Gold News

From Lehmans to Fracking

The biggest financial change since 2008...

I WANT to move away from the "ten years on" coverage, writes MoneyWeek's executive editor John Stepek in his free daily investment email Money Morning.

I'm not promising I won't return to it. In fact, I'll probably start taking a weekly Friday look at comparable financial crises and the experience of other countries (such as Iceland) to see what we can learn (and what we haven't learned) from 2008.

But for now, let's move onto something more contemporary.

One of the most interesting and dramatic economic changes over the past ten years has occurred in a sector that is almost the diametric opposite of the financial sector.

We're talking about the business of real stuff. We're talking ten-gallon hats and cowboy boots, not three-piece suits and hipster beards.

We're talking about oil.

In 1970, US oil production hit a peak of 9.6 million barrels of oil a day.

From that high point, it declined. It didn't fall in a straight line, not quite. It rose between 1976 and 1985, to hit a secondary peak of just under nine million barrels a day. But from there, it was basically in free fall.

And that slide didn't stop for over 20 years (this data is all from the Energy Information Administration (EIA), a US government agency, in case you're wondering).

This is one reason that fears of "peak oil" took such a powerful hold in the mid-2000s. The main proponent of the theory – M.King Hubbert – had successfully predicted the peak in US oil production. And it increasingly looked as if he'd be right about everywhere else too, particularly as no one really knew how much oil the Opec cartel really had.

Oil prices spent most of the 2000s hitting records we'd never seen before (I'm barely middle-aged – ahem – but I'm already old enough to remember when $40 a barrel of crude was shockingly high, not stunningly low).

The idea that we were going to run out of oil went from being a fringe concern that united both hardcore small-government libertarian survivalists and left-leaning eco-anarchists, to being the sort of thing that analysts would happily toss out to justify their forecasts on CNBC of a morning.

In 2008, US oil production hit rock bottom. America was pumping out five million barrels of oil a day (this was partly due to the impact of the financial crisis – production basically was consistently low between 2005 and 2008).

But that changed dramatically. It took the United States 38 years to go from pumping out 9.6 million barrels to pumping out five million. It took less than a decade to jump back up above the nine million mark.

And this year, the US has surpassed its old peak. It's now pumping out more than 10.5 million barrels a day. It is now, according to the EIA, the largest crude oil producer in the world.

What happened? Two things. Oil prices soared, and markets did their thing. Because oil became so expensive, it meant you could spend more on trying to get the stuff out of the ground.

As a result, fracking – one of many "unconventional" oil sources – became worth doing. The US was already using it to produce natural gas, but the idea of extending the technique to oil seemed difficult.

When I first read about it in the early 2000s, the idea of fracking for oil appeared to be one of those "maybe in 20 years' time" technologies.

Turns out it was easier and more worthwhile than they thought. And over time, a combination of improving technology and better-than-expected oil fields meant that the price of production fell.

And thankfully, the oil price remained high enough to justify the interest in fracking. Although the price of oil collapsed after the financial crisis very briefly, it had a spectacular rebound and spent most of the period between the crisis and 2014 above $100 a barrel.

The other factor that kept fracking going, of course, was low interest rates. In 2015, when oil prices collapsed, oil production in the US dipped too – not by a lot, but it broke the breathless run of increasing production to that point.

Opec tried to break the frackers. With their low cost of production, the Saudis could technically afford to hold out at a lower oil price than the fracking companies. The big scare in 2015 (as well as concerns over a slowing China) was that, as a result, the debt of fracking companies would turn bad and batter markets.

But at low interest rates, the fracking companies could afford to roll over their debt. They could afford to borrow more. They could take each other over. And they could avoid going bankrupt.

Eventually, Opec called it a day first. And now the oil price (as measured by the Brent crude benchmark) is challenging the $80 a barrel level again.

This is an extraordinary shift in the balance of global power. The US is effectively energy independent. It still imports oil, but that's down to the way the market works – if it was shut off in another 1970s embargo, say, the impact would be far less important than it was back then.

This is also another factor behind the strong US Dollar story, incidentally.

If the US is importing less oil, then that means it's exporting fewer Dollars too. In effect, the US Dollar is becoming a petrocurrency – one that strengthens when oil does.

So what's next? It's hard to see scope for an oil-price crash any time soon. I don't know that it'll go a lot higher (the politics of higher oil prices would not be welcomed by US president Donald Trump ahead of the mid-term elections, so at the very least, he'd probably send some market-rattling tweets about it).

But I think you're safe to hang on to your oil stocks for a while longer.

Launched alongside the UK's highly popular The Week digest of global and national news in 2001, MoneyWeek magazine mixes a concise reading of the latest financial events with expert comment and investment ideas.

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