Bill Holter

Oil Crashes, Who Really Wins?

December 2, 2014

I'd like to address the outright crash of the oil market this past week.  The hope was the Saudis would cut back on production to stabilize prices somewhere in the $80+ range.  This was not to be as Saudi Arabia announced no cutback whatsoever ...oil then fell over 10% in one day on Friday and actually traded to a $65 handle.  First and most importantly, oil is THE biggest and most widely used commodity on the planet.  For a market of this importance to outright crash or rise over 10% in one day, unintended consequences not seen or anticipated can be expected at some point.

I guess the initial question that should be asked is "why has oil been so weak in the first place?"  There are several answers to this but the two main drivers are "supply and demand".  Demand has definitely dropped as the global economy has slowed.  There is no getting around this, less oil is being used now than say two or three years ago.  On the supply side, the U.S. shale industry which has been in an outright boom has actually made the U.S. a larger producer than Saudi Arabia.  I can remember two-three years back when the stories arose, "the U.S. was going to become energy independent."  What the stories forgot to include is the fact that shale production has a very high cost to breakeven.  The current estimates for breakeven are $75 per barrel or higher.  Just as I wrote earlier regarding gold and silver, I believe "low prices will cure low prices" for oil.  I will get to this thought shortly.

When looking at the new, low oil prices, one must ask the questions "who, what and why?"  Why would Saudi Arabia not want to cut back on production to stabilize the price of their product?  If Saudi Arabia has budgeted a price of $95 for their own production, why would they allow the price to drop unabated (or in Friday's case "helped")?  What's in it for them?  Before digging any deeper, I want to remind you how the U.S. broke the Soviet Union in the late 1980's.  The U.S. baited the USSR into an arms race and then with the help of the Saudis, broke the price of oil down to $10 per barrel ...the rest is history as the USSR bankrupted from the starvation of oil revenues.   

Fast forward to current day, are we seeing the same sort of operation?  Some say that the target is Iran who is a religious enemy of Saudi Arabia and also happens to have the highest cost of production in the Middle East, I'm not buying this theory.  I would rather look at Saudi Arabia's latest business deals and go from there.  They just a few months ago signed long term energy contracts with non-other than China.  Taking this one step further, "who" would benefit the very most from cheap oil prices?  The answer of course is China as they are THE biggest importer of oil in the world!  Can you see where this exercise may be going?  Most everyone in the West believes Saudi Arabia was engaged with the U.S. to hurt Russia's energy revenues, what if this is not the case ...or maybe our leaders believe this to be the case?  What if Saudi Arabia, who has definitely been in serious talks with China is obliging them while wiping out one their most recent competitors?  

Who is this new competitor you ask?  Why the shale industry in the U.S. which was supposed to make us energy independent and a bigger producer than even Saudi Arabia?  The cost of production for shale is estimated at $75 per barrel.  $100's of billions have been borrowed (and lent) in order to get this production up and running.  As of this past Friday there may be a little, previously unforeseen problem.  You see the debt issued is almost entirely "high yield" (understand "risky") and makes up somewhere near 20% of this entire market.  Also please understand many of these bonds are used as collateral and then re hypothecated for further borrowings.  This is not yet a disaster but a "margin call" to such a leveraged industry could turn the lights out VERY QUICKLY.  Of course, you can add the rest of the financial system to this as leverage has never ever been higher systemically than it is right now.   

I would also like to add the comment "someone, somewhere, got hurt and hurt very badly this past Friday."  I am talking about speculators, OTC derivatives between banks and financial institutions, institutions which issue CDS, etc...  We don't know who, what, how much or even "if" this 10% drop in one day has caused a chain reaction but the odds are pretty good this will not pass without someone important being financially killed.    

Before putting this all together, mention must be made of Russia.  Yes, Russia is being hurt financially and economically.  Their currency the ruble has been hammered as well as their sovereign bond market but ...it is important to understand they only carry $200 billion worth of debt.  Will these low oil prices bust Russia?  No, it will however make life very hard as the economy slows and their social programs do not get fully funded.  In my opinion this is a huge blow to Russia but not a fatal one.

Putting this all together I will ask some questions, however, there are no firm answers yet.  Who is really behind this?  Would the U.S. cut the legs out from under their own shale industry or is it more likely the Chinese wooed Saudi Arabia into aiding them in filling their reserves?  If it is China rather than the U.S., what does this say about Saudi Arabia?  Are they in the process of switching allegiances?  Is this a case where they are abandoning the petrodollar?  I obviously do not have the answer but I will ask another question or two.  Is it possible China has swayed Saudi Arabia by promising to pay them with something real?  Like gold?  Could this even be possible?  It is already rumored that Russia is trading oil for gold, maybe the Saudis have seen this and a light bulb went on for them?

Financially, yes I believe it is possible but not probable.  Much more likely would be payment in yuan.  Would Saudi Arabia accept the paper of another sovereign in the place of dollars?  In my opinion they would ...if they are able to see the writing on the wall.  Has China let the Saudis in on their future plans for their currency?  Maybe a gold backed yuan?  A gold backed yuan which is backed by or one that is ratio pegged to gold?  Does China have enough gold to do this?  Let me say this, China very probably has as much gold (or much more) as the U.S. "claims to have."  Would this be enough gold?  The answer of course depends entirely on what "price" they value or peg gold at.  At "some price", China can go to a 100% gold backed yuan, any country can ...if they have gold and the international price is high enough.

