Peak Fracking, Perpetually Higher Oil Prices

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Includes: UGA
by: Bill James

Summary

Peak Fracking occurred in June 2015 with production falling 672,000 barrels per day; by March 2017 decrease will exceed the 1973 Oil Embargo.

Rig counts dropped from 1840 in December 2014 to 420 in April 2016.

Fracking wells deplete quickly. Without 1840 active drilling rigs, fracking production will deplete quickly.

Fracking companies are $200 billion in debt. Without capital, replacement wells seem unlikely.

UGA increased from $20.40 on February 2016 to $28 in April.

Six mega-trends are combining to persistently drive gasoline prices higher until price kills demand:

  1. Peak Fracking occurred in June 2015. Since Peak Fracking, US Oil Production has decreased approximately 0.672 million barrels per day (mb/d). To put this change in perspective, the 1973 Oil Embargo was a 6 months, 1.2 mb/d reduction. In the next 10 months, losses will exceed the Oil Embargo and will last forever. The Oil Embargo caused oil prices to quadruple. (click to enlarge)
  2. Fracked oil wells deplete quickly, and account for half of US oil production.
  3. The current drilling rig count is 420. To sustain fracking production at least 1,840 drilling rigs are required (rig count in December 2014) to replace depleting wells.
  4. Frackers are $200 billion in debts and behind on payments. Access to capital to drill more wells will be complicated by current debts, high extraction costs, and short life of fracked wells.
  5. The US Government has few friends among oil exporters. The US did nothing to reign in the fracking boom and the consequence of low oil prices that harmed the economies of oil producing nations. It is highly improbable that those same nations will or can increase production to keep oil prices low as US oil production depletes. Example: Saudi Arabia threatens to dump US bonds.
  6. Political instability could at any moment disrupt the long and fragile oil supply chain and radically spike gasoline prices. Example: Venezuela is having an economic crisis.

The net of these trends is that oil will likely never again be at the Februray 2016 lows.

As a warning to investors, EIA (Energy Information Administration) and IEA (International Energy Agency) data is reliable; however, their judgments are politically motivated. Here is a graph by the Dallas Federal Reserve on how, year after year, EIA forecasts repeatedly estimated oil prices would drop as the 2008 economic collapse approached. Life requires energy. Less affordable energy, less life.

In the graph below, I erased the brown part of EIA's current forecast to reflect that Peak Fracking occurred in June 2015. There is a huge (White Area) gap in their forecast based on Fracking depletion and idle drilling rigs. As with failing to warn of higher oil costs in the ramp to the 2008 economic collapse, the EIA is failing to warn the nation of the economic consequences of Peak Fracking. This provides investors a knowledge gap.

To better understand oil geology and economics here are two links:

The mega-trends will force oil prices higher much faster than most believe.

Also, there is no "glut" of oil. The market need is to power a 365-day food cycle. The reported "glut" is a storage problem of having 33.8 Days of Supply, 10 days more than the 24 Days of Supply typical for the past decade. Economic fragility is created by not having 365 Days of Supply to meet the needs of a 365-day food cycle; Examples: 1973 Oil Embargo, 1979 Iranian Revolution. Having 33.8 Days of Supply is only a 9% safety factor on a survival need. Take away the 18 Days of Supply required to fill pipelines and there is a 4% safety margin on a non-elastic survival need. Fragility is extreme.

(click to enlarge)

In July 2008 the EIA's This Week in Petroleum indicated the low inventories circled in the above graph. Gasoline inventories in the US Southeast were so worrisome that a Seeking Alpha article was published on the economic risk. In September 2008 that inventory fragility hit the market, "Frustration in the South as a Gasoline Shortage Drags On". Note, the EIA issued no warning of risk.

Fear caused drivers to switch behaviors from having half-empty tanks to mostly-full tanks. This pulled 3-days inventory out of the whole system (green circles in the following 5-year inventory band (blue area). Current gasoline inventories (right) are only 5-Days Supply above where outages occurred in September 2008.

The petroleum companies are extraordinarily well run. They are spectacular examples of "just-in-time" efficiency. This "just-in-time" skill does not diminish the 365-day market need.

As awareness of Peak Fracking grows, I believe people, at every level of the supply chain, will stockpile more to meet the 365-day market need. Also, as prices rise, my guess is that Frackers will slow pumping as higher prices helps them make bond payments.

Stockpiling and slower pumping will amplify the rate of price change.

Recommendations

I follow energy intensely in my efforts to retool transportation but do not trade in oil and gas. So my estimate that ETF (NYSEARCA:UGA) will consistently increase from its February 2016 lows of $20.40 is not connected to my personal investments.

Logistics have mass and momentum. The current mass and momentum -- debt, stacked drilling rigs, and depleting oil wells -- will ratchet the price of oil higher for at least a year. I completely agree with the Saudis that the "Post-Oil Era" is at hand. Life requires energy. Less affordable oil energy will dramatically affect long-term investing.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.