America’s energy independence was an illusion created by cheap debt. All that’s left to tally is the damage.
Ever since the oil shocks of the 1970s, the