This is much speculation on my part but it does make common sense.  The U.S. may believe we can bankrupt Russia with low oil prices ...and this is "our" plan, I don't believe it is "the" plan.  In fact, the argument can be made that not only does this hurt (destroy) our shale industry, crashing oil prices actually endangers our financial system.  After six years of trying to reflate the system via outright monetization, would we really risk a wildfire of deflation?  I don't think so.  I believe it is much more likely this is a Chinese/Saudi partnership play where they both "win" and the U.S. is left out in the cold.  This would also be a terminal event for the U.S. petrodollar and a "polite" way for the Chinese to move center stage.  If this is so, we will be watching the formation of a "new world order," just not the one the Rockefellers had in mind!

Shale Oil 2015 = Subprime Mortgages 2008

December 1, 2014

As I suggested yesterday, today's article title will be eye-popping. And surely, it's lived up to expectations!

Sadly, the 2015 shale oil collapse is essentially set in stone; and as it unfolds, could quite possibly prove to be the "black swan" that finally destroys TPTB's best laid market manipulations. Pretty soon, even the most died in the wool perma-bulls will throw in the white propaganda flag; and when they do, the first they'll do is short everything remotely related to shale oil drilling, production and service. In my view, the only industries have ever as egregiously hyper-promoted and recklessly financed as 2012-14 shale oil were to 1997-99 internet start-ups and 2005-07 subprime mortgage originators. Only this time around, the worldwide economy is in dramatically weaker shape and the capacity to whitewash unwieldy debt with new money printing no longer viable. Very likely, $65/bbl. oil will destroy any remaining semblance of American economic activity; and worse yet, fundamentals suggest prices could drop significantly lower, perhaps to the $40/bbl. lows of early 2009.

I'll get to that in a second; but first, several other catastrophic headlines - all published in the past 12 hours. And I do mean catastrophic, starting with the utterly unfathomable news that the four-day "Black Friday" weekend not only didn't produce the year-over-year improvement expected by Wall Street, but was so bad even I am speechless. And no, this is not a typo - as over the four-day weekend, U.S. holiday shopping receipts were an astonishing 11% lower than a year ago; which, I might remind you was the worst holiday shopping season since 2009. And the scariest part of all, demonstrating not only how weak America's "economy" is, but how far its society has degraded - is that Thanksgiving Day spending rose 24%, whilst spending on the following three days plunged precipitously. In other words, not only did the paradoxical "strategy" of all companies simultaneously front running Black Friday fail miserably but the institution of America's most joyous family holiday was soiled in the process.

Worst yet, we haven't even seen the horrific margins retailers "earned" this weekend; and oh yeah, brick and mortar traffic plunged precipitously, supplanted permanently by online sales. Which means, of course, that thousands of retail stores - and jobs - will be permanently lost; as will the value of millions of square feet of highly leveraged commercial real estate. And just wait to see the retail industry impact when the bankrupt U.S. government decides to tax online sales, which we assure you it will!

But let's not forget, America's "recovery" is six years old; and its economy by far the world's "strongest" - LOL. That is, according to Wall Street propaganda, Washington lies and MSM foolishness. Sadly, this point is actually arguable for what it's worth - as essentially all "non-reserve currency" nations are not only in equal states of economic freefall, but so are their currencies. Overnight, for example, we saw an "unexpected" contraction in Chinese PMI manufacturing to 50.3, its lowest level in eight months - which in unrigged numbers, means the supposedly "7.5% growing" Chinese economy is flat-lining.

In Europe, the overall PMI was 50.1, as its own book cookers try to pretend Europe is not contracting - even as its largest component, Germany, printed at a recessionary 49.5 down from 50.0 just a few weeks ago. And then there's Japan, whose BOJ-supported stock market hit multi-year highs whilst Moody's downgraded its credit rating from Aa3 to A1 - enroute to junk status, as the "Land of the Setting Sun" deflates into its radioactive seas. Meanwhile, the stock markets and currencies of commodity-based economies the world round are imploding - from the Brazilian Real, to the Russian Ruble, and the Nigerian Naira. And by the way, all five of the supposedly world-leading BRICS' currencies have been in or near freefall mode, for those that think there's any economic bright spots in the world. Finishing the thought, the U.S. just followed up Wednesday's nine weaker than expected economic data points with its lowest PMI Manufacturing PMI reading since January. I wrote Thursday morning, that I expected the 10-year Treasury yield to plunge below 2.20% Friday and potentially 2.15%; and lo and behold, it ended Friday afternoon at 2.17%, and sits at 2.16% as I write - as the "most damning proof yet of QE failure," i.e., plunging rates amidst so-called "recovery" becomes more visible each day.

