
Crude prices plunged from more than $100 a barrel to the lowest in more than a decade.
This arguably should have benefited the U.S. economy because lower gasoline prices aid consumers by lowering their fixed expenses. But the pain of investment losses largely outweighed the positive effects as investors from Main Street to pensions and foundations lent piles of money to speculative energy companies that looked increasingly fragile.
Some of those investors didn’t even realize it. That’s because energy debt was accounting for an ever increasing part of the overall speculative-grade debt market, meaning that anybody who wanted to put their money in junk bonds was buying a whole lot of energy, often whether they knew it or not.
It was a great bet for the investors until it wasn’t.
And then they weren’t interested in lending to these companies anymore, especially as a growing number of them started going bankrupt. This has become a spiral, with a lack of easy financing spurring more defaults and making investors less willing to lend to energy companies.
And that’s where we are now, with a growing number of insolvencies and mounting losses, even as oil prices rebound a bit and investors start warming a bit to commodity-related companies.
Shale drillers aren’t going away. Some will survive and thrive once oil prices stabilize and competitors go out of business. But this boom and bust wouldn’t have been so big and painful if it hadn’t been for all the leverage in these companies.
31 Comments on "Cheap Money Helped Inflate Energy Balloon"
rockman on Mon, 6th Jun 2016 10:19 am
Lots of words discussing “cheap money” yet no mention of the actual rafes. Hopefully no one here was thinking of anything close to the fed rate.The cheapest rates were typical bonds bought by investors. Can pull up any pubco and find that record. Last time I looked Chesapeake bonds ran 5.5% to 8.5%.
But the traditional banks charged a good bit more: typically Libor+. But usually only when there was additional hard collateral. And when the collateral wasn’t there and the risk was significant: that’s when operators would go to “mezzanine banks”. Not really banks but finance companies. And while usuary laws kept the rates relatively low they weren’t low. And they got around the laws by getting a % of the “profit” which was really not profit but a share of the initial cash flow whether the well turned a profit or not. Bottom line these “mezzanine banks” typically netted 20-25% return on those “loans”.
What helped many companies was a combination of MSM hype about the shales and low fed rates that drove investors into the oil patch bond market. The investors who have been slaughtered as bonds have been discounted 20-75%…or more.
Plantagenet on Mon, 6th Jun 2016 10:20 am
Exactly right. The Fed (and the Obama administration) gambled on a zero interest policy to fix the economy.
It didn’t work.
CHEERS!
Boat on Mon, 6th Jun 2016 11:57 am
Plant,
Remember during the election Obama and McCain came in from the trail to support the biggest bailout in world history. GW and Paulson were to blame. The world were very close to collapse. Obama was the savior.
Remember when Al Gore was laughed at by the Republicans for talking about climate change? FF 15 years and your party gives us trump. Your party is filled with dumb asses.
joelund on Mon, 6th Jun 2016 1:21 pm
Rockman, web site below has some good financial analysis for 30 of the oil operators in very difficult financial position. There is a table half way through that lists the YTM of their bonds. Only 6 are not junk status. May be a trend, few are permian operators.
http://seekingalpha.com/article/3977613-e-and-p-bottom-barrel-club-16minus-4-livin-prayer
Twocats on Mon, 6th Jun 2016 1:32 pm
The only people with zero interest rates or similar are the same ones that have algorithms telling them when to pull their money out after theyve lured in sheeple with promises of double digit returns. I remember seeing the click bait ads for “guaranteed income from oil”.
GregT on Mon, 6th Jun 2016 2:26 pm
“The world were very close to collapse.”
Not quite. The US was very close to collapse. Some 70% of the world’s population wouldn’t even have noticed.
dave thompson on Mon, 6th Jun 2016 3:18 pm
The big issue is, the rates are so low that they can only go up. Well not exactly. They could go negative. Raising rates will crash the whole system. Negative rates will only work in a cash less society. So what shall they do?
