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Science/Tech See other Science/Tech Articles Title: Here's the "Worst Case Shale Scenario" "Everybody has one," a reader writes, cleaning up an old saying, "but that doesn't mean they are worth listening to. I hope you don't clutter your pages with endless snarky reader arguments back and forth on the question of shale being a fad or techno breakthrough. "As Jim Rickards said in today's piece, it will be difficult enough to ascertain where the risks may be hiding in the derivative shuffle without introducing baseless opinions. I am certain, however, that some readers, or your industry contacts, must be involved at ground zero, either in the shale patch directly or on the finance side." "I work in the industry," another writes as if in response. "The dominoes are already starting. H&P (driller) just idled 50 or 60 flex rigs, and at least one player (oil company) just filed for bankruptcy." Unfortunately, we didn't get much detail on which companies he's referring to. "Why do I have to pick one?" asks another in response to our original question of a tech-driven boom or fiat fraud? "As with most things in this complicated world," the reader begins, "the answer is usually not black or white, A or B. No doubt the U.S. advances in drilling technology make the shale play a possibility. Oil prices high? Perfect, lots of profit potential for drillers with the new technology. Cheap money available? Perfect! The third leg of the stool. New technology, good profit margin, cheap finance money. "What don't you like about that setup? [Ha!] “$50 crude... who saw that coming? I’ll tell you who... Nobody!” "$50 crude... who saw that coming? I'll tell you who... Nobody! Sure wasn't the horizontal shale drillers. Sure wasn't the bankers. Nobody saw it coming. This may have been the 'shot over our bow,' and I think we'll be seeing more signs in the near future of a world economy getting sand in its gears." "As it stands currently," our first reader returns, "I have just enough data -- $5 trillion credit at risk -- to feel my heart racing but no clear direction on where to hide. "Right now, I feel like I did when I lived in the Midwest right in the middle of Tornado Alley. I see the super-high-altitude thunderhead clouds have formed and the sky has taken on a strange copper-green hue. The winds have died down to a dead calm, and suddenly you realize the birds have all left the sky and are completely quiet. "All you can do at that point is make sure you are close to secure shelter and watch to see what type of beast is going to be unleashed and hope that not too many lives are destroyed." Yesterday, we had a chance to catch up with Erik Townsend. We first met Erik, a self-made software entrepreneur who's become a successful hedge fund manager in midlife, when we were doing research on our Great American Energy Boom issue of Apogee last spring. He's been actively trading futures in the oil space for seven years. And managing a hedge fund for two. He is also currently featured as the commodities expert on Jim Puplava's Financial Sense podcast. Erik outlined the following chain of events, which for ease on the eyes, we paraphrase here from his latest newsletter. The scenario might help explain why you feel like you're living in Tornado Alley. "This is not a prediction," Erik cautions, "but the scenario that scares me the most": •The current "anything can happen" sell-off continues, and prices eventually stabilize and consolidate in the $50-60 range. This lasts for a year or two •The U.S. shale industry would not be put out of business by any means, but the "boom" phase would be over. The days of 19-year-old high school dropouts being paid $100 per hour to drive trucks in North Dakota would definitely be over. Existing shale wells would continue to operate, but their output would decline rapidly after a year or so. New shale wells would still be drilled, but at a much subdued pace •The OPEC cartel either collapses or becomes completely irrelevant as the peripheral producers (nations other than UAE and Saudi Arabia) figure out there's nothing to gain by respecting production quotas. They begin producing every barrel they possibly can and selling it for whatever they can get. This deepens and prolongs the temporary oil price depression •The U.S. economic recovery would be jeopardized. Some analysts estimate as many as 90% of new jobs created in this recovery have been energy related. The boom days would be over. This creates a feedback loop, further depressing demand as the economy slows or falls into recession. That could further prolong the period of low oil prices •During the prolonged period of lower prices, it's likely the Fed will pursue another round of QE, further expanding the Fed's balance sheet. It's also possible that QE will be used differently, in a stimulus effort aimed more at Main Street than Wall Street •Eventually, net supply destruction occurs, and prices begin to rise. The U.S. shale boom resumes, but there is a six-12 month lag before the resulting production capacity actually comes online. During that time, prices run up dramatically. Along with the worst-case scenario is the license a "temporary oil price depression" will give to the Fed to pursue an even more reckless monetary policy. "When the Fed tapered asset purchases in 2014," Townsend notes, "they were looking at $100-plus oil prices, and my belief is that fear of triggering an economy-crippling energy price inflation was a key reason they tapered when they did. But remember, they've been super-clear in saying that going forward, their policy will depend on new developments in economic conditions. "The temporary oil price depression now upon us has effectively granted central bankers a license to print more money. Deflationary pressure across the entire commodities complex is strong, and oil is far and away the most important commodity in terms of evaluating the risk of dovish monetary policy. "Central bankers no longer fear $100-plus oil prices, and my prediction is that they'll print money with reckless abandon as long as markets allow them to do so." And so it goes. That the Fed will address a historic drop in oil prices with excessive liquidity appears to be the only certainty in the market right now. Regards, Addison Wiggin The Daily Reckoning Poster Comment: Excessive liquidity in the market? Sounds like trouble is brewing to me. Post Comment Private Reply Ignore Thread
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