Oil drop hits hedge funds and threatens shale producers

These are the best of times and the worst of times for U.S. energy producers. While U.S. oil production is breaking records, the recent unraveling of global oil prices threatens to break some U.S. energy producers and oil’s big money investors.

Now you would think that with near record demand in the U.S. and record crude imports into China, U.S. shale producers would be printing money. Yet the realty is a bit more complex and it has the potential to derail the progress of America’s energy revolution.

Part of the problem is that the price of oil is out of step with traditional market fundamentals. Oil got hit after President Donald Trump backtracked on his hardline ban of all Iranian oil exports. By granting waivers to Iran’s biggest buyers, he set off a wave of selling that has accelerated as geopolitical risk factors and wildly shifting waves of volatility caused massive liquidation from hedge funds and traditional hedgers. U.S. crude is hovering around the $53 per barrel level.

An estimated 174 hedge funds were liquidated in the third quarter globally, according to Hedge Fund Research. This unwinding added more selling pressure to the price of crude, distorting prices and perhaps sending a signal to the market that the world has more supply than it actually has. 

Plain vanilla commodity traders are also on edge as sentiment could change after any Presidential tweet. This comes as the International Energy Agency says very clearly that the volatility in prices is not in the interests of producers or consumers.

That is a real concern because the International Energy Agency (IEA) reports the global oil market could see a supply deficit sooner than people think, raising the specter of a damaging oil price spike that could drive weaker economies into a recession. The crash in prices forced OPEC into production cuts and along with cuts from Russia and Canada could leave the oil market short next year.

Yet U.S. oil producers may not have the luxury to wait that long. The falling prices may force many producers to cut back. U.S. shale producers of course have been the wonder of the world, using American ingenuity, along with spit and grit to lead the U.S. to become the biggest oil producer in the world. The IEA says that dominance is going to continue unless oil prices crash again.

The risk is that U.S. shale producers are being looked to carry the load as far as raising output to meet growing global demand. Many shale producers need prices above $60 a barrel to make money and expand production.

In fact, the world had better hope that they stay high enough for U.S. shale, as based on future demand expectations, we will need that oil.  Yet out of the top 20 U.S. oil companies that focus mostly on fracking, only five managed to generate more cash than they spent in the first quarter, according to a Wall Street Journal analysis of FactSet data. The top 20 companies by market capitalization collectively spent almost $2 billion more in the quarter than they took in from operations, largely due to bad bets hedging crude prices, as well as transportation bottlenecks, and labor and material shortages that raised costs. Many of the producers did better to start this year than at any point since 2014, when oil prices began a crash that the industry is still recovering from, and now we have another crash.

For shale it’s the best of times, it is the worst of times.