… especially by coal rollers.
… especially by coal rollers.
In the early 1970s President Richard Nixon instigated two changes that had profound effects. The first of these was taking United States off the gold standard; i.e. henceforth US dollars would no longer be convertible to Gold. Ordinarily this might have been expected to have significant ramifications for the value of the US dollar.
Deleterious effects however, were avoided by another equally profound change. Nixon’s National Security Adviser Henry Kissinger negotiated an agreement with Saudi Arabia that henceforth all oil (initially from Saudi Arabia but rapidly extended to all OPEC countries) would be traded only in US dollars, the birth of the so called petrodollar.
It was a classic mafia style arrangement. In exchange for Saudi Arabia’s agreement to the sole use of the dollar for oil transactions, the US underwrote Saudi Arabia’s security thereby ensuring the continuity of one of the world’s most corrupt and repressive regimes.
Also unknown at the time, the US and Saudi Arabia entered an arrangement whereby Islamist terrorist groups (as long as they were Sunni) would be financed by Saudi Arabia and armed by the Americans and then used in pursuit of US geopolitical goals. Operation Cyclone, begun under the Carter administration in the 1970s was an early forerunner of this tactic, but it has been refined and utilized in different formats in a wide number of countries ever since.
The objective was always fundamentally the same: to undermine and if necessary replace governments that were insufficiently compliant with US geopolitical aims. As and when necessary, US troops and their “coalition” allies would be inserted into the target countries. The destruction of Afghanistan (2001 and continuing) Iraq (2003 and continuing) Libya (2011 and continuing) are only three of the better-known examples.
The huge financial cost of these military and geopolitical ventures did not impose a proper price upon the US because of the hegemonic role of the US dollar. The US, in effect, had their multiple wars of choice paid for by other countries as the dollar’s role in world trade created a constant demand for US Treasury bonds.
The role of the US dollar also permitted the US to impose sanctions on recalcitrant countries. The selective nature of the sanctions, always directed toward a US geopolitical or commercial advantage, were clearly an instrument of repressive power. Notwithstanding claims that they were to “punish” the alleged misconduct of the specified country, their actually use betrayed their geopolitical purpose.
Sanctions against Russia for its” invasion” of Ukraine “annexation” of Crimea, and against Iran for its “nuclear program” are two of the better known illustrations of sanctions being justified on spurious grounds..
The use and abuse of the dollar’s power is clearly unacceptable, but the capacity to invoke countermeasures was until quite recently severely limited. The single most important countervailing force is the rise of China as the economic powerhouse of the world, and importantly, the creation of alternative structures in trade, finance and security, that translate China’s economic power into a force for major change.
That change is assisted by the number of collateral developments. In 1990, the G7 nations (Canada, France, Germany, Italy, Japan, the US and UK) had a combined GDP approximately six times greater then the seven economically most important emerging nations (Brazil, China, India, Indonesia, Mexico, Russia and South Korea).
By 2013 the “emerging seven” had surpassed the G7’s GDP total and according to the IMF’s estimates for 2017, the GDP of the two groups will be $47 .5 trillion and $37.8 trillion for the emerging seven and the G7 respectively. Turkey, which is growing at 5% per annum, has replaced Mexico in the top emerging seven.
BRICS, which contains four of the emerging seven nations and the Shanghai Corporation Organization (SCO), which includes China, India and Russia, are working together on the architecture of a monetary alternative to the dollar. The SCO alone contains 42% of the world’s population.
India’s role in BRICS and the SCO is one reason it is being assiduously cultivated by Australia, Japan and the United States in an attempt to set up a “quadrilateral four” to slow and undermine the role of China and Russia in creating an alternative to longstanding western domination and exploitation.
It was in this context that Russia’s President Putin at the recent BRICS meeting in Xiamen, China said that
“Russia shares the BRICS countries concerns over the unfairness of the global financial and economic architecture, which does not give due regard to the growing weight of the emerging economies.”
This speech developed a theme that Putin had developed in an article published prior to the BRICS meeting. Putin bluntly vowed to destroy the US led financial system, aiming to reform a system that gives excessive domination to a limited number of reserve (i.e. predominantly western) currencies.
China has developed a new Cross Border Interbank Payments System (CIPS) to replace the US dominated SWIFT system, itself used as a tool for financial bullying by the US. Russia has also taken steps to insulate itself from the ill effects of being excluded from SWIFT.