As for PMs, does it really surprise anyone that after last night's unfathomable post-referendum raid - in which silver was smashed by nearly 8%, atop Friday's ridiculous 7% attack - prices have surged sharply ahead? In other words, TPTB duped the Swiss into believing gold was "too volatile" and "unloved" to own, just enough to ensure a "no" vote before covering their paper shorts this morning. Clearly, the 15-year low forward rates - not to mention, Miles Franklin's business - demonstrate loud and clear that nary a shred of real metal was sold this past month; and given the expanding economic implosion and surging physical demand, the shortages the U.S. Mint experienced last month could easily mushroom to 2008-like proportions at any time. Heck, according to my good friend Rob Kirby, prices for size gold purchases in Asia, as I write, are closer to $1,800/oz than the rigged $1,200 level in Western paper markets.

With that in mind, it's time for the "main event" - which, in my mind, is as important a topic as any the Miles Franklin Blog has covered. Which, of course, is the utter collapse of global oil prices, to a potentially "new normal" level well below the cost of shale oil production. Unlike, precious metals, which are no more than niche markets in the monetary and industrial realms - for now, at least - crude oil is the basis of entire economies on multiple continents. Consequently, as we wrote October 15^th, such a plunge portends "unspeakable" geopolitical and economic horrors, particularly in high-cost markets like U.S. shale oil, which we mocked nearly two years ago. To wit, if there's one thing I learned in my ten years of Wall Street energy research, it's that the U.S. cannot compete with Middle Eastern oil production, particularly in a rapidly declining price environment.

Now that the peak oil price era has likely arrived - at least, until hyper-inflation inevitably trumps it - numerous articles have been published depicting just how dire the situation is for America's only strong industry since 2008.

To that end, let's start with the horrifying fact that a whopping 15% of all U.S. junk bonds are related to shale oil drilling compared to just 4% when the environmentally toxic "fracking boom" commenced a decade ago. Unlike essentially all Federal Reserve supported debt markets, shale oil bonds have plunged precipitously in line with the internet-like plunge in such companies' stocks. At $65/bbl. oil, the vast majority of shale oil production is unprofitable - but the real horror of it all is that the discounts to spot received by such companies can be dramatic, given the less desirable blends produced and more costly transportation infrastructure required. For example, Bakken crude from North Dakota is typically worth no more than 80% of the spot price.

And given shale oil's dramatic decline rates - and subsequently, soaring capital expenditure requirements - plunging oil prices can and will bankrupt dozens, if not hundreds of companies in a heartbeat. Back in my oil research days, we deemed such high depletion fields as being "on the treadmill"; whereas, without consistently increasing drilling expenditures, production dramatically declines. In other words, the oilfield equivalent of a PONZI SCHEME - which, in this case, was funded with junk bonds possible only due to artificial rate suppression by Federal Reserve QE - which consequently can NEVER end.

According to Daniel Dicker, a long-time energy trader, "Everybody is trying to put a very happy spin on the industry's ability to weather $80 oil, but a lot of that is just smoke - as at $80, the shale revolution doesn't work, period." If this is the case, what does today's $65 oil portend? Let alone, "points below?"

Worse yet, an astonishing 33% of the entire capital expenditures of S&P 500 companies emanate from the energy sector; which ominously, were plunging before this fall's historic oil price collapse. Throw in the fact that many major oil companies are faced with exploding exploration, production and development costs (sound familiar, mining share owners?) have instead been buying back stock and paying outsized dividends also funded by Federal Reserve subsidized debt. To that end, in this must read article...

Ambrose Evans-Pritchard avers that...

The vast majority of public oil and gas companies require oil prices of over $100 to achieve positive free cash flow under current capex and dividend programs, while nearly half need more than $120...

-Peak Oil, November 30, 2014

Last but not least, is the simple COMMON SENSE of what collapsing oil prices means for the global economy, financial markets and geopolitical environment - as beautifully summarized in this additional must read article. As we have written relentlessly, the minor economic "benefit" of lower gasoline prices will be dwarfed by the terrifying negatives - which clearly were witnessed Black Friday weekend, when historically few people drove to stores to take advantage of holiday sales. In our view, there is a nearly 100% chance that oil prices will remain mired in "shale oil death" territory for as long as the low cost Middle Eastern producers need to recapture market share - and the longer this takes, the more catastrophic losses will occur to shale oil investors. Which again, has been the only viable American industry in the post-2008 world of QE, other than the high-end QE subsidized real estate market that has indisputably rolled over as well.

To conclude, now that the Swiss gold referendum has been successfully manipulated into a "no," the entire world lies in a sea of recession and money printing with precious metals in a potentially historic supply/demand situation. The catalysts to set off an historic melt-up of gold and silver prices - and economic conflagration - are too numerous to count; and frankly, it's difficult to believe "something" won't give soon. Here at Miles Franklin, we dutifully await your call, hoping you will be one of the "new 1%" that protect themselves before this happens with the same real money that has stabilized civilizations for millennia.

The Swiss Blow It Big Time

December 1, 2014

Andy Hoffman joins Kerry Lutz of the Financial Survival Network to discuss the Swiss referendum, gold and silver prices, the stock market, Japan downgraded by Moody's and currencies the world round in freefall.   To listen to the interview, please click below.

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