Plunging Crude Prices: Audience Q&A

February 11, 2015

Julie Stackhouse moderates this question and answer session with Mine Kuban Yücel; Michael Plante, senior economist at the Federal Reserve Bank of Dallas: and Alejandro Badel, economist at the Federal Reserve Bank of St. Louis.


Julie Stackhouse: So as I indicated we will reconvene and let me just quickly introduce those members of our panel. Of course you've met Mine. To Mine's left is Alejandro Badel. He's a senior economist here at the Federal Reserve Bank of St. Louis. In other words he's fair games. You can really ask him anything you want. And then also Mike Plante and Mike is an economist at the Federal Reserve Bank of Dallas who works with Mine and co-author of the study. So let's go ahead and I'll move over here. And let's see if you have any questions. Yes, sir.

Question: I know you can't get in the head of the Saudi Arabians but are they trying to put the U.S. shale oil out of business or are they trying to put Iran out of business or are they trying to put Russia out business?

Mine Kuban Yucel: It's all of the above [laughs]. Yeah, I think so. I mean for sure Russia and Iraq, I mean Iran, and yeah, they're trying to get some of the marginal players in the U.S. out of business, the shales. You know the CEO of Exxon said—we were talking about breakeven costs. He said who knows what the breakeven is but the Saudis are sure in this game to find out. And they're trying to get those marginal guys out of the market I think. So yeah.

Julie Stackhouse: Michael, anything to add?

Michael Plante: No.

Julie Stackhouse: You know it's always good to agree with the boss, right? Yeah, okay, good. Yes, sir?

Question: Yes. In the '70s we've had these oil crises because people were saying that we're getting to peak oil. Are we—40 years later it doesn't seem like we're at peak oil? Are we anywhere close?

Mine Kuban Yucel: I don't think so. I mean technology's a great thing. And so we thought we were there. You saw how production had gone down in 2005. But with the fracking of wells began in the gas, actually, in the Barnett, and then they started using it in oil. And low and behold here we are the third largest producing country in the world. So no, I don't think we're there and I think going forward, you know, technology, something will come up and that will get a lot of the other oils out of the ground too. There was something—I can't remember the name of this deposit but in Canada they say they have found—it's very hard to get out at these prices. Obviously it's not coming out but they were talking about 600 billion barrels of reserves. So there will be some technology that's going to get that out of the ground when prices go up. So no, I don't believe in peak oil.

Michael Plante: No, I don't believe in that at least at any time in the near future, although what I'll add to what Mine said is I also like to think about the fact that since it's a market, as Mine mentioned, you know if we did start running out of stuff prices will go up. And actually we do know there's lots of garbage—that's what I call it—low-quality deposits that just require a high price. For example in Canada and Venezuela and well, in the future you may have to pay $4 or $5 a gallon for gasoline. You may not like it but there is a lot of this stuff there that if the price is right someone will try to get it out of the ground.

Alejandro Badel: So I think this gets to an interesting point that probably that probably wasn't emphasized enough before, but it's the expectations of what this potential supply if prices go up enough would be. In this case you see a higher marginal cost technologies would immediately jump in. As prices start going up the skilled labor that you need to do shale extraction would be developed in other countries besides the U.S. so you would you see that supply—if prices were to go up supply would automatically expand. So the expectation of that happening already could be pushing prices down today. So that's kind of an additional mechanism that I think should be—

Mine Kuban Yucel: Expectations. Right.

Julie Stackhouse: Sir.

Question: Two questions, both related to debt. The first is do you have any idea how many municipalities have floated debt that is highly dependent, so say over 20 percent dependent on oil revenues? I'm already starting to see some impact from that in Kern County in California a few weeks ago. And second is on the producers themselves. Do you have any idea at what price that will stop and the day we will start seeing a fall. Even though they're at less than the breakeven price I would think they'd still have to produce just to pay off their debt, which is fairly high in some circumstances. If you could honor both of those.