Other major changes are also occurring. Venezuela, with the world’s largest known oil reserves, has ceased accepting payment in US dollars. In the past US retaliation through regime change would have been immediate as happened to Libya’s Gaddafi (confirmed by Clinton’s leaked emails) and the Iraq’s Saddam Hussein who had announced that he would henceforth accept payment in euros and not dollars.
China and Qatar recently concluded a $50 billion deal denominated in Yuan. There were immediate threats and absurd demands from Saudi Arabia, undoubtedly acting as the voice of the US administration, but nothing more serious. The lack of military intervention or attempted regime change was probably attributable to Turkey’s military intervention, a series of agreements with Iran, and the probable implied threat of Chinese intervention should the Saudis further demonstrate their military incompetence (as in Yemen) by anything as rash as direct military moves against Qatar.
Saudi Arabia is rapidly reaching a crunch point in its relationship with China, a huge purchaser of Saudi Arabia’s oil. It is widely known that China wants future oil contracts denominated in Yuan. The attraction for Saudi Arabia is that the Chinese guarantee their Yuan with gold traded on the Hong Kong and Shanghai exchanges. Ironically, this puts China in the same position as the United States prior to Nixon’s withdrawal from the gold backed dollar.
The dilemma for the Saudis is that if they comply with the Chinese demands they risk losing the Americans underwriting their security. US instigated regime change in Saudi Arabia is a very real possibility and the recent maneuverings by Mohammad bin Salman to consolidate his power can be interpreted as a response to that possibility.
Typically, the western media focused on relative trivialities, such as women being able to drive motor vehicles from 2018 (in limited circumstances), rather than examining the underlying geopolitical power struggle.
The other major development worth mentioning in this context is the rapid increase in the number of countries doing deals with China using the Yuan or their own national currencies as the medium of exchange. China’s Belt and Road Initiative, currently involving 65 nations, will undoubtedly accelerate this trend. Russia and China are already each other’s critically important trading partners and all agreements between them are being denominated in either Yuan or Rubles.
It would be naïve to assume that this is all going to occur without a massive rear guard action by the Americans who know full well that their ability to defy economic logic is only possible because of the dollar’s unique role, allowing in turn military interventions to prop up their now rapidly declining power.
The United States’ aggressive and provocative actions in the South China Sea, North Korea, Ukraine, Syria and elsewhere our best interpreted as the flailing’s of a declining empire. The real question is will the United States accept the disappearance of the unique power that it has wielded since the Bretton Woods agreement of 1944 and adjust its policies accordingly, or destroy us all in their attempts to recapture a lost world.
Syria – U.S. CentCom Declares War On Russia
Yesterday three high ranking Russian officers were killed in an “ISIS attack” in eastern Syria. It is likely they were killed by U.S. special forces or insurgents under U.S. special forces control because ISIS is a proxy army, created and financed by USA.gov and her allies to grab as much land as possible in this region. The incident can be understood as a declaration of war.
The U.S. Central Command in the Middle East wants the oil fields in east-Syria under control of its proxy forces to set up and control a U.S. aligned Kurdish mini-state in the area. The Syrian government, allied with Russia, needs the revenues of the oil fields to rebuild the country.
Last week the Russians issued sharply worded statements against U.S. coordination with al-Qaeda terrorists in Idleb province and warned of further escalation.
Yesterday the Russian Ministry of Defense accused the U.S. military in east-Syria of direct collaboration with the Islamic State:
US Army special units provide free passage for the Syrian Democratic Forces (SDF) through the battle formations of Islamic State (IS, formerly ISIS/ISIL) terrorists, the ministry said in a statement.“Facing no resistance of the ISIS militants, the SDF units are advancing along the left shore of the Euphrates towards Deir ez-Zor,” the statement reads.
The newly released images “clearly show that US special ops are stationed at the outposts previously set up by ISIS militants.”
“Despite that the US strongholds being located in the ISIS areas, no screening patrol has been organized at them,” the Russian Ministry of Defense said.
This map marks the currently relevant conflict area – (U.S. proxies – yellow, SAA – red, ISIS – black):
The accusations are plausible. Large parts of ISIS in Deir Ezzor consist of local tribal forces from eastern Syria. U.S. special envoy Brett McGurk recently met tribal leaders who had earlier pledged allegiance to ISIS. Deals were made. As we wrote:
The U.S. diplomat tasked with the job, Brett McGurk, recently met with local tribal dignitaries of the area. Pictures of the meeting were published. Several people pointed out that the very same dignitaries were earlier pictured swearing allegiance to the Islamic State.
