DANIELLE DIMARTINO BOOTH: When you put WTI, West Texas Intermediate crude oil on a chart, and you pit that against the Fed's balance sheet, they literally track one another up to this day.
I think that that connection starts to come undone in the coming years. I don't think that that's probably well appreciate it right now.
TRACY SHUCHART: We've been in a $50 to $60 range for this entire year. These guys are really making money at those prices even if you're still not making money. Eventually, this money is going to dry up, and it's already starting to dry up.
ED HARRISON: Hi, I'm Ed Harrison for Real Vision. We're going to have a discussion today about monetary policy and energy markets and the intersection between those two and we have two experts here with me to talk about that. We have Danielle DiMartino Booth, who is our monetary expert. We also have Tracy Shuchart, who is our oil expert. I got that one right in terms of the name.
Now, let us start off going back to the great financial crisis. I'm going to let you guys lead the discussion, but I want to start out there because I think that's where a lot of this stuff happened where this intersection came to play, because we had the Fed going to zero rates in 2008. It was off to the races after that in the energy sector here in the United States. Danielle, talk to me about the chart that you were just talking to me about offline.
DANIELLE DIMARTINO BOOTH: It's interesting. Sometimes, you sense that there are relationships and sometimes, you see that there are relationships. When you put WTI, West Texas Intermediate crude oil on a chart and you pit that against the Fed's balance sheet, they literally track one another up to this day. It's just fascinating to me that we wouldn't have made the leaps and bounds we have, we wouldn't have had a revolutionary shale revolution had it not been for all of the easy money flowing that started in December 2008 when the Fed lowered interest rates to the zero bound, and started its quantitative easing policy and growing its balance sheet that in turn, ended up funding all manner of investment in this burgeoning industry that Tracy can speak to much better than I can, given shale got it foundings in 2008. Tracy, you tell me, I think it was that easy money that really, really got things going.
TRACY SHUCHART: Yeah, absolutely. Shale revolution, the gas revolution actually started in 2005. They didn't really take off until after the Great Financial Crisis and we had all this easy money, and they were just throwing money at the shale industry. At that time, we had seen oil prices go from $33 all the way up to $115. That's really when, in 2010, that's really when all the money started funneling to shale and the shale revolution, revival revolution I should say, really began in 2011. That's really when we started to see production and whatnot increase.
ED HARRISON: When I think about that, what you're saying is I think about in terms of the reach for you, because when you had zero rates, and the Fed come in there with QE, basically people were like, we need some yield, we can get it in the shale patch.
TRACY SHUCHART: Yeah, absolutely. That's when we saw a bunch of high yield bond issuance. When I come online, if you look at-- I think we have a chart. If you look, you can literally see it explode. Then as recently after 2016, that's gone downhill, but you can really see exactly when that happened when you look at it on a chart.
DANIELLE DIMARTINO BOOTH: Yeah, had it not been I think for easy money policy, you would certainly not have seen the level of high yield bond issuance. In addition to that, and this is present to this day, you wouldn't have seen private equity absolutely swarm this sector, which was a good thing. You know me, Ed, it's very unusual for me to say that there was a silver lining to easy monetary policy, but I think that-- let me put it this way, I think OPEC would characterize it much differently.
It certainly wasn't a silver lining for OPEC, but it has really accelerated what's happened in the oil patch to an extent that I don't think anybody can quantify had it not been for the Fed launching its unconventional monetary policy. I'd love to hear Tracy take us through the OPEC backfire, because I think that that's really a fascinating aspect of this whole evolution.
ED HARRISON: Actually, let me go back a little bit further because I want to know that period from 2008 to 2014 when the Saudis and OPEC were like, let's go hog wild here, and crush these shale guys. What happened in that period? What were the market dynamics that led up to OPEC getting in there and trying to really lower the boom?
DANIELLE DIMARTINO BOOTH: Tracy, help us out here. Before we jump into answering that question, tell us where US oil production was on a global level before all this got started.
TRACY SHUCHART: Globally, we were far behind actually back in the '70s. We were producing a lot of oil and then that came down, it was the conventional oil and our oil production was flat for a lot of years there.
ED HARRISON: Yeah. When you say flat, what about demand versus supply? What was the differential between those two?
TRACY SHUCHART: We were importing, you have to remember at that time, we were not exporting oil until 2015. We were strictly an importer and using what we produce. That dynamic completely changed the industry within itself when we became an exporter.
DANIELLE DIMARTINO BOOTH: Going back, I think that we have to remember how very dependent we were on OPEC, and on importing oil and how the refinery capacity that we have to this day that was built out was built on the premise that we would remain an importer. I think back before this whole easy monetary policy imposed itself and created the show revolution, I think we were not even 5% of global oil production.
