Pied Piper of Dumb Money

A strategy of denial is to treat (unpleasant) factual arguments as opinions and assertions and to offer unsubstantiated contrary opinions and assertions. One set of opinions cancels out the others; in the meantime the firms making the contrary assertions continue business as usual while the various arguments recede into the background.

John Mauldin in his newsletter, ‘Thoughts from the Frontline’ follows the denial strategy exactly. Who can argue? After all, everyone is entitled to an opinion, one is as good as the other, right?

Riding the Energy Wave to the Future

John Mauldin

August 14, 2015

“Formula for success: rise early, work hard, strike oil.”

– J. Paul Getty


This week’s yuan devaluation was big news, but it’s really part of a much bigger saga. Events around the globe are combining to create huge economic change over the next few years. We are watching giant, multidimensional chess games played by some master players.

Mauldin is in trouble already: there are no master players in the 2015 economic ambit, only pretenders …

Energy is the chessboard that connects all the players. What happens when the board changes shape in the middle of the game? If you don’t know the new energy landscape, you’ll have a hard time playing to a draw, much less winning.

Today I’ll tell you about some big shifts in the energy industry. These shifts are about as positive as can be, unless you need high oil prices to run your country. In the long run, these changes are bullish for the whole world, which I think this will surprise many of you. And though we’ve been used to thinking about energy and technology as two different facets of modern life, today they are inextricably linked.

So far, so good …

Barrons 1

“COMMODITIES: TIME TO BUY,” Barron’s practically screamed at its readers. In case you can’t read the fine print on the cover, it says,

The harsh selloff in energy, gold, and other commodities is starting to look like capitulation. Opportunities in Exxon, Chevron, BHP, Goldcorp. Plus six funds and six ETFs to help build a position in this oversold sector.

I presume the photo is supposed to show the sun rising on an oil rig, not setting. The article quotes some very smart people who are bullish on commodities right now. Some energy stocks look like real bargains. Barron’s is simply repeating the market’s conventional wisdom: After a brutal decline, oil prices are stabilizing and should head higher as the global economy recovers.

That’s a perfectly defensible position – but I think it’s wrong.

It’s wrong because it misses a major shift in the way we produce energy. Many people think OPEC’s high oil and gas prices led to the US shale energy boom. That’s not right. The shale boom was born in a time of lower energy prices, and it was the result of new technologies that make recovering large quantities of oil and gas less expensive than ever.

Mauldin’s pricing assertion is taken directly from industry ad-man Mark Mills; not only is it factually incorrect but he (Mills) contradicts it himself in his own report. The assertion is important because it allows the larger argument that low prices cannot adversely affect the unconventional oil industry.

I used to get the occasional letter from James Howard Kunstler, who would tell me that whatever letter I had just written was completely bass-ackwards, and how his books explained that we were going to run out of energy and then collapse. His books (Wikipedia lists about a dozen) and dozens of others warned us of Peak Oil. (For the record, James, a certain longtime editor on my staff made sure I got all your letters, reports, and more, as he is firmly in your camp! I kept smiling and saying that he was (and is) wrong; but Charley is a phenomenal editor, and you put up with a few quirks for brilliant editing that makes you look better. Besides, if the world does come to an end, I can wend my way to his survivalist farm and beg for a job and food, although I’m not exactly sure I’m ready to milk goats. Just for old time’s sake.)

Mauldin is disingenuous and puerile; he takes on a soft target, urban design critic Kunstler but never oil industry analysts such as David Hughes, Steven Kopits or Art Berman. By framing Kunstler as the carrier of the ‘Peak Oil’ idea, Mauldin ducks the risk that any technical argument he might make would be revealed as nonsensical.

As it is, Kunstler has a far greater grip on ongoing reality than the various energy industry hucksters such as Mills, IHS and Ambrose Evans-Pritchard … that Mauldin trots out further down.

I have written for years that Peak Oil is nonsense. Longtime readers know that I’m a believer in ever-accelerating technological transformation, but I have to admit I did not see the exponential transformation of the drilling business as it is currently unfolding. The changes are truly breathtaking and have gone largely unnoticed.

Except that the industry has been bleating about them tirelessly in the finance media for years.

By now, you probably know about fracking, the technology where drillers pump liquids into a well to “fracture” the ground and release oil and gas deposits. It’s controversial in certain quarters, especially among those who hate anything carbon-related.

Fracking technology is moving forward like all other technologies: very fast. Newer techniques promise to reduce the side effects, at even lower operating costs. Furthermore, fracking is only the beginning of this revolution. The Manhattan Institute recently published an excellent (bordering on brilliant) report by Mark P. Mills, ‘Shale 2.0: Technology and the Coming Big-Data Revolution in America’s Shale Oil Fields’. I highly recommend it.