Davy on Mon, 6th Jun 2016 3:22 pm
Not true Greg, the global world was about to shut down. Go back and read up on the months before and after the tarp debate and the beginning of QE. The world had invested in many of the same securities that had caused all the problems in the US especially Europe.
Contagions of risk off behavior was apparent everywhere. Trade was collapsing everywhere. Letters of credit were not being accepted. China was chugging along but for how long with the US and Europe shutting down demand. You do admit the US and Europe are major markets for the Chinese. The commodity super cycle was rupturing only to be reignited by QE months later.
Davy on Mon, 6th Jun 2016 3:39 pm
Dave at this point it looks like “they” are being boxed into a corner that occurs when there is no good choices only bad ones. From here on out they will be reacting and most often in dysfunctional ways. Look at how China is increasing its credit creation. Look at how the fed is unable to raise rates because the markets and China are not allowing it. China and the markets are diverging from the fed not by choice but because of debt deflation.
rockman on Mon, 6th Jun 2016 3:49 pm
Joe – Thanks. What won’t get much publicity are companies that went with mezzanine finance. Those investors rarely miss their big payday since they tend to monetize their profits early on. The operators are typically left with a lot of plugging liability and limited free cash flow. Any service company that extended them credit often take a loss to some degree. These are the companies that often sell out for pennies on the $ to stripper operators and those deals are almost never seen by the public.
GregT on Mon, 6th Jun 2016 4:19 pm
Davy,
Unbanked: Three-Quarters Of The World’s Poor Do Not Have A Bank Account
“More than 2.5 billion people — or half of all adults around the world — are “unbanked,” meaning they don’t have a bank account, according to data released by the World Bank on Thursday.”
http://www.huffingtonpost.com/2012/04/19/unbanked-population-three-quarters-poor-no-bank-account_n_1438299.html
I don’t need to read about it Davy. We wrote down 63M.
Davy on Mon, 6th Jun 2016 5:16 pm
Greg, they may not have bank accounts but they need to eat right? They need a multitude of products produced by a globalize world to make a living and live right? Exactly. Bank accounts mean little but economic activity in general is essential for life.
GregT on Mon, 6th Jun 2016 5:49 pm
“economic activity in general is essential for life.”
I would have to strongly disagree with you there Davy. If anything, human economic activity is destroying life.
onlooker on Mon, 6th Jun 2016 6:00 pm
I would have to agree to a point with Greg. However, a certain level of economic activity is keeping people alive at present so a complete breakdown and collapse of the world economy would in the immediate time frame threaten people and their lives.
GregT on Mon, 6th Jun 2016 6:12 pm
“However, a certain level of economic activity is keeping people alive at present so a complete breakdown and collapse of the world economy would in the immediate time frame threaten people and their lives.”
Completely agree. That being said, the global economy isn’t sustainable, and neither are our current population numbers.
onlooker on Mon, 6th Jun 2016 6:14 pm
Absolutely agree Greg. That is why for some time now the question is do we wish to preserve a living planet or Industrial Civilization. Because we cannot have both
Aire on Mon, 6th Jun 2016 7:16 pm
Of course it’s a bad system, Greg. Davy’s point is that the main reason world population has risen has been due to globalization via plenty of excess energy. There’s still starvation in the 3rd world but imagine without the global system
onlooker on Mon, 6th Jun 2016 7:31 pm
And that Aire is the Paradox and Catch 22 of our current Global Economic System. It is allowing temporarily this great human population with a significant proportion of it living harmful consuming lifestyles. So the whole system is in itself making things worse as it continues viable. Too many people consuming too much. Now that Peak oil is becoming more prominent it is threatening this system. Yet we should voluntarily renounce this system for the long term benefit of the planet and the living beings who depend on it. That is why Davy espouses a voluntary gradual orderly Powerdown Some hurt now to prevent greater hurt later.
makati1 on Mon, 6th Jun 2016 7:37 pm
GregT / onlooker, I agree. Westerners do not understand just how little “economic activity” outside of barter and trade exists in the 3rd world. I have seen only a few things in my farm neighbor’s homes that might have been imported into the Ps. And not a lot of manufactured “stuff”. Certainly nothing that would be missed if globalization/economics stopped tomorrow.
