End game to the oil rout, page-46

It gets worse.

Here is an extreme shale industry cheerleading piece that I found on another forum.

http://www.manhattan-institute.org/pdf/eper_16.pdf

The most important take-away I got from it was this statement below, which the article tries to paint as some sort of incredibly positive thing.

"The Fracking Backlog

Even more oil supply is now, de facto, being stored underground. As noted, production begins with the distinct second stage of well construction. Once a shale site is mapped and long horizontal wells completed operators can delay the expensive step of fracking. Since the latter constitutes 50–60 percent of total costs, significant spending can be deferred with no loss of the core asset. The oil is simply left stored, in situ, until markets and prices make retrieval more attractive. When such sites are eventually stimulated, operators will be able to harness technological advancements that have occurred in the interim. The U.S. currently has roughly 3,000 drilled wells awaiting completion—likely rising by the end of 2015, to more than 5,000. Given current market realities, many - if not most - such wells will remain idle."

The article goes on to say that the oil stored in those 5,000 wells is at least 4 times more than that which is almost now brimming over the edges of the US's current storage capacity.

The truth is that the capital invested to drill those 5,000 wells is now locked in the ground and the debt that funded it from the printing press of the US Federal Reserve bank has totally mispriced the market risk. This capital/debt needs to be serviced and if they don't make a decision to stimulate the wells they will not be able to service the debt and the operators of those wells will join a rapidly increasing number of shale oil companies joining the end of the debt default queue.

The conventional wells of the Saudis can be cycled (turned on and off and on again) whereas the stimulated shale well will lose about 50% of its productivity if it is cycled. So the Saudis have it all over the shale industry in any price war as the Saudi wells are

1) fewer (90 Saudi wells per 2,500 shale wells for the same level of production)

2) already paid for from oil profits stretching back to 1938, not from an engineered central bank credit bubble which will pop soon enough.

Also the shale oil owner of one of those 5,000 wells does not know the productivity of his well with any complete degree of certainty until the second part of the well is completed and it is stimulated. It is only then that they can start trying to estimate the return on capital on that well. So in a fully blown price war over oil the US shale operators are sitting on a time bomb of their own making with all these idle wells just sitting there and the debt repayment clock ticking faster and faster. If they pull the trigger on their 5,000 wells their storage tanks will over flow, the price of oil will fall and any hope for those oil wells to become economic and able to service the debt that created them will disappear. Meanwhile the Saudis could at any time open the spigot sending a flood of oil into the world and blow up the shale oil/gas junk bond/debt market for good. The reason they don't do this is not economic, they are just very wary of antagonising their so called allies and the most powerful military in the world.

I have posted before on the widening spread that exists between junk bonds in the US and investment grade bonds and below is a short piece from one of my favourite Wall St watchers and critics Pam Martens.

http://wallstreetonparade.com/2015/08/keep-your-eye-on-junk-bonds-theyre-starting-to-behave-like-08/

Access to the massive junk bond market mentioned in the article above has been packaged up through the proliferation of bond mutual funds and exchange-traded funds (ETFs) in the US, which provide synthetic (derivative) products to retail investors whereby they can supposedly trade the underlying bond markets. The fear is that mutual funds and ETFs appear to offer greater liquidity than the markets in which they transact and there is significant potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions. I don't have the exact statistics but I recall reading an article last year that said that about 20% of the US junk bond market is related to shale oil fracking companies.

The above article written by the shale oil cheerleaders (from memory) claims that about 60% of the sunk cost of each well comes from the stimulation process so about 40% of the cost is in the spudding. With potentially 5,000 wells being spudded but not triggered because the oil has no where to go, one could probably estimate the very large amounts of sunk capital which is laying idle and giving no return to the bond holders. What's more come September after Obama uses his veto to lift the sanctions on Iranian oil the oil price might fall further (if the market hasn't already completely factored that in) which will mean that those spudded but not stimulated wells might need to lay idle for a lot longer because when the operators of those wells run their numbers on the expected rates of return on those wells they might find that their returns are now turning out to be negative. A possible corollary of this confluence of events might be that the spreads in the shale junk bond market continue to widen to a point that come a day that the accelerating number of redemption requests from the overlying derivative market are not met by counter parties on the buy side holding cheques in their hands in the underlying market that the resultant mass liquidity squeeze in such a large segment of the US junk bond market has a flow on effect which could become the catalyst for a fully blown US market meltdown.

Just idle speculation but watch this space and look out if you see the big names like Vanguard, PIMCO, American Funds or BlackRock get the wobbles and come up in the news around April of next year. Bond ETF's are a source of risk in the US markets.

Eshmun