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Oil: The Biggest Crash in History

(Mon, 9 Mar 2020). Crude futures opened down a massive 31% today. Prices have recovered a bit, but price is well below cost of production as Saudi Arabia and Russia started an Oil Price War on Saturday. The carnage was far worse than expected. Oil futures opened near $30, down a record breaking 27%. That's the biggest crash in history.

 

US's Crude Oil Production

The average breakeven price of oil has fallen 4 percent (or $2 per barrel) over the past year, to $50 per barrel, according to the latest Dallas Fed Energy Survey. The $50 top-line figure masks some important differences. Areas such as the Midland and Delaware basins in the Permian Basin, hotbeds of shale activity, are routinely lower on average than other locations. There is also variability among operators; within the Permian Basin, for example, individual responses to the most recent survey ranged from $23 to $70. Bloomberg New Energy Finance’s breakeven prices in the Permian range from $46 per barrel in Loving County to $87 per barrel in Reagan County.

While market participants may differ on how much oil is available at a given price, they are all aware of the overall trends. These represent strong forces that should keep long-dated futures prices from rising too high or falling too low. Given current market prices, U.S. shale production will continue growing this year. Indeed, a recent report by the International Energy Agency highlighted that shale production is likely to be a major driver over the next five years.

 

Evaluation

Drillers and frackers that borrowed heavily and are dependent on higher prices to pay interest are now in serious trouble. Oil exports also did not feasible, as demand is crashing with people working at home and refusing to fly. A lot of leveraged drillers and crude suppliers dependent on prices above $50 will see a credit implosion.

 

Deflationary Outcome

As noted previously, a Very Deflationary Outcome Has Begun. Blame the Fed. Deflation is not really about prices. It's about the value of debt on the books of banks that cannot be paid back by failed corporations and individuals.

 

Liquidity Crisis 

The liquidity crisis will quickly spread far beyond energy.

 

 

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