TRACY SHUCHART: Not even, not even. Really, that's when we started. The oil crisis in the '70s is exactly why we started in SBR, too. We were never really expecting an explosion to what we have to say at all.
ED HARRISON: The way I remember it is people were talking about peak oil, because remember when you were talking about that hundred and some dollars, 115 bucks, people are talking peak oil, but that peak conventional oil, people weren't really thinking about shale production.
DANIELLE DIMARTINO BOOTH: They were thinking about offshore drilling. One of the best ways that I ever had shale explained to me in layman's terms was think about what an offshore rig is, you're going straight down and pulling oil out of one spot, whereas with shale, you think of it as being a stack of pancakes and in each pancake, you go horizontally and pull from it. It literally exponentially, the technology itself increased the capacity of any given find.
I think that's what people really do need to understand about the process of fracking itself is how much it changed how we extract oil and really, how it made obsolete the whole notion of peak oil. There's been other technology, you're going to correct me if I'm wrong, that has shown that the shale actually reproduces itself, it revitalizes itself in time.
TRACY SHUCHART: Well, and on top of that, it's cheaper and it's faster to earn. Sorry, it's not cheaper, it's faster to extract when you talk about these mega projects, these offshore oil drills, you're talking four to seven years just to be able to get some oil out of the ground. With shale, you can do that much, much more quickly.
ED HARRISON: Yeah. As you were saying that, the first thing that came to mind-- there are two things that came to mind. One is technology. People talk about technology, and when you think about all the technology stocks and so forth, that's what draws people to shale. The second thing that I thought about--
DANIELLE DIMARTINO BOOTH: It was disruptive before Uber.
ED HARRISON: Right. The interesting bit though is if you think about it from an Austrian School perspective, Austrian School of Economics, where the long lead times that you have for things to come around, when you have prices really low, the price of money is really low, suddenly, people are like, wait a minute, these whiz bang technology things, they're an amazing thing. That's essentially what was going on in the oil space.
DANIELLE DIMARTINO BOOTH: It was and Tracy probably remembers that November OPEC meeting in Vienna better than I do. What I found fascinating in doing research for the report we're going to put up is that in 2014, as OPEC was considering their next move, because oil prices have gone from 107 to that November meeting, they were around $70. It was a dramatic decline in a very short space of time. At the time, the United States was just producing 5% of global oil production. I think OPEC was of the mind, you know what, they're so small, this is such small potatoes that we can shut them down, and they opted at that meeting to do what, Tracy?
TRACY SHUCHART: To do nothing. They opted to not cut and that subsequently, we obviously saw the price of oil go from $75 to February of 2016, we were at $26.
DANIELLE DIMARTINO BOOTH: That was a huge gambit that did not pay off. I think it also completely changed the dynamic of OPEC holding the keys to and being the arbiter of where global oil prices are.
TRACY SHUCHART: Absolutely.
ED HARRISON: Let me interject something here because I think there's a certain tension between the concept that this technology will save us and the potential that maybe actually it's not enough because when we talk about 5%, and maybe even 10% when we, Americans are guzzling gas like crazy. Tracy, help me out, is it likely over the longer term that we actually are going to be oil-- are we going to be independent?
TRACY SHUCHART: I think it is a tremendous feat that the United States has now-- we've reached this milestone October-November where we are exporting more than we are importing. However, when you logistically look at this, United States consumes 20.5 million barrels a day. A day and we produce 12.8, and that's including the lower 48 in Alaska. We have a differential there that has to be made up somewhere. Also, not to be a downer, but if you look at our just crude oil, we actually still are importing more than we are exporting. If you look at crude oil plus products, then we've hit that mark. We're at a deficit of between October and November, a deficit of about 62,000. It's exciting, but.
DANIELLE DIMARTINO BOOTH: Yep. In fact, Tracy was the first one to come out on Twitter when somebody put out this explosive, look, the United States is energy independent. She's like, wah, wah, actually.
ED HARRISON: Actually, I want to go a little bit more into the energy independence for a second here because I was talking-- I think I was telling you this. I was talking to a guy who's an expert in foreign policy, Alan Tonelson. He's an America firster, and he was talking about energy independence. It was almost like it was an assumption that we're going to become energy independent. In the back of my mind, I was thinking to myself, is that really true? Can America become energy independent? What are the obstacles to that independence? What's going on there? What do you think?
TRACY SHUCHART: The fact that we have global oil flows, this enables traders and users, refiners, petrochemical companies, to source the oil that they need from all over the globe. Another reason that we are not necessarily energy independent, because we have a global marketplace. It's on a global forum. To bring that-- we can't bring it all in house and it would be detrimental to the industry and into all of these companies to not be a part of this global flow.
