The Oil Price War Could Be Bringing About Imminent Change

OPEC has declared open season on U.S. shale oil companies through its decision to leave oil production unrestricted. On separate accounts, Matt Phillips and Steve LeVine insist that “the fallout could create a crisis” in the American banking market as well as the energy industry, while Bloomberg notes how China has capitalized on this escalating feud.

American shale’s rise to power is largely credited to advancements in hydraulic fracturing, a method used by companies attempting to extract the resource from underground, as well as additional funding from junk bond investors who have been attracted by the high returns and low interest rates. Consequently, drilling companies both large and small have had an ample supply of credit and financing, such that 17 percent of the $1.3 trillion market is now financed exclusively by such contributions. With the abundance of equity, falling gas prices were to be expected as a simple byproduct of increased production.

In an unexpected response, OPEC signaled its unwillingness to reduce market share and kept production ― and hence future prices ― constant. Phillips and Levine warn that maintaining competitive prices has forced U.S. companies to dig into their profit margin. Normally this would not be a problem were it not for the prevalence of creditors and private owners bloating market value through their contributions. The desire to be on the energy-boom bandwagon has thus indirectly created a host of unfunded liabilities and nurtured an environment for assets such as receivables to fester and become toxic to the global banking system. Jan Stuart, the Director of Credit Suisse’s investment banking division issued a statement insisting “investors remain hungry for yield” and will remain so, deepening the divide between listed externally acquired funds and suffering shale oil companies’ ability to perform up to par.

While America stares down the looming double-threat, China has quietly begun increasing crude oil stockpiles by as much as seven-hundred thousand barrels per day amidst a fading “golden time window.” Bloomberg notes the steady progress taken by the creeping giant, even despite comparatively lackluster current and future growth of 7 percent as projected by fifty-six independent economists. At the current rate, the opportunist state hopes to stockpile 570 million barrels of crude by 2020, reserves equal to about 100 days of their domestic demand.

American lenders and shareholders must necessarily become more stringent with their credit and their capital when assessing companies. Phillips and Levine warn that there are negative “implications for everyone” from hydraulic fracking fields to Wall Street if financing dries up or if OPEC succeeds in destabilizing American shale, but in a time when the rising industry could be facing one of its greatest global triumphs or defeats, this is clearly an understatement.

Santiago Bello is a research associate at the National Center for Policy Analysis.


Comments (2)

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  1. Daphne says:

    Do you think OPEC will succeed in running shale industries out of business? Are there limits too how long the cartel can hold together if members such as Venezuela want to cut production?

    • Santiago says:

      β€œThe clear losers in a low-price environment are going to be smaller companies that are overleveraged.” Though the quote refers to businesses, the precarious position of small and oil-reliant countries like Venezuela is not much different. While the weaker OPEC members exert pressure to optimize price, strong private producers in the U.S. are trying to minimize costs. My personal opinion is that the friction of interests and production capabilities is what may spare U.S. shale, but it’s too early to tell.

      To an extent this war is very healthy for our economy, those who cannot compete in the market will be forced out and the industry should be more robust at the end of the day. However, if the two sides relax prices to the point of economic self-mutilation (and the current volume of financing continues) then we could be facing some serious trouble in the energy and banking sectors as warned by various experts.

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