Tuesday, 16 December 2014

Frack meet ZIRP

Near Zero Interest Rates favour risk over thrift and puff up stocks.  They put at hazard an industry undergoing capital intensive expansion which became dependent on low rates of interest and high prices per barrel of oil.  Zero Hedge, in self-congratulatory fashion, makes this point well about fracking.  The fracked wells take a lot of capital and are spritzed up for just a couple years during which time the money must be recovered.   A reversion to the mean for interest rates to give savers a premium for taking on risk will send a shock through the fracking industry which, coupled with the drop in world prices for oil, will stall out the industry for a few years.

From the source article at Zero Hedge:

"ZIRP destroyed the most fundamental index in the financial universe: the true cost of borrowing money. ...  It also destroyed the entire relationship between borrowed money and the cost-structure of the endeavors it was borrowed for. Take shale oil, for instance.  The fundamental limiting factor for shale oil was that the wells were only good for about two years, and then they were pretty much shot. So, if you were in that business, and held a bunch of leases, you had to constantly drill and re-drill and then drill some more just to keep production up. The drilling cost between $6 and $12-million per well.   .... In a few short years they drilled to beat the band and the results seemed so impressive that investment money poured into the sector like honey, so they drilled some more. It was going to save the American way of life. We were going to be “energy independent,” ...They goosed so much oil out of the ground in a short period of time that they killed the goose — demand for oil at a price that made it worth drilling for. Now, much of the junk financing will default, and the result of that is no more junk financing for a long, long time, meaning that a lot of planned wells will not be drilled and completed, meaning that the current crop of short-lived wells will crap out in the 24 months ahead, and production will not be replaced by new wells".

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