Just like during the “Anbar Awaking” in its war on Iraq the U.S. is bribing the local radicals to temporarily change over to its side. This will help the U.S. to claim that it defeated ISIS. But as soon as the payments stop the very same forces will revert back to their old game.
The local criminal Ahmad Abu Khawla, circled in the pictures above, who had earlier fought for ISIS, was suddenly installed as commander of a newly invented “Deir Ezzor Military Council”, set up under U.S. special force control.
Last night a Russian three-star general and two colonels were killed in a mortar attack while they visited a Syrian army headquarters in Deir Ezzor:
Lieutenant-General Valery Asapov, of the Russian armed forces, has been killed after coming under shelling from Islamic State (IS, formerly ISIS/ISIL) militants near Deir ez-Zor, the Russian Defense Ministry has announced.In its statement, the ministry said that Asapov was at a command outpost manned by Syrian troops, assisting commanders in the liberation of the city of Deir ez-Zor.
Lieutenant-General Valery Asapov is the highest-ranking Russian officer to be killed in the Syrian campaign. He was a commander of the 5th Army in Russia’s Eastern Military District, one of the four strategic commands in the Russian Armed Forces. The army is based in Russia’s Far East, in the city of Ussuriysk, some 98 km (61 miles) from Vladivostok.
For three years ISIS had besieged Syrian troops in Deir Ezzor city and its airport. It had not once managed to successfully attack the Syrian headquarters or to kill high ranking officers. Now, as U.S. proxy forces “advised” by U.S. special forces, have taken position north of Deir Ezzor, “ISIS” suddenly has the intelligence data and precision mortar capabilities to kill a bunch of visiting Russian officers?
That is not plausible. No one in Damascus, Baghdad, Tehran or Moscow will believe that.
The Russian military, as usual, reacts calmly and officially attributes the attack to ISIS. Doing so avoids pressure to immediately react to the attack. (The U.S. will falsely interpret this as a face-saving Russian retreat.)
But no one in Moscow will believe that the incident is independent of other recent maneuvers by the U.S. forces and independent of the earlier accusations the Russian military made against the U.S. forces.
Nominally the U.S. and Russia are both in Syria to fight the Islamic State. The Russian troops are legitimately there, having been invited by the Syrian government. The U.S. forces have no legal justification for their presence. So far open hostilities between the two sides had been avoided. But as the U.S. now obviously sets out to split Syria apart, openly cooperates with terrorists and does not even refrain from killing Russian officers, the gloves will have to come off.
U.S. Central Command has declared war on the Russian contingent in Syria. A high ranking Russian general was killed. This inevitably requires a reaction. The response does not necessarily have to come from Russian forces. Moscow has many capable allies in the area. The response does not necessarily have to come in Syria.
“Accidents” and “incidents”, like an “ISIS mortar attacks”, or unintentional bombing of troop concentration of the other side, can happen on both sides of the front. Cars can blow up, bridges can collapse. Any U.S. officer or civilian official in the larger Middle East should be aware that they too are now targets.
Back in November, before most grasped just how serious the collapse in crude was (and would become, as well as its massive implications), we wrote “How The Petrodollar Quietly Died, And Nobody Noticed“, because for the first time in almost two decades, energy-exporting countries would pull their “petrodollars” out of world markets in 2015.
This empirical death of Petrodollar followed years of windfalls for oil exporters such as Russia, Angola, Saudi Arabia and Nigeria. Much of that money found its way into financial markets, helping to boost asset prices and keep the cost of borrowing down, through so-called petrodollar recycling.
We added that in 2014 “the oil producers will effectively import capital amounting to $7.6 billion. By comparison, they exported $60 billion in 2013 and $248 billion in 2012, according to the following graphic based on BNP Paribas calculations.”
The problem was compounded by its own positive feedback loop: as the last few weeks vividly demonstrated, plunging oil would lead to a further liquidation in foreign reserves for the oil exporters who rushed to preserve their currencies, leading to even greater drops in oil as the viable producers rushed to pump out as much crude out of the ground as possible in a scramble to put the weakest producers out of business, and to crush marginal production. Call it Game Theory gone mad and on steroids.
