Oil is on a course to test its $42 lows from March, as I’ve said it would. And the way it’s been falling lately, I wouldn’t be surprised if it happens in the next couple of weeks.
There are several ramifications to this. In the long-term it will devastate the global economy as shrinking demand wipes out oil players and oil jobs around the world. But in the short-term it will affect the US, possibly more than any other country – striking a death blow to the fracking industry, specifically because it’s become such a staple of our bubble economy and recovery.
Many are quick to think that since oil bounced back in recent months, it will do so again. We did say it would bounce, and it did just that – bouncing back to $63, right in our target range of $62 to $74.
But I don’t expect it to bounce for long this time around. And John Kilduff from Again Capital, who will be speaking at our Irrational Economic Summit in Vancouver September 10 to 12, shares our view. That’s because the world is quickly becoming a different place. The bubble euphoria investors have enjoyed since 2008 is showing several signs that it cannot continue.
And since the fracking industry is one of the highest cost producers and nothing more than a mirage created by QE economics, it might well be one of the triggers for what could become the greatest crash of our lifetime.
Fracking had been around for awhile before it really took off in the last decade. Its large upfront costs had made it impossible for it to become a leading player in the oil industry.
But the zero-interest rate policies launched by the Fed and other central banks suddenly caused junk bonds to drop to more affordable levels. Yields that were once 10% fell to 5.5%. So the frackers swooped in, jolting their industry forward like a shot of crack cocaine straight to the heart.
Along with the global economy, QE propped up the oil industry – lifting it off its 2008 low of $32 (which would’ve been much lower if QE hadn’t come into the picture) to the early 2011 high of $115. Fracking could exist in that environment. At today’s prices, it can’t.
I don’t know how else to say it – without QE, it’s a mirage. An illusion. Totally artificial! And like the trillions that are about to disappear from the world, it’s like magic. Now you see it, now you don’t. The way oil prices are falling – and the way the global economy is displaying greater signs of weakness – you can bet that fracking is doomed! Its breakeven cost is around $65 – and between $55 and $80 for most producers.
That’s to say nothing of profits and long-term sustainability as a business! With oil below $42, frackers have no hope—and a mountain of debt they can’t repay.
Beyond that, there are two key reasons oil will not return to the more profitable mark of $80-plus for at least a decade. Kilduff and I agree here as well.
There is no government or central bank supporting the fall of oil like they are stocks and bonds. Saudi Arabia, the largest producer which also pumps oil the cheapest, is hell-bent on wiping out its competition by churning out more and more oil to feed the supply glut.
They will stop at nothing to achieve this – and since they don’t see the huge falloff in demand ahead that we see globally, the Saudis will keep pumping even at the expense of their own government budget.
The other reason is that when all this global stimulus starts to unravel, demand for oil will fall at an unexpected rate. We’re talking $30 by Christmas time. I’ve been saying $32 by late January, but John is the ultimate expert in this sector.
That said, it’s very possible and likely that oil could bounce after touching a $30 to $32 bottom in the months ahead—once fracking stops adding to the supply glut.
You’d be surprised just how big a contributor this industry has been to this bloated oversupply in oil. Just look at how many rigs belong to fracking or “horizontal” drilling:
That should make it very clear that the death of fracking will wipe away most of the oil supply and return it to more ordinary levels. And it will crush the American energy industry.
But the larger issue is what follows: a greater global slowdown that’ll unfold in the latter part of this decade. That will absolutely crucify global demand for oil.