ED HARRISON: Global supply chain, if you will.
TRACY SHUCHART: You would have to completely change every supply chain just to become energy independent.
DANIELLE DIMARTINO BOOTH: I think it comes down to the refineries we've built, how much does it cost to build a refinery? Billions of dollars.
ED HARRISON: Who's going to want a refinery in their backyard? When was the last time a refinery was built in the United States?
TRACY SHUCHART: Years ago. The thing is these refineries are already tools to refine a mix of light and heavy crude. Because we were refining what we had what we've produced and we were importing all this heavy crude from the Middle East, from Canada, from Mexico. Changing your lens and whatnot, and retooling your refineries is also another huge, costly expense. They're just not, especially now that nobody wants to pour money into that at this point.
DANIELLE DIMARTINO BOOTH: Yeah, I think the Accounting 101 tells us that the depreciation schedules for refineries stretch past a decade in time. You're talking about a massive investment here in infrastructure when it's hard to see what's going to happen the next year, when you've got central banks all around the world effectively discouraging capital investment. I think that goes across all industries at this point.
ED HARRISON: When you say discourage capital investment, immediately, it made me think back to Tracy's, what she had to say earlier about capital investment when I was talking to her in the green room, that essentially the scenario that you are talking about playing out is anti-CapEx for the oil patch going forward as well. Is that right?
TRACY SHUCHART: Well, it is that's what we're really seeing after the 2016 crash, we've really never recovered as far as CapEx is concerned. We have seen oil production increase, but we haven't seen capital expenditure increase. All you've been hearing from these companies the last couple years is they want to be conservative, they want free cash flow, investors want to see dividends, they don't want to see spending right now, investors do not want to see spending. If you look at the oil industry, it's gone from 20% of S&P 500 to 4.5% in weighting. This is an industry right now that people aren't really interested in so companies are doing whatever they can to gain investor confidence and tried to see money pulled back into this industry.
ED HARRISON: I got the impression though that somehow, that 2015-2016 wasn't a wipeout, but it sounds almost like they're just rolling over the debt and they're like hey, make sure that you meet our requirements.
DANIELLE DIMARTINO BOOTH: Look, there was a lot of excitement in 2015 and 2016, and this is where private equity reenters the picture. There's been a tremendous amount of fundraising. Right now, we're sitting on $2.47 trillion worth of dry powder on deployed capital worldwide, and that situation has been really increasing and intensity and existed-- that dynamic existed in 2016. Private equity that's been starved for truly distressed investments, because that's what they're supposed to do, they're the barbarians at the gate. They're supposed to be the ones who go in and poach things at fire sale prices.
I think there was a lot of excitement in New York road with these firms that were sitting on billions and billions of dollars. They saw what was going on in the Permian, they saw what was going on in Bakken, and they said, you know what, let's be energy investors. They just they switched hats, they put one on to the other. I like to think of the old oil veterans in Texas, sitting back and shaking their heads and saying, what are these city slickers doing throwing all of this money at this sector they have no idea the true economics of what they're doing. They're throwing good money after bad. There was a ton of excitement on Wall Street, but the economics we're finding out now in the second wave of high yield energy defaults, the economics didn't make sense at the time.
ED HARRISON: I want to explore a little bit more on the credit side there when you say that because I saw a chart that you put out, it was showing the difference between BB and BBB credits in terms of the option adjusted spread, BB and CCC. What I noticed is that there was a divergence maybe starting in 2018. Is that an energy specific divergence, or what's going on there?
DANIELLE DIMARTINO BOOTH: Boy, I'm going to get some hate mail on this one. Actually, I just got the data today. If you look at the portion of the high yield market that is trading what would be considered to be distressed, less than 90 cents on the dollar, only 26% of that part of the CCC universe, if you will, at only 26% of it is oil. The rest of what's trading south of 90 cents on the dollar is in other industries. This is I think the second or third hottest topic right now on Twitter, is this continuous focus on it's only an energy problem. It's only an energy problem.
Well, energy is certainly a big part of it, but it's not the whole story and it's extremely rare broadening out the picture that you've seen the persistence of this divergence between CCCs and the next rung up on the higher ladder, BBs.
ED HARRISON: When Daniel was talking, I thought, okay, so this is potentially end of cycle stuff that we're talking about, not just something that's happened in the oil patch. The big question for me comes, what's happened now that these oil companies went through their crisis in 2015 and '16 and got their breakevens down? Where's that going to go? Is shale viable in that environment?
TRACY SHUCHART: Well, although we did bring breakeven zone, when shale first begin, we started at about $80. Now, depending on-- and you can't really say it's one price because it absolutely depends on what basin it's in and the well--
DANIELLE DIMARTINO BOOTH: Correct me, I