Ironically, when the price of crude started its self-reinforcing plunge, such a death would happen whether the petrodollar participants wanted it, or, as the case may be, were dragged into the abattoir kicking and screaming.
It is the latter that seems to have taken place with the one country that many though initially would do everything in its power to have an amicable departure from the Petrodollar and yet whose divorce from the USD has quickly become a very messy affair, with lots of screaming and the occasional artillery shell.
As Bloomberg reports Russia “may unseal its $88 billion Reserve Fund and convert some of its foreign-currency holdings into rubles, the latest government effort to prop up an economy veering into its worst slump since 2009.”
These are dollars which Russia would have otherwise recycled into US denominated assets. Instead, Russia will purchase even more Rubles and use the proceeds for FX and economic stabilization purposes.
“Together with the central bank, we are selling a part of our foreign-currency reserves,” Finance Minister Anton Siluanov said in Moscow today. “We’ll get rubles and place them in deposits for banks, giving liquidity to the economy.“
Call it less than amicable divorce, call it what you will: what it is, is Russia violently leaving the ranks of countries that exchange crude for US paper.
Russia may convert as much as 500 billion rubles from one of the government’s two sovereign wealth funds to support the national currency, Siluanov said, calling the ruble “undervalued.” The Finance Ministry last month started selling foreign currency remaining on the Treasury’s accounts.
The entire 500 billion rubles or part of the amount will be converted in January-February through the central bank, according to Deputy Finance Minister Alexey Moiseev. The Bank of Russia will determine the timing and method of the operation.
The ruble, the world’s second-worst performing currency last year, weakened for a fourth day, losing 1.3 percent to 66.0775 against the dollar by 3:21 p.m. in Moscow. It trimmed a drop of as much as 2 percent after Siluanov’s comments. The ruble’s continued slump this year underscores the fragility of coordinated measures by Russia’s government and central bank that steered the ruble’s rebound from a record-low intraday level of 80.10 on Dec. 16. OAO Gazprom and four other state-controlled exporters were ordered last month to cut foreign-currency holdings by March 1 to levels no higher than they were on Oct. 1. The central bank sought to make it easier for banks to access dollars and euros while raising its key rate to 17 percent, the emergency level it introduced last month to arrest the ruble collapse.
Today’s announcement “looks ruble-supportive, as together with state-driven selling from exporters it would support FX supply on the market,” Dmitry Polevoy, chief economist for Russia and the Commonwealth of Independent States at ING Groep NV in Moscow, said by e-mail. “Also, it will be helpful for banks, while there might be some negative effects related to extra money supply and risks of using some of the money on the FX market for short-term speculations.
Bloomberg’s ready summary of the US economy is generally spot on, and is to be expected when any nation finally leaves, voluntarily or otherwise, the stranglehold of a global reserve currency. What Bloomberg failed to account for is what happens to the remainder of the Petrodollar world. Here is what we said last time:
Outside from the domestic economic impact within EMs due to the downward oil price shock, we believe that the implications for financial market liquidity via the reduced recycling of petrodollars should not be underestimated. Because energy exporters do not fully invest their export receipts and effectively ‘save’ a considerable portion of their income, these surplus funds find their way back into bank deposits (fuelling the loan market) as well as into financial markets and other assets. This capital has helped fund debt among importers, helping to boost overall growth as well as other financial markets liquidity conditions.
[T]his year, we expect that incremental liquidity typically provided by such recycled flows will be markedly reduced, estimating that direct and other capital outflows from energy exporters will have declined by USD253bn YoY. Of course, these economies also receive inward capital, so on a net basis, the additional capital provided externally is much lower. This year, we expect that net capital flows will be negative for EM, representing the first net inflow of capital (USD8bn) for the first time in eighteen years. This compares with USD60bn last year, which itself was down from USD248bn in 2012. At its peak, recycled EM petro dollars amounted to USD511bn back in 2006. The declines seen since 2006 not only reflect the changed global environment, but also the propensity of underlying exporters to begin investing the money domestically rather than save. The implications for financial markets liquidity – not to mention related downward pressure on US Treasury yields – is negative.
Considering the wildly violent moves we have seen so far in the market confirming just how little liquidity is left in the market, and of course, the absolutely collapse in Treasury yields, with the 30 Year just hitting a record low, this prediction has been borne out precisely as expected.