Mine Kuban Yucel: I'll say something and maybe Mike can add something. So I have no idea about the municipalities. I have to say so. I don't know the answer to that question. With respect to the other one, yes, we hear—again, I don't have any numbers—but we hear from talking to contacts that the smaller companies who are highly leveraged do have to produce to be able to have some cash flow even though in the long run they would not have been with these prices. But right now they have to so they're sort of hoping that the price will go up a little bit and sort of make them even, but they do have to produce because they have a lot of debt and they have to pay off that debt. But that's just anecdotal evidence. I don't have any numbers on it.

Michael Plante: We do know a lot of companies have accessed the junk bond market. But they're sort of, from what I've read there's a wide range of situations and so the guys you're going to read about are the guys who have access to the junk bond market. And the reason they access the junk bond market is because they were sort of the speculative, for lack of a better word. They're the guys basically at the place where if oil is $100 a barrel they'll make a lot of money. If it's $50 a barrel they're probably in trouble. And those will be the guys we're going to read about and the market's actually already responded to this with, you know, their high-yield bond prices for energy companies going down way, way, way lower than other companies have gone down in recent months.

Mine Kuban Yucel: You had a number about—do you remember—

Michael Plante: Yeah, I forget the number now.

Julie Stackhouse: I might also add just a comment on the banking system, which I read a lot about. And one of the things that is really interesting is post-Dodd Frank we have far more data on the large banking organizations than we ever had. They run these exercises we call capital stress tests. And to do that they submit thousands of line items of data. So in that regard we can look at the large financial institutions and pretty clearly understand what their direct exposures are. What's harder to always understand are the indirect exposures. So it's the small retailer or the hotel or those sorts of things. And I don't think any of us are losing sleep with what we see in the data. The trouble is when you get into the banking system then there are the other 6,000 small banks and any one of those could be very exposed. But we also know that doesn't create a financial crisis. It's the big ones that create a crisis in the financial system.

Mine Kuban Yucel: So again this is all anecdotal because we talk to bankers. I don't have access to any of the data that, you know, how much are there, what percent of their loans are energy loans for example. But just talking to bankers in the area, what we hear is like 10 to 20 percent. And so it could be more for the smaller banks in the small regions. It could be more but from the people that I've talked to those are the numbers that I got, all anecdotal I hate to say.

Julie Stackhouse: Sir.

Question: And a follow-on question. Best guess, especially both of you. I'm curious about your opinion. If you were private investors would you see this as an opportunity, for example, to provide mezzanine financing to some of these distressed producers, or would you not touch it with a 10-foot pole?

Julie Stackhouse: [Laughs]. Be really careful about this one.

Question: And then my second question is in your opening remarks you indicated that like last May/June when oil was over $100 you said we all thought it was going to stay over $100. What did everybody miss? What did most people miss?

Mine Kuban Yucel: So there are lots of opinions out there but we think that it was really the unexpected supply that came on the market. That's what we think. Now so there was weak demand and some people say well it was expectations, and maybe Alejandro can talk a little bit about that. But we really think it was unexpected supply that wasn't expected and it came on the market and sort of really pushed prices down. In terms of the financing, maybe I won't touch that question with a 20-foot pole. But what we see, again, I'm not answering your question right on but what we see is the larger companies are actually waiting to buy the smaller guys right now, so they have the money and what we hear anyway, the larger like the Exxons and the ConicoPhillips, they're sort of waiting and they're going to come in and buy the smaller companies who are in dire straits. So that's what we're hearing. I don't know what I would do as a private investor. You want to add something?

Michael Plante: Sure. The only thing I would add about the question about what people missed, I mean I would view this as a supply issue but it's an expectation of future supply. So given that the price of oil fell $7 a barrel on the day of the OPEC meeting, people must have expected that Saudi Arabia would respond to this kind of situation by reducing their production. And they made a very clear-out statement that they are not going to do that at this point in time. So now people are also not just revising their belief of what the supply is today but what they think the supply is going to be three months from now, six months from now, nine months from now. And so since there is a very large and liquid market for futures contracts on this stuff this will feed back of course into the price today as well. And that's additional, also in some sense supply related as well.

Julie Stackhouse: Alejandro, anything to add?