Yes, petroleum and modern medicine made the huge numbers of humans possible, but we are soon going to pay the cost of that excess by plague/starvation/war. Mother Nature doesn’t differentiate between species like humans do. She will wipe us off the planet as easily as the dodo bird.
The party is over, now the cleanup and hangovers begin.
GregT on Mon, 6th Jun 2016 8:15 pm
“There’s still starvation in the 3rd world but imagine without the global system”
Without the global system Aire, the 1st world will be much like the 3rd world. The transformation is unfolding before your eyes.
Survivalist on Tue, 7th Jun 2016 12:11 am
while a zero, or close to it, percent interest rate didn’t ‘fix the economy’ as Plant so simplistically puts it, it is doubtful that a higher interest rate would have done any better. Whole the blogoshpere abounds with folks claiming zero percent interest rates are not the right thing to do I notice that they don’t have a recommended alternative. Would 18% interest rates be better at ‘fixing the economy’ Plant? From what I’ve observed the people who wish for higher interest rates are generally wealthy people who live of the income they earn from their annuities. Those folks hate low interest rates as it reduces their income. I suggest that neither austerity, aka Europe, or QE, USA, do much better than each other when it comes to ‘saving the economy’. low interest rates and QE seem to lower unemployment, austerity seems to lower debt. Folks who benefit from austerity generally speaking want high interest rates on their investments and low taxes on their earnings. People who want low interest rates and QE generally speaking want a job. Neither option seems to ‘save the economy’, it’s just that they benefit different groupsd of people who are trying to get by in a shitty economy.
Davy on Tue, 7th Jun 2016 6:28 am
There is more to it than interest rates because of the QE and the moral hazard of guaranteed returns. It was the combination and other efforts that made this economic policy so destructive. The very low interest rates along with bond buying allowed for the big banks and connected rich to basically get cheap money handouts to invest in high yield risk. That allowed risk to be “risk off” or in other worlds the bubble markets. An economy of the rich for the rich and by the rich was allowed through legalized disregard for normal fundamentals, corruption, and disregard for traditional laws. Meanwhile the savers and the fixed income folks who generally work hard, live modest lives and tried to save for some kind of future where forced into ever more narrow pathways for their meager prosperity prospects.
What was needed was to acknowledge 08 was a recessionary event as well as a massive destructive bubble popping. They took the mess from the bubble deflation from financialization and reflated it into a commodity, market, and high end asset bubble. Near the point when stability returned they should have allowed a recession to clean the system of bad debt. Instead we had bubble reflation along with extend and pretend of bad debt.
This new class of economically connected were instead allowed to take very cheap money and turn it for guaranteed profits. This they thought would stimulate growth and trickle down and they further theorized amortize away the bad debt from pre-08. What an Alice and Wonderland story. This economic fantasy world of QE it was thought would allow debt to be absorbed into a new prosperity.
The problem with this policy was this involved wealth transfer and moral hazard to achieve dubious goals of having the cake and eating it. The cake was prosperity and eating it was solving old problems. Our economic cycle is cyclical for a reason. It reflects nature and in that respect must be respected as a fundamental law. We should have allowed a recession even a strong recession. Interest should have remained higher than near zero but of course not at the Volcker rates of the early 80’s.
It is not clear at all if this would have worked because the global system is at, near, and approaching systematic incongruities that are making real growth impossible. We are at or in the vicinity of basic foundational limits across a broad spectrum of sectors and environments. Diminishing returns to our economic system and its drivers of growth through technology, innovation, and efficiency are now entrenched.
We may not have recovered in 08 and that time period may well have been the final adjustment period of modern man. An adjustment period is coming anyway and the sooner it would have come the better. When I say adjustment process that is an understatement. What I mean is a paradigm shift to destructive change of growth to decay. We could have slowed economic activity that would have helped with climate change. The slowing would have forced attitude and lifestyle changes to help with collapse induced peak oil dynamics. Instead we ushered in a decade of excesses that clearly benefited the global rich at the expense of the global poor directly and indirectly. Directly from physical wealth transfer and indirectly from a perpetuation of corruption, manipulation, and psychopathic rewards.