And now, we await to see which other country will follow Russia out of the Petrodollar next, and what impact that will have not only on the world’s reserve currency, on US Treasury rates, and on the most financialized commodity as this chart demonstrates…
… but on what is most important to developed world central planners everywhere: asset prices levels, and specifically what happens when the sellers emerge into what is rapidly shaping up as the most liquid market in history.
It’s no secret that a massive supply glut has caused global oil prices to crash this year. Ferocious production from OPEC and near-record U.S. output is adding to sky-high oil inventories around the world.
But what’s less widely known is that the oversupply problem has gotten so bad that oil tankers waiting to be offloaded are piling up off the U.S. Gulf Coast because there’s nowhere to put the crude.
So-called “floating storage” of crude oil soared to nearly triple the normal level last week, according to ClipperData, which tracks global shipments of crude.
It’s a “super tanker traffic jam,” said Matt Smith, director of commodity research at ClipperData.
Not Enough Buyers
Smith first noticed the maritime congestion popping up a month ago off the coast of Singapore. That was alarming because Asia accounts for one-third of global oil demand.
“It was kind of strange to see. The ships didn’t have any buyers,” he said.
And then ClipperData discovered a similar phenomenon off China and even the Arabian Gulf.
“There just appears to be more oil than can be dealt with. They haven’t got anywhere to put it,” said Smith.
$2 Gas Coming Soon
That, of course, is great news for American drivers. National average gasoline prices have dropped to $2.10 a barrel, down by 75 cents from a year ago, according to AAA. U.S. prices could slip below $2 by Christmas nationwide for the first time since 2009, AAA said.
Oil prices are also heading south. The latest evidence of the lingering glut helped cause oil prices last week to briefly tumble below $40 a barrel for the first time since late August. Over the past year and a half, oil has lost more than 60% of its value, an epic crash that has thrown the energy industry into disarray.
The problem is OPEC producers, led by Saudi Arabia and Iraq, are pumping oil aggressively despite depressed prices. U.S. output is also near record highs, though it has slowed a bit.
Inventories As High As They’ve Ever Been
There is a “massive cushion” of crude oil around the world, with global stockpiles sitting at a record 3 billion barrels, according to the International Energy Agency.
A stunning 487 million barrels of crude is sitting in U.S. inventories, levels unseen at this time of the year in the last 80 years, according to the U.S. Energy Information Administration.
“We’ve been through a low-price environment all year — yet the world is still awash with crude here,” said Smith.
Scott Sheffield, CEO of Pioneer Natural Resources, addresses the Permian Basin Chapter of Division Order Analysts during a luncheon Wednesday, Feb. 18, 2015 at the Petroleum Club. Photo by James Durbin/Reporter-Telegram. Article by Mella McEwen
Midland’s economic landscape is expected to look very different, even compared to November when Scott Sheffield celebrated the opening of his company’s new regional office building.
Fueled by a thriving oil and gas industry powered by strong commodity prices, Midland has boasted one of the strongest, if not the strongest, economies in the nation.
But current crude prices are half of the $107 peak that was reached in June, companies have slashed budgets and activity plans, and layoff announcements are becoming a daily occurrence.
Already the nation’s rig count has fallen from a high of about 1,960 to 1,300. The Permian Basin rig count may fall to 300 rigs before beginning to rebound this summer.
Sheffield, chairman and chief executive officer of Pioneer Natural Resources, said during a visit to Midland last week that this is the industry’s fifth major downturn since he arrived in Midland in 1979.
This downturn is more significant, in part because the root cause is different, he said. He discounted the 2008-2009 downturn, caused by the Great Recession that depressed demand globally, because prices rebounded quickly.
Previous downturns were caused by other nations trying to take market share from the Organization of Petroleum Exporting Countries, particularly Saudi Arabia. They would then react by increasing supplies that would exceed demand, sending prices lower.
This time, “we were too good at our jobs” and developed shale plays that have added 4.5 million barrels of oil a day to the nation’s output. The United States has become the world’s largest producer of oil and natural gas and the nation’s crude inventories are at 80-year highs.
“The additional production is a game-changer for the Permian Basin, for the Untied States, for the industry,” he said.
Permian Basin production has soared from about 750,000 barrels a day in 2007 to a little more than 1.9 million barrels a day today.
The New Cycle
Midland will recover, “but not as strong as six months ago,” Sheffield said.