Alejandro Badel: Well I guess one could play devil's advocate and say that there may be global demand factors such as, you know, oil prices at the beginning of the 2000s were at around $25 a barrel or something like that.

Mine Kuban Yucel: When?

Alejandro Badel: 2000.

Mine Kuban Yucel: Yeah, they were. You're right.

Alejandro Badel: And then you know China started expanding the demand for commodities and some people would say that drew oil prices up with China possibly accelerating a little bit. Now it could be that that's also part of the story.

Mine Kuban Yucel: No, I'm not disputing it. For sure there's demand. But I mean I think it was more supply than demand but no, both of them are a huge factor, yes. And we talked about, you know, China, much slower now that it was and so that's a big factor. Yeah, absolutely. No, that's right.

Michael Plante: Okay, now that we're making this complicated actually, I can actually give you an additional point to your question about what people missed. So in regards to the demand side story, I mean so Mine showed this picture about what the forecasts are for GDP growth in 2015 for some of these countries. So these sort of get revised in steps and a change in one month doesn't really matter much. But you could see in the picture there's been a downward revision particularly for some of the developing countries, and that's where a lot of the source of growth has come from. So and again like I said there's a huge market for thinking about buying and selling this stuff six months from now, 12 months from now. And so when they see this, this is also going to get built into the price today because they know, well okay, Russia's going to grow a little slower. China's growing a little slower over the course of the year. And they know this and so they sort of say okay, well I better cut back what I think the price should be in the future and that will feed back onto the price today as well.

Mine Kuban Yucel: Okay. Way in back there.

Question: Would the Keystone Pipeline have any effect on the U.S. economy if it were to pass and not get vetoed?

Mine Kuban Yucel: Well, so yeah. I mean so here's what I think the effect of Keystone would be. So we have plenty of oil down here. So what Keystone would do is depress the prices in like the mid-U.S. even further. But there is something that Keystone would do positively, which is I showed you the—well I didn't show you that but I talked about how the refinery mix was, we were importing a lot of heavy crudes and now we have all this light crude that's coming on the market and we can't really handle it efficiently. The stuff that's coming down from Canada is heavy crude. So that would sort of make those refineries maybe get more of the heavy crude into those refineries and would make them a little bit more efficient. We have a lot of refinery expansions now so with that coming down, that refinery allocation between heavy and light would be a little bit more balanced. But I don't think we're going to see that. Do you think we're seeing Keystone come down?

Question: Again my question is if it would pass, the effect on the economy—would it be a boon or—

Mine Kuban Yucel: Oh, you mean would it add? You know some construction jobs, yes, but how big is that? I mean it's pretty local so in that sense I don't think that's going to be much. But it would lower the prices of the Midwestern crudes if they can't get out. But the positive would be the refineries would be more efficiently allocated. But I mean in terms of jobs, no, I don't really think so. I mean it's not a huge thing.

Julie Stackhouse: Sir, way in back in the green shirt.

Question: Yes. Growing up we always thought OPEC set the prices of oil. So why is Saudi Arabia all of a sudden acting, you know, on their own? Is this OPEC disbanded or what?

Mine Kuban Yucel: Well I'll start it and Mike can add if you want. Well, so Saudi Arabia has acted on its own for quite a while, not just now. Saudi Arabia was always the swing producer so to speak. So they always either came into cut or came in to add sort of to balance the market to have OPEC work. But right now what they're doing is they're trying to keep their market share, protect their market share. So that's why they're not producing. They're not cutting back on their production. But Saudi Arabia is the one and only country and has been for a long while with excess capacity, so they've been the swing producer since the '80s really.

Michael Plante: Yeah, I'll also add that they and several other countries in the Arab Gulf are one of the few countries in the OPEC group that actually saved some money during the last 10 to 15 years. And as a result they are the only ones who can, in my opinion—so this is just me—they're the only ones who can really afford to cut back. Well they can afford to cut back production but they can also afford to choose not to cut back production whereas the rest of these guys like Venezuela, there's no way they can cut back production. It's not credible. They need every dollar that they can get to fund the government spending so they're in very different positions.

