What is OPEC Doing? Shale Producers will Get Decimated

OPEC left production the same. They made no reduction to output, and while it was a rather contentious decision, the damage is done. There is a supply overload and even worse, we could now see a series of debt defaults among U.S. shale oil producers.

The oil cartel, known as the 12 member OPEC, decided to leave its output target at 30 million barrels per day. The price of U.S. crude oil imploded by nearly $6 dollars per barrel to $67.75 in early trading today. This is its lowest price level since May 2010.

This could very well see the risk rising for bankruptcies in the U.S. shale oil industry as companies will have problems paying back debt. While production is strong in the U.S. and North America, the debt situation for companies is not good. There is a lot of distressed debt now and it will get worse.

The price of $68 dollars is not profitable for these oil wells. The spread between debt and price is beginning to soar higher. At these price levels, we will begin to see some defaults and even some bankruptcy situations. Since 2011 companies have poured $1.5 trillion into increasing shale oil operations. They have taken on a huge debt burden and this debt makes up 15 percent of the U.S. junk bond market. It was under five percent a decade back.

Small companies are leveraged up to their necks to fund exploration and production. Margins are now being squeezed tighter and making their ability to pay back debt hard to impossible. These companies, better known as “upstream operations” have way too much capital sunk into production and the cost to set these operations up will, in all likelihood never be recovered. The lower oil prices go, the worse off they will be.

OPEC has a goal to clean up the American marginal market by 2016. Once this is done, oil prices will go back up. The shale oil boom is no longer sustainable. This is like a genetic battle with only the strong surviving.

Not very nice, but it is reality.

In all reality now, $50 per barrel by mid-2015 is not out of the question. This will make high leveraged shale companies an even bigger risk and cause even more bankruptcies. Could this cause another doomsday scenario like what we saw when the U.S. banks collapsed in 2008? Not likely but worth watching.