He stands by his prediction that Midland’s population will grow to 200,000, but thinks it will take longer — maybe 12 years — to reach that figure.
“We know the oil is here; it will always be here. We know in the Midland Basin, in the Delaware Basin, you can always make a well,” he said.
The Spraberry-Wolfcamp formation that lies under Midland contains an estimated 75 billion recoverable barrels of oil equivalent, he said.
The Midland Basin has several stacked plays, and operators already have proven 10 zones reaching down about 4,000 feet, he said. The Delaware Basin has an estimated 25 billion barrels, but “not enough work is being done there,” he said.
He predicted the industry will become more cyclical and hedging of oil prices by operators will be a major component of their operations.
“The Permian Basin will come back; I just can’t tell you if it will be at $60 or $70 or $80 oil,” he said.
The world population will rise from 6 billion to 9 billion people and they will need oil for their energy needs. “The world needs the Permian Basin,” Sheffield said.
He said Saudi Arabia doesn’t want to eliminate the nation’s shale production but to slow it down because the Saudis know the world will need that oil in the future.
Sheffield said lifting the 40-year ban on exporting domestic crude could be a key to improving the industry’s fortunes.
He said he has spent a lot of time in the nation’s capital educating lawmakers, regulators and President Obama’s staff on the benefits of lifting the ban.
“My main point is the differential is widening,” he said, referring to the price differences between West Texas Intermediate and Brent grades, and even between West Texas Intermediate-Midland and West Texas Intermediate-Cushing.
For most of the past 40 years, WTI and Brent brought prices within $1 or $2 of each other, he said. But over the last three years, that gap has widened to an average of $15 a barrel. Currently, it is about $8 a barrel and is expected to increase. There is also a gap between Midland and Cushing grades because Cushing storage is expected to reach capacity in the next couple of months and there is still limited pipeline transportation to send Midland crudes to other markets, such as the Gulf Coast.
Pioneer and other producers want the flexibility to send their product to the Gulf Coast or to overseas refiners that are configured to process the light, sweet crude coming out of the shale plays. This would help narrow the differential, he said.
“That extra $8 or $10 a barrel would have a tremendous impact on production, on jobs, on investment,” he said.
It could also benefit consumers because gasoline prices are based on the price received for Brent, with is about $8 higher than West Texas Intermediate. Eliminating the ban now, while crude prices are low, could lessen the impact of higher gasoline prices should they rise in response, he said.
He thinks the ban has a 50-50 chance of being lifted this year but virtually no chance next year — an election year. “I’m 80 to 90 percent confident it will get done by 2017,” he said.
In the $1.6 trillion-a-year oil business, there are global titans like Exxon Mobil Corp. (XOM) that wield more economic might than most of the nations on Earth, and scores of wildcatters scouring land and sea for the next treasure troves of crude.
Then there are the strippers. For these canaries in the proverbial coal mine, the journey keeps going deeper and darker.
Strippers are scavengers who make a living by resuscitating once-prolific oil fields to coax as little as a bathtub full of crude a day from each well. Collectively, the strippers operate almost half-a-million oil wells that produced more than 730,000 barrels a day in 2012, the most recent year for which figures were available.
That’s one of every 10 barrels produced in the U.S. — equivalent to the entire output of Qatar, or half the crude Royal Dutch Shell Plc (RDSA), Europe’s largest energy company, pumps worldwide every day. With oil prices down 58 percent since June, these smallest of producers will be the first to succumb to the Great Oil Bust of 2015.
“This is killing us,” said Todd Shulman, a University of Colorado-trained geologist who ran fracking crews in the Rocky Mountains before returning to Vandalia, Illinois, in 1984 to help run the family’s stripper well business.
Stripper wells — an inglorious moniker for 2-inch-wide holes that produce trickles of crude with the aid of iconic pumping machines known as nodding donkeys — were a vital contributor to U.S. oil production long before the shale revolution.
Though a far cry from the booming shale gushers that have pushed American crude production to the highest in a generation, stripper wells are a defining image of the oil business, scattered throughout rural backwaters abandoned by the world’s oil titans decades ago.
With the price of crude dipping so low, there’s no way Shulman will be able to drill a new well that regulators have already permitted. Nor is he even going to turn on a well finished last month that’s ready to start production.