Julie Stackhouse: Okay. Right there.

Question: I know my conspiracy theory, but what's the probability that Saudi Arabia is being influenced by some agency to damage the economies, if you will, of Russia, Venezuela, and Iran? I mean it looks like it happened so suddenly, overnight—

Michael Plante: I don't know any probability.

Mine Kuban Yucel: Your guess is as good as ours.

Question: But when we look at the damage from the, just the head count from the oil batches, not really significant. When you go right up the road up here at Caterpillar tractor who makes X millions of dollars off of every one of those oil sands trucks that they import, and the exclusive buyers are up there in Canada right now. They can ship anything like this and it's taken them to their knees, you know, and so there are all kinds of second-order industries that are being damaged severely by end employment.

Mine Kuban Yucel: Well Canada's an oil exporter so they're one of the countries who will be hurt by these lower oil prices, right? But I don't, as I said your guess is as good as ours.

Julie Stackhouse: Ma'am, in the back.

Question: South America has supposedly a band of oil companies with lots of reserves. Are they going to be a factor in the supply in the near term?

Mine Kuban Yucel: Well you know Mexico was supposed to be coming on. They passed these reforms and they were opening up their economy, and Mike actually has a paper on this so he can talk a little bit more on it. But now with the prices falling to like 50, it's not going as fast as they would have liked because it's not as profitable. But Mexico was one of these. I mean they just passed these huge reforms to open up the country to foreign investment. So as I said with these prices they're not moving forward as much. But Mike, can you add? You did some work on this from Mexico. Is there anything you want to add?

Michael Plante: Well actually what I was going to mention was more about Venezuela.

Mine Kuban Yucel: Okay, well go ahead.

Michael Plante: So I think the company that's, if there's one specific company that's really going to be in trouble it's going to be PDVSA. That's the one in Venezuela because they are actually already strapped for cash because the government sort of taxes a lot of money from them anyways and so this is probably going to create some problems for them. Now whether it actually ends up hurting production I don't know. I don't know enough about Venezuela to be able to talk about it. But if I was going to pick a place where there might be problems that would be the place I would look first.

Mine Kuban Yucel: I mean we could also add, so Brazil has all these pre-salt oil. Now what I heard last was they were going to continue with what they were doing in the pre-salt because some of that investment was there already. But they were not going to go into any new investments because these prices have come down. But Brazil has quite a bit of reserves there so if prices come up you're going to see some coming from there. And then Argentina has a lot of shale gas. But Argentina is a basket case so who knows what will happen there. So yes, there are reserves. You need the price a little bit higher for them to come up and you need, as Mike says, sort of a better governance for people to feel confident to go invest there.

Julie Stackhouse: Yes, way in the back.

Question: I've heard recently that there's an expectation that in the future Japan's economy is going to grow rapidly with their capacity for manufacturing batteries and that at some point in time batteries will take over the need for oil.

Michael Plante: Okay, so this will be about a renewal energy stuff, which both of us, neither of us actually know much about. I think I may know a little bit more than Mine but like just this much. So I don't know anything about batteries manufactured in Japan. I do know that on some areas there have been some pretty significant improvements in terms of pricing, in terms of selling the stuff cheaper, for example solar panels. And I guess the only other thing I could say is, in terms of making any headway in renewables, batteries do seem to be like an important component to any of this plan because a lot of the renewables are, I would say for lack of a better word, plagued by issues where they are either intermittently generated and unpredictably generated, which is an issue with wind. Or in the terms of solar, also sometimes intermittently generated and that's not necessarily a problem if storage is cheap, but storage in batteries is actually quite expensive. But that would be an important progress in the future for making renewables more competitive in the marketplace.

Mine Kuban Yucel: I was just going to say with the current, the electric cars for example, the amount they can go on one battery was pretty limited. The ones in the U.S. I think the max I heard was like 100 or something miles before you have to recharge that battery. But that's probably less of a problem in like Europe, where the distances are much smaller, and maybe even Japan. But as battery technology gets better and they sort of get over that hump then, yeah, I can see that happening. I mean the Tesla I think they said goes like 200. But the Tesla's pretty expensive so to put that Tesla into production and have the average Joe buy it, that's like a bit down the road.