Just look at the excesses of China and their building boom. It was not the fed that did all this bubble reflation. It was China and the Fed. The fed allowed China’s huge physical malinvestment bubble that is the entire “China” in every way. The Fed allowed this. The bubble the fed inflated allowed the China bubble. We would have been far better and the average Chinaman far better without this. We blew through some of our last remaining good resources for what, a new bubble inflated destructiveness.
We could have skipped this directly to the adjustment and mitigation phase of the collapse process of globalism. Of course the powers to be would not look at it that way. Collapse process is an idea not spoken but they could have taken the course following economic fundamentals and allowed a recession to cleanse the system of bad debt and allowed the destructive side of the bubble to adjust. Banks should have failed. The auto industry should have deflated into a much smaller industry as a short list. The worst of the China build out would not have happened.
We likely never would have recovered from this but right here right now we would have been in a stronger position relative to what is coming for us now. What is coming is a very hard landing because of the fact we exhausted our systematic economic tools on bubble reflation instead of adaptation and mitigation efforts.
This mistake represent the biggest and most destructive bubble in human history. This is a poison pill and a crime against humanity that will ensure modern mans painful end. We are now going to have much worse pain and suffering than may have happened. The dead state of oil is ahead and destructive abrupt climate change. Both conditions were ahead anyway but we could have slowed our approach to them and prevent other problems to accumulate that in summation will make efforts to adjust and mitigate to these predicaments that much harder. We chose that road of drunken false prosperity instead of sober reality of decline and Spartan living to atone for our previous economic sins.
Davy on Tue, 7th Jun 2016 7:08 am
“But I don’t want to go among mad people,” Alice remarked.
“Oh, you can’t help that,” said the Cat: “we’re all mad here. I’m mad. You’re mad.”
“How do you know I’m mad?” said Alice.
“You must be,” said the Cat, “or you wouldn’t have come here.”
― Lewis Carroll, Alice in Wonderland”
“S&P Nears All Time High, Global Stocks Rally As Dovish Yellen Unleashes Animal Spirits”
http://www.zerohedge.com/news/2016-06-07/sp-nears-all-time-high-global-stocks-rally-dovish-yellen-unleashes-animal-spirits
“And in a world where a hawkish Fed is bullish but a dovish Fed is even more bullish, stocks took their cue from Janet and sprang higher first in the US, and then across the globe, rallying with emerging markets because as Bloomberg put it, Yellen won’t “derail the recovery with a premature interest-rate increase.” If by premature BBG means a second hike one in a decade, then yes.”
“Of course, what Yellen really meant is to give algos a green light to trigger all stops at the new 2016 highs, and then to continue to the fresh all time high in the S&P500, which as of this moment is less than 1% away, and will likely be taken out today.”
“It seems likely that we will get at most one rate hike this year and that’s positive for equities and commodities,” said Ric Spooner, chief analyst at CMC Markets in Sydney. “Of the beaten-down commodities, the oil market is the best place. We’re already seeing supply cutbacks.”
“Finally, for commodity watchers, WTI advanced 0.4% to $49.90 a barrel, having risen above $50 earlier in the session. API data later on Wednesday is forecast to show crude stockpiles dropped for a third week, declining by roughly 3 million barrels. The reason for the latest leg higher in oil was the dollar weakness in the past 24 hours. Also, Eni SpA said 65,000 barrels a day of supply was halted Friday after a militant attack in Nigeria.”
rockman on Tue, 7th Jun 2016 7:21 am
Well an 18% interest rate wouiwouiod have greatly benefited the Rockman and his company. First, the Rockman doesn’t owe money because he doesn’t borrow. If he wants something he buys. Can’t afford it…don’t buy it. Of course folks buying stuff on credit helps sellers and that helps the economy…until they can’t pay the derbt off so they just keep transferring income to the money lenders. Great for the bankers’ economy.