Mills outlines the way the new technologies are turning this industry on its head. Shale production or “unconventional” production is really a completely new industry. Here is a short quote:

The price and availability of oil (and natural gas) are determined by three interlocking variables: politics, money, and technology. Hydrocarbons have existed in enormous quantities for millennia across the planet. Governments control land access and business freedoms. Access to capital and the nature of fiscal policy are also critical determinants of commerce, especially for capital-intensive industries. But were it not for technology, oil and natural gas would not flow, and the associated growth that these resources fuel would not materialize.

While the conventional and so-called unconventional (i.e., shale) oil industries display clear similarities in basic mechanics and operations – drills, pipes, and pumps – most of the conventional equipment, methods, and materials were not designed or optimized for the new techniques and challenges needed in shale production. By innovatively applying old and new technologies, shale operators propelled a stunningly fast gain in the productivity of shale rigs (Figure 4), with costs per rig stable or declining.


Look at the above chart for a few moments; it’s truly staggering. In just seven years, the amount of oil per well in some shale plays has risen by a factor of 10! That is almost all due to new technologies that are increasingly coming online.

Indeed, look @ Mills’ staggering chart! What it actually indicates is hard to tell because it is mislabeled. The ‘Y’ (vertical) axis indicates output per day per rig while the title indicates output per well … these are two different things. As it is, the production profile of conventional oil fields is little different from those indicated on this chart.

Shale companies now produce more oil with two rigs than they did just a few years ago with three rigs, sometimes even spending less overall. At $55 per barrel, at least one of the big players in the Texas Eagle Ford shale reports a 70 percent financial rate of return. If world prices rise slightly, to $65 per barrel, some of the more efficient shale oil operators today would enjoy a higher rate of return than when oil stood at $95 per barrel in 2012.

Read that last paragraph again. Some shale operators can make good money at $55 a barrel. At $65, they can make higher returns than they did three years ago with oil at $95. I have friends here in Dallas who are raising money for wells that can do better than break even at $40 per barrel, although they think $60 is where the new normal will settle out. Texans are nothing if not optimistic.

How are these new economies possible? Answer: they bent the cost curve downward. It has fallen fast and – more importantly – it will keep falling.

The same process that doubles the power of your smartphone every couple of years without raising its price, is also unfolding in the energy business. That’s why you see per-well production rising so fast in the Eagle Ford, Bakken, and Permian Basin fields. It’s not a result of more wells; rig counts have been falling this year. Rather, the producers are pulling more oil and gas out of the existing wells.

The Fracking Gospel

How are they doing this? Many different technologies and techniques are helping. The Daily Telegraph’s Ambrose Evans-Pritchard reported from a Houston energy industry conference earlier this year:

IHS said an astonishing thing is happening as frackers keep discovering cleverer ways to extract oil, and switch tactically to better wells. Costs may plummet by 45pc this year, and by 60pc to 70pc before the end of 2016. “Break-even prices are going down across the board,” said the group’s Raoul LeBlanc.

Shale bosses have been lining up at this year’s “Energy Davos” to proclaim the fracking Gospel. “We have just drilled an 18,000 ft well in 16 days in the Permian Basis. Last year it took 30 days,” said Scott Sheffield, head of Pioneer Natural Resources. “We’ve cut spud-to-spud time to 19 days,” said Hess Corporation’s John Hess, referring to the turnaround time between drilling. This is half the level in 2012. “We’ve driven down drilling costs by 50pc, and we can see another 30pc ahead,” he said.

Right now, some US shale operators can break even at $10/barrel. Costs for the “expensive” ones run around $55 per barrel but are falling fast. With massive quantities of oil and gas still in the ground, there is no economic reason these companies can’t make big money even if energy prices stay in the $40s.

The Peak Oil proponents weren’t just wrong; they were exponentially wrong. We’re not going to run out of oil, and it is not getting too expensive to produce. Quite the opposite on both counts.

<End of article.>

“Break-even prices are going down across the board,” said the group’s Raoul LeBlanc.

Maybe not, says Wolf Richter:

… oil prices plunged to six-and-a-half year lows, taking out the low set earlier this year, instead of bouncing off it. West Texas Intermediate ended the week at $42.18 a barrel. But in Canada, the benchmark blend Western Canada Select hit a catastrophic C$29.79 a barrel.

WCS always trades at a discount to WTI. But as some refineries were shut down for scheduled maintenance, a BP refinery in Whiting, Indiana, that can process Canadian heavy crude, was also shut down for “unscheduled repair work.” Getting the refinery up and running at full capacity again could take several weeks. Meanwhile, the crude, with no other place to go, goes into storage.