Alejandro Badel: So my two cents for this question is that the current technology for batteries, for car batteries and many other batteries such as cell phones, et cetera, are based on lithium. And so I guess if these technologies, I guess if all prices remain low we won't see that boom in Japan for some time. But if it were to happen then we would be shifting our attention from oil prices to lithium prices. So it's also a finite resource.

Julie Stackhouse: All right. Right here.

Question: After everything we've heard tonight I'd like to poll the panel and ask if you would be a buyer or a seller of oil stocks today and why.

Michael Plant: I'm not touching that one.

Julie Stackhouse: I'm not touching it. What did you say?

Mine Kuban Yucel: We won't touch that one.


Julie Stackhouse: Alejandro.

Michael Plant: Okay. Anonymous answer is I'm there.

Alejandro Badel: Can I be perfectly honest?

Mine Kuban Yucel: Yeah.

Alejandro Badel: I bought some today.


Mine Kuban Yucel: I was going to say my husband bought some actually.

Julie Stackhouse: Did we do the disclaimer about this doesn't represent the views of the Federal Reserve Bank of St. Louis, the Federal Reserve System? Over on this side.

Question: By its very name the U.S. Energy and Conservation Act would tend to make you think the intent was to conserve U.S. strategic resources. And yet we allow for those resources to be fractionated and then sold throughout the world. Do you have a comment on that?

Mine Kuban Yucel: I didn't hear. Did you hear?

Michael Plante: It's about the export ban and it's about the condensates.

Mine Kuban Yucel: Oh, the condensates.

Question: No, refined products, gas and diesel fuel, et cetera. We allow all that to be exported but the basic crude that's the precursor of all that, the law says you can't do that and yet we in fact are exporting our strategic resources.

Mine Kuban Yucel: So Mike wrote something on this. I'll let him Answer. Do you want to answer that?

Michael Plante: Well the way you're framing the question, you're saying it's a strategic resource, and so as an economist myself is I don't view much of this stuff as strategic or not. And I wrote an article on the export ban itself and my argument in the article is that especially given that we can export refined products, that essentially the export ban on crude oil is basically completely, well—

Mine Kuban Yucel: Inefficient? Useless?

Michael Plante: Yes. Basically all it does is shift money around between one major group of producers, which is oil producers, and then another major producer, which is refiners. And that's the end result. It's just a distortion, which basically, and as far as I wrote in the article, basically has minimal impact on the U.S. consumer itself. It's mainly just shifting money around between two different sets of companies.

Julie Stackhouse: Okay. I think we have time maybe for two more questions. Actually we'll do three, one from each section. So right in back here.

Question: How many companies are there that make drilling bits?

Julie Stackhouse: Can you turn your mic up please? It's off right now.

Question: Oh. Baker Hughes and Halliburton are going to join so Schlumberger, how many other companies are building drilling rigs?

Mine Kuban Yucel: Oh gosh.

Michael Plante: That's for you.

Mine Kuban Yucel: Yeah. There are quite a few. I mean there's—wasn't Transocean one of these? I don't know the answer. You have to be a pretty large company to build the big ones that are like offshore, but the smaller ones that are onshore; I don't think you have to be too large for that. But I don't know the number. I mean but you're right about the big companies. They're the ones who are doing the big platforms and stuff offshore. I don't know though how many they are. Sorry.

Julie Stackhouse: Oh my gosh. For those we don't get to you're welcome to come down afterwards. So lets' go over here on this side. Yes, in the blue knit.

Question: I'm just surprised that you all have not talked about what's in OPEC's self-interest. Surely a maximizing income policy for OPEC if they can get agreement would be much, much higher than this. And in history they've done better. How come you all aren't considering this possibility now?

Michael Plant: You're the boss. Go first.

