Kunstler’s predictions for 2016: Oil and Deflation

  • Published on January 6th, 2016

By James Howard Kunstler

(You can find the introduction to this series here, and read part 1: Banking and Markets, here.)

The oil picture has bamboozled both the broad public and the smaller cohort of supposedly big_oil_influencesentient observers.

I maintain that the deflationary contraction underway worldwide is largely due to the fact that the world has run out of a particular form of oil: affordable oil. Turns out the peak oil story is still true, just playing out differently than a lot folks predicted. We’re at the mercy of a pretty basic equation:

  • oil over $75-a-barrel destroys industrial economies
  • oil under $75-a-barrel destroys oil companies.

There is no “just right” Goldilocks place on the gradient.

The public got bamboozled by the Ponzi scheme of shale oil. It seemed like a fabulous techno-rescue: the “fracking miracle!” It operated by converting mountains of cheap leveraged capital into a very rapid bump-up in US oil production.

It got full traction after a couple of years of $100 oil squashed economic activity — and then squashed demand for oil. Whoops. The problem was that shale oil was very expensive to produce even if reduced demand drove the market price very low.

Back at $100-plus a barrel, hardly anyone made any profit on shale. At $40 a barrel shale was a laughable loser. So, in 2015, the shale oil companies laid off thousands of workers, idled the drilling rigs, and kicked back to pray that the price would go back up. Which it didn’t.

Incidentally, all kinds of associated ventures went bust with that. The landscape of North Dakota is littered with unfinished garden apartment complexes that may never be completed, and the discharged construction carpenters and roofers drove back to Minnesota ahead of the re-po men coming for their Ford F-110s. Sad, I know….

The rapid ramp-up in shale oil production from 2010 to 2014 was intended as a demonstration project to convince Wall Street to stuff ever more investment capital into oil companies. It was also part of an enormous PR campaign to allow the people running things in business and government to pretend that America’s oil problems were behind us.

The “shale miracle” was going to make us “Saudi America,” It was going to boost us into “energy independence.” It played into the Master Wish beneath all the wishful thinking in America: Please, God, let us be able to drive to WalMart forever. It wasn’t so much an evil conspiracy as a feckless collective effort in denial and self-delusion

It happened that a lot of that Wall Street finance came in the form of high-yield (junk) bonds issued by the oil companies — with fat commissions for the big banks to cream off in creating the bonds. So when the price of oil crashed below $50, a lot of oil companies — especially the smaller ones with no cash flow — couldn’t service the interest payments.

What lies ahead in 2016 is a debacle of bond defaults and corporate bankruptcies in the US oil patches.

What’s more, because of the peculiar geology of shale oil and the rapid depletion of the fracked wells, it is necessary to incessantly drill and frack new wells to keep production even level, let alone rising. That calls for evermore rounds of new financing.

But since the current financial obligations can’t be serviced, new financing will not be forthcoming. And so neither will additional production. All of which means that shale oil production is going to crash in 2016 when the backlog of previously-drilled but untapped wells runs out.

I’ll predict that US oil production will go down a million barrels a day before 2017. That includes the roughly 5 percent annual decline of conventional oil.

Some might suppose that such a crash would drive prices back up again as the supply necks down. There are a couple of problems with that supposition.

One is that the previous round of $100-plus oil did a lot of permanent damage to the economy, in particular to small businesses and households (i.e. middle-class workers). That damage looks more and more permanent, meaning a smaller aggregate economy and still-shrinking demand base as businesses and citizens go broke and stay broke.

If oil prices do return to a level that would justify exploration and production of expensive, hard-to-get oil, (probably north of $110) it will only crash industrial economies again — and there are only so many times this can happen before the system is so damaged recovery is no longer possible.

Another problem is that the oil price crash has done significant damage to the oil industry itself, including its credibility as a viable target for investment.

Contrary to hopes and expectations, current low oil prices are doing nothing to re-stimulate economic activity. It all has the look of a self-reinforcing feedback loop, a downward spiral in a global complex networked system getting clobbered by the diminishing returns of its principal activities.

Hence I would predict that the price of oil will fall further in 2016, below the $30 mark, and that it will lead to more carnage in the oil industry, in banking and debt defaults, and to new manifestations of geopolitical trouble that could lead to profound oil scarcities and rationing.

We can’t seem to face the fact that our techno-industrial paradigm was designed to run on cheap oil, which is just no longer available.

Return to part 1, Banking and Markets,  or continue to part 3, Geopolitical Clusterfuck, part 4, Election 2016, or part 5, Climate Change.

 

About the Author

James Howard Kunstler has been writing about peak oil and the destruction of American civil society since the 1990s. He is the author of The Long Emergency, Too Much Magic, The Geography of Nowhere, the World Made By Hand novels, and more than a dozen other books. He lives in Washington County, New York.