This scenario was punctuated by a cascade of bankruptcies that eviscerated unsecured bond holders, and not all of them were energy-related. In Delaware alone, there were 20 Chapter 11 filings this week, including the prepacked bankruptcy of Hercules Offshore and a gaggle of related companies. Risk, which the Fed had so ingeniously removed from the equation, is suddenly rearing its ugly head again.

It appears that the folks who actually lend money to oil drillers didn’t read the ‘Fracking Gospel’; they missed the part where the industry thrives @ $10 per barrel (or $40, for that matter). The hedge funds, banks, private equity, energy tycoons and other smart-money-turned-dumb-money-overnight have been destroyed. While Mauldin speaks, the market acts and the outcome so far hasn’t been pleasant.

As it turns out the drillers need +$100/barrel payments in order to meet expenses. If they don’t get it they die. Costs are costs, they are grounded in physical reality and cannot be cajoled or negotiated with; they are either met or they aren’t. Right now costs are met with boatloads of borrowed money from Wall Street. The problem is proportionately more funds flow to drillers than to the customers who are short of the credit needed to retire the drillers’ loans. That’s why prices have declined, bankrupt customers cannot borrow enough to offer a bid.

Mauldin & Co. discuss fracking but ignore the rest of the oil drilling business. Most of the world’s oil is recovered from legacy conventional fields that have been subject to long-term advanced recovery techniques … all of which cost enormous amounts of money. Extraction expenditures have a binding relationship to the amount of work required to lift oil from what are now depleted, difficult and inaccessible formations. There are also greater costs for processing and transport, infrastructure and maintenance, environmental remediation and leases/taxes/administration. These ‘cost slices’ must be cut from a rapidly dwindling cash-flow pie. Drilling costs per foot of well might indeed be decreasing due to better drilling techniques and highly skilled crews but the complete industry life-cycle costs are not. That this is so is self-evident: if life-cycle costs were falling, there would be no arguments, no denial … no fracking either; these things would be unnecessary.

Mauldin & Co. ignores the affect of low prices on syncrude extraction in Alberta. He fails to mention cancelled drilling projects in the Arctic, the cancelled gas to liquids plants; he fails to note the slumping earnings of major oil companies. Carnage isn’t confined to drillers. Rail transport is hemorrhaging money, so is the steel industry, also oilfield service companies, home-builders and construction contractors.

Why are prices falling? Mauldin doesn’t discuss. Like almost every word written or spoken about the energy business, the focus is on extraction rather than consumption … which is where the bulk of our difficulties lie. Mauldin and Co. assume the free markets will ‘manage’ consumption, that no special examination is required, as indeed there is none. Yet, the fuel after it has been extracted is simply wasted. We have nothing to show for our guzzling of a trillion- plus barrels of irreplaceable fuel other than smog, dead-money debts and a bunch of used cars.

Because there are no revenue returns on driving a billion cars in circles, returns/cash flow must be borrowed. The outcome is the financialization of the world and everything in it, the rise and dominion of the banks, the expansion and bloat of government and its hollowing out by corruption; the need to ‘keep the economy growing’ … or else. Our precious world of waste has saddled itself with hundreds of trillion$ of dollars worth of debt that cannot be ‘worked off’; not even the smallest fraction. The excess leverage represents systemic insolvency without the possibility of relief. The process of ‘restructuring by other means’ is taking place right now under John Mauldin’s nose.

How is this happening?

Labor force

US labor force participation: Americans working as a percentage has declined to levels last seen in the 1970s, more find themselves on the dole …

USDEUR 081215

The euro (in dollars): currency depreciation/dollar preference means everything marked up in other ‘Brand X’ currencies is worth less, including the economies of entire countries …

Triangle of Doom 041515

Triangle of Doom: energy deflation, where any price — even the lowest — is too high as customer solvency is undone by energy shortages …

Aleppo 1

Aleppo destroyed: endless- and pointless wars over resources and the effects of climate change destroy consumption, literally … by killing off the consumers, (photo by Narciso Contreras/AP). Adding to the tech arsenal used to extract more capital simply cannibalizes what remains that much faster … bankruptcy on a stick.

The march of time provides the proof of Mauldin’s errors and ultimate irrelevance. Part of our onrushing ‘World of Less’ is the end of money-making-money; the process multiplies claims against resources and purchasing power that no longer exist. Promoting the money-making process is Mauldin’s reason to be. As such he is the Pied Piper of dumb money, leading the clueless (hopeless) to oblivion.

— NOTE: You are free to comment here or over on the main page if you like.

2 thoughts on “Pied Piper of Dumb Money

  1. Ken Barrows

    The biggest problem is not Mr. Maudlin; you know he’s a cheerleader for BAU. The biggest problem is the journalist who thinks s/he is digging at the truth but takes industry PR as the gospel truth.

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