Mine Kuban Yucel: So yes, they have but not for long, long periods of time because they've always cheated. And part of—I think you know we talk about Russia; we talk about Iran. Part of Saudi Arabia's reluctance to cut was they also want to punish the cheaters like Venezuela who wants Saudis to cut but they will produce at maximum. So I don't know how successful they have been in a longer timeframe. I mean they've done it for a short while but they have always cheated. There's always this incentive to cheat. So I don't think they've held together too well, is what I'd say.

Michael Plant: Yes, in recent, I mean in the last 20 years the last time they really tried to get together that I remember reading about was in the late '90s and early 2000s. And they actually then for a short period of time were able to convince not only OPEC members but some non-OPEC members to cut. But from what I've read going through news articles for some research project that I'm doing, basically it's the story that Mine is just saying. There are a couple of these guys who are committed and then everyone else is basically cheating and lying and saying—they say that we're only producing X amount but basically the market watchers who are tracking tankers and stuff leaving the countries are saying actually no, these guys are lying. So my opinion is yes, if they could get together and credibly agree it would be in their own self-interest to probably cut production and raise prices. But if I'm Saudi Arabia personally I can tell you I wouldn't trust any of the other countries to actually follow through, and so maybe I would like to punish them. I don't know what's going through their heads but that's a possible outcome too.

Julie Stackhouse: Any last thought, Alejandro?

Alejandro Badel: Well sure. I guess from the point of view of economic theory it could happen that there are these price cycles where a producer that is larger and has maybe lower costs every once in a while wants to punish the smaller guys that start increasing a little bit. So that would explain why prices are in fall to the marginal costs of the smaller producer, and then they quickly rise back up. So if this is what's at play we should expect like a short period of low prices and then very quickly up to what is best for OPEC.

Mine Kuban Yucel: And you know we saw that in the '80s too. Saudi Arabia actually flooded the market, remember, in '86. That's when we got prices down to $11, so as you said, the guy who has the most excess capacity can do this to sort of punish the cheaters and so on. But it just doesn't hold for too long. It's just hard to get that discipline going for too long.

Julie Stackhouse: One more question way in the back and that's it.

Question: We know that gas in Europe has traditionally been very, very expensive. What effect does this have in Europe in terms of gas prices there? What have you seen?

Mine Kuban Yucel: You mean gasoline or natural—

Question: Gasoline.

Mine Kuban Yucel: Gasoline. It's expensive because they have a lot of taxes on it. So what I remember again from like Italy for example, about 80 percent of the price is tax and about 20 percent is the oil input cost. So that means that when oil prices move around they don't see that much of an increase or decrease in their prices because a big portion doesn't change, which is the tax. Now I remember Italy from just some work that I had done. I don't know what the levels are in other countries but, again, Europe has very high taxes on gasoline. So they just feel the impact much less whether going up or down.

Julie Stackhouse: So if you do have a question and you want to stay a minute later we invite you to do so but to close out here tonight we saw that band of prices. Put on that crystal ball for a moment. It is now year-end 2015. What is the price of gasoline at the pump? I know Alejandro, you are a risk taker so you can go first.

Alejandro Badel: Can I say end of 2016?

Julie Stackhouse: Okay, end of 2016. We'll be a little, you know, safer here. That's a long ways out. You know economists, the really great thing about economists, they can say something today and then they go, well there's new information that comes in, and then they say the next thing tomorrow and they were right. So okay, end of 2016.

Alejandro Badel: About $75.

Julie Stackhouse: $75.

Mine Kuban Yucel: Oh for oil price.

Alejandro Badel: For crude oil.

Julie Stackhouse: Let's just do a barrel. Okay, $75.

Mine Kuban Yucel: Oh dear. Well I can just make up a number, right? $65.

Julie Stackhouse: $65.

Michael Plante: I'm going to be more optimistic. I'm going to say $80.

Julie Stackhouse: Okay. I'm not going to say anything. December 31, 2016. I'm looking at my colleague Marcella. I don't know if she's there in back. I need you to write this down and then on our Federal Reserve Twitter feed we'll report the results. How's that? Well thank you all for coming tonight and again we invite you if you have a question to come on up, and we hope you'll join us the next time.

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