And the Rockman would have made mucho $’s on his CD’s. Off course the stock market would not have boomed since there would have been safe havens for $billions of investors. Of course those high rates would have killed a lot of risky loans like those that fueled the shale boom. Which did increase our oil production. Of course now we have hundreds of $billions lost by investors and lenders…and happened while we still have low rates. Reminds of the days of mucho $’s lost on low rater home mortgages taken by folks who would not have normally qualified. Difficult to see much net gain to the economy despite the $billions made on all those new home sales.
Bottom line: it’s easy to argue low/high interest rates hurt/help the econmomy if one focuses on just one or two aspects. Also easier if one just looks at a short term snapshot and ignores the full cycle.
PracticalMaina on Tue, 7th Jun 2016 8:40 am
Why didn’t the federal reserve just step up and lend straight to companies that are doing it right, I know Solyndra didn’t turn out too well, but there are many solar companies, that have had explosive growth, that are currently over exposed. Lend to these people for free! After they start making a very healthy profit lend at a market rate, but only after they have an extremely healthy production rate, that not even a fortune 500 CEO could over-leverage.
Spain has a solar thermal tower co, that has thermal storage for night generation, they have built several plants in the Southwest, as well as many other projects. They are currently about 10billion in debt, get out the checkbook because these European solar thermal cos, working in Northern Africa and the Middle East are going to be the power plants of the EU, along with wind.
http://www.nytimes.com/2016/03/18/business/international/once-a-darling-spanish-solar-company-abengoa-faces-reckoning.html?_r=0
Davy on Tue, 7th Jun 2016 8:49 am
PM, how would that clean up past problems and avoid extend and pretend? It won’t because it was lending which is the creation of more debt without realizing past bad debt that is the problem in the first place.
PracticalMaina on Tue, 7th Jun 2016 8:56 am
Davy, that one co had subsidies removed from them in their home country because of the budget crisis, thank you Goldman Sachs and your bought candidate Hillary. Then they are paying interest on massive projects, once you erase this debt with zero interest debt you can begin to get the company operating cash flow positive. Yes it is picking favorites, yes it is not how things are supposed to work, but we are in a time when Chapter 11 fossil fuel company’s are getting their debts and responsibility forgiven, and still continuing to operate. Peabody energy is chapter 11, and still harvesting coal from federal land for pennies on the dollar. Throw money at renewables because they will continue to make money for decades, instead of costing huge sums for decommissioning and clean up after decades on the other side.
shortonoil on Tue, 7th Jun 2016 9:26 am
” Count the intensity of the shale oil boom — and its severe bust — as one of the unintended consequences of the Federal Reserve’s efforts to buttress the economy.
“
The shale boom busted because the ERoEI of shale has never been high enough to support its production. That is a simple, straight forward calculation that needs little explanation. All that is required is the formula ERoEI = Er/Ei, the energy density expressed in nominal dollars, and the price. It is why “easy money” is no longer buying increased production, and never will again. For $50 oil in 2016 the ERoEI must be 21.8:1 to breakeven.
Shale is a massive loser at today’s prices.
http://www.thehillsgroup.org/
Davy on Tue, 7th Jun 2016 9:26 am
I am all for it PM, bring it on and other destructive change but that is still not solving the problems of an entire system built on extend and pretend.
PracticalMaina on Tue, 7th Jun 2016 11:59 am
destructive change? Yeah some birds have been getting toasted flying in front of the mirrors, and it is a continuation of the buildup of the Southwest, and BAU, but when extend and pretend fails, we will still hopefully have a serviceable renewable system, 160,000 homes in the southwest are being powered by this one co currently, they can keep providing juice 6 hours after sunset. I am not really sure what my point is anymore, I just really like solar concentrating tech I guess.
Davy on Tue, 7th Jun 2016 1:46 pm
PM, you don’t get my drift friend, by destructive change I mean anything that points to a power down of BAU and a power up of post BAU. I am not talking about grilled pigeon.