It would be foolhardy to harvest crude from wells that won’t pay for themselves, said Shulman, who scrapes remnants from old Texaco (CVX) and Shell fields 310 miles south of Chicago, in the heart of what had been a booming oil region in the 1930s. He’ll wait for prices to rebound.
The economics of most stripper wells stop making sense when Brent crude, the benchmark for more than half the world’s oil, drops under $50 a barrel, U.K.-based Wood Mackenzie Ltd. said in a Jan. 9 note to clients.
Brent fell as much as 2.2 percent to $47.78 a barrel in London today, and lost 48 percent of its value for the full year 2014 amid faltering global demand and rising U.S. output that fed a supply glut.
“Once the oil price reaches these levels, producers have a sometimes complex decision to continue producing, losing money on every barrel produced, or to halt production, which will reduce supply,” said Robert Plummer, a corporate research analyst at Wood Mackenzie. “U.S. onshore ultra-low production volume stripper wells could be the first to be cut.”
Although stripper wells extract only a tiny fraction of the oil reaped from a successful shale development, a stripper can be drilled for less than $300,000, compared with $7 million to $9 million for shale wells, which require hydraulic fracturing, or fracking, to flow oil and natural gas.
For stripper-well operators like Shulman and thousands of others across the U.S., the situation is especially dire: unlike shale fields that can be quickly shut down and restarted in response to price swings, stripper operations are geologically and technically delicate.
Shut a stripper well down and chances are the bottom of the hole will fill with water or permanently clog with sand and you’ll never see another barrel of oil, said Brad Gessel, who operates 200 stripper wells in fields formerly owned by the likes of Shell near Whittington, Illinois.
“If you shut it in, you may never get that production back again,” Craig Hedin, a veteran Illinois oil lawyer whose four-decade career included helping negotiate Exxon’s 1989 sale of the sprawling Loudon field in 1989. Loudon was a 400 million-barrel jewel in Exxon’s crown for half a century until output slowed to such a slow gurgle that it was no longer worth the company’s attentions. Now, the 25-mile vein of oil-soaked rock north of Vandalia is being worked by strippers.
Before considering the last resort of shutting down producing wells, stripper owners are coping with low prices much like every other oil company. First, they’re suspending new drilling, Gessel said in an office at the back of an industrial showroom stocked with heavy-duty elbow pipes, gauges and other gear sold by the family’s other line of business, Gessel Pump Sales & Service Inc.
The next step is to look for cost-cutting measures in the field and office, and defer new equipment purchases, said the 55-year-old Gessel. Finally, they’d have to lay off employees and Gessel would stop taking a paycheck himself.
It got that bad just 17 years ago.
“When prices crashed and went below $10 a barrel in ’98, I laid off every single employee, my pay went to zero and every piece of equipment was parked in the barn,” Gessel said. “I hope that isn’t where we’re headed this time around.”
Every drop of crude produced in Illinois comes from stripper wells, rather than conventional wells or shale formations, according to the Interstate Oil and Gas Compact Commission. That’s a higher proportion of stripper-oil supply than any other crude-producing state except Missouri, which also gets 100 percent of its oil from scavenged fields.
The vast majority of Illinois’s oil is fed into Countrymark Cooperative Holding Corp.’s refinery in nearby Mt. Vernon, Indiana.
The price Countrymark, a closely held Indianapolis-based maker of fuel for farmers, pays oil producers averages about $7 a barrel less than the U.S. benchmark, West Texas Intermediate crude. The discount accounts for transportation costs incurred by Countrymark to gather and ship the oil to the refinery by truck and pipe.
That means that last week, when WTI dipped as low as $44.20, Illinois crude fetched less than $38.
“I’m going to try not to lay anybody off because we’ve spent years building a really good workforce,” said Gessel, who started the company with his father and brother in 1980 by kicking in $5,000 apiece. The company now employs 25 workers, including two full-time geologists.
Gessel is betting shale drillers in North Dakota and Texas carrying heavy debt loads and multi-million dollar well costs will fold before stripper operators like him.
Bakken crude, which like Illinois oil trades at a discount to the benchmark to account for shipping costs, fetched $39.97 a barrel on Jan. 13 before rebounding to $43.08 the next day. The price’s 2014 peak was $103.01 in June.
“I maintain the shale stuff has to have a high price to work,” Gessel said. “The Bakken stuff doesn’t work at $35. Hell, even my stuff doesn’t work at $35.”