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Oil’s “Other Shoe” Just Dropped

by | published March 2nd, 2016

As you’re reading this, I’m preparing for tomorrow’s flight to London and the annual high-stakes energy consultations at Windsor Castle.

As veteran readers of Oil & Energy Investor are aware, each year in early March I provide one of the private briefings at this event to a select international audience of energy figures, ambassadors, ministers, and high commissioners assembled at the castle.

The briefings are conducted under royal charter provided by the queen, with the British royal family in residence at Windsor Castle when the briefings occur. That Marina and I get to stay at the castle for three days is an extra perk.

Now, the meeting is conducted under Chatham House rules. That means no one in attendance can ascribe any particular position to any named individual. These rules are designed to allow for open and frank conversations.

Still, I’ll have much to say, right here in Oil & Energy Investor, on what transpires there when we return next week. Stay tuned.

But there’s something I won’t be telling them at the Windsor meeting. It’s the “other shoe” dropping for oil…

And it’s going to affect each and every one of us…

Oil and Gas Company Bankruptcies Are On the Rise

This ripple effect will extend to much more than just oil and gas. And it looms as an ongoing concern, one that is likely to have a longer-lasting effect than the price of oil itself – unless, that is, there is a reversal of trajectory.

Crude oil prices took a rest yesterday after spiking up 13.9% over the six preceding trading sessions. Of course, having started from $29.04 a barrel for WTI (West Texas Intermediate, the NYMEX trading price set daily at Cushing, OK), the new level remains well below the level necessary for any appreciable increase in survivability for operating companies in the U.S.

On the natural gas side, things are far worse.

Here, prices have fallen appreciably. The Henry Hub price (the location in Louisiana where NYMEX daily rates are calculated) closed yesterday at $1.71 per 1,000 cubic feet (or million BTUs), matching the low hit last Thursday and the lowest price in almost a decade.

The Henry Hub price has now fallen almost 26% in a month.

Of course, both of these low price levels adversely impact the survivability of companies. It comes as little wonder, therefore, that bankruptcy rates are accelerating in the oil and gas sector. This is clearly demonstrated by one of the slides I’ll be showing during my Windsor briefing later this week:

2015 cumulative e&p debt

As you can see, the rate of bankruptcies among U.S. exploration and production (E&P) companies increased dramatically over 2015.

Yet both the price doldrums and the rising bankruptcies are precursors to a longer-lasting problem. This is the proverbial “other shoe” dropping. And it is a matter that adversely impacts a much broader range of services and expenditures…

Without Oil and Gas, Two Dozen States Are Now Struggling

Over two dozen states collect taxes from the activities of oil and gas producers. Some of these states – such as North Dakota, Oklahoma, Texas, Alaska, Pennsylvania, Arkansas, West Virginia and even Kansas or Colorado – have budgets that have become heavily dependent on what the producers do.

Now, the plight of publicly traded companies, the ones we target in Oil & Energy Investor because any investor can buy their stocks and bonds, are a problem enough.

But the real crisis hitting state houses across the country comes from the thousands of private companies cutting back operations significantly. Here, the impact on everything from education to bridge repair, health care, and assistance for the elderly, is becoming acute.

Just look at the following chart, from the U.S. Energy Information Administration (EIA), a division of the U.S. Department of Energy. It provides three examples of states most heavily dependent on oil and gas, but also indicates just what is transpiring only from “severance tax” revenues. These are taxes collected by states from producers and are based on volume at the wellhead.

quarterly severance tax revenue 2011 to 2015

As you can see, severance tax revenue has been decreasing significantly. And these figures are only through the third quarter of last year.

Matters have become more acute since then.

This clearly indicates the impact of lowered oil and gas production on state revenues. But even that only points to a portion of the problem…

Oil and Gas Production Companies Aren’t the Only Ones Feeling the Pain

That’s because, as production slows down, there is an expanding negative effect on business revenues for a much wider range of the “three S” (support, supply, and service) companies relying on ongoing contracts from the producers.

That, in turn, exacerbates the state (and local) revenue shortfalls.

In addition, the ripple effect depresses employment almost across the board. The employment drain is now more extreme than the decline in prices, as this next chart shows.

federal reserve bank oil production

Once again, the situation is now worse than this graph from the end of December illustrates. The next shoe has already started to drop and it is likely to have a destabilizing impact on an entire range of public services.

But there’s a way out…

Oil and Gas Exports Will Support Local Jobs

As you’ve seen here in Oil & Energy Investor, the export of U.S. liquefied natural gas (LNG) has finally begun and Congress has approved the export of crude oil after over 40 years of restrictions.

Don’t be surprised if oil and natural gas exports from the U.S. will ramp up as a way of supporting local tax bases and jobs. As you can see, there’s now significant interest on the state and local levels in pushing for these exports.

For many parts of the country, the higher prices commanded by the global market may well become a lifeline to Main Street.

That means how you play energy companies will have to change. There will be some nice new opportunities here, once the commotion has blown over.

And stay tuned for next week, when I’ll be bringing you as much insight from the Windsor energy conference as the rules will allow…

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  1. gerry
    March 2nd, 2016 at 18:35 | #1

    Please notify me immediately on ur next report from the conference,
    Thank you
    G. Yerves

  2. gerry
    March 2nd, 2016 at 18:41 | #2

    I’m look’in 4 a investment in what u feel will benefit from what u learn @ conference

  3. EdInvests
    March 2nd, 2016 at 19:13 | #3

    One must believe that there is something else amiss when the US uses twice the oil we produce and yet our domestic oil continues to go to storage, implying to me that our ability to process it has maxed out. I still contend that our refineries can no longer process our lighter oil and can’t quickly or economically convert refineries to handle our new oil production. I am also confused as to why we have seen no export to speak of since Congress allowed it and thus why our storage continues to rise and not drop. I find the EIA to be worthless and at least a month behind even if remotely correct.
    Ed

  4. Robert in Vancouver
    March 2nd, 2016 at 19:20 | #4

    The root of gov’t revenue problems is that gov’ts have become too overgrown, bloated, fat, lazy, expensive, wasteful, and inefficient. Taxes collected are a much higher percentage of GDP than ever before, but it’s still not enough. Even a 100% tax rate wouldn’t be enough.

    Gov’ts have to cut all spending by 60% then keep increases in line with GDP growth. But any politician who promises to do that would never get elected because such a huge number of voters live off the gov’t one way or another.

  5. Bill Yellonnoc
    March 2nd, 2016 at 20:54 | #5

    Good reading any investing advice

  6. Thierry
    March 2nd, 2016 at 22:37 | #6

    Thanks for the info , im one canadian oilsand worker 🙂

  7. Ger
    March 3rd, 2016 at 14:11 | #7

    What is the situation in the oil service industries ?

  8. Mike
    March 4th, 2016 at 10:50 | #8

    From your assessment it appears companies providing electric power to well sites are going to see a drop in revenues as well heads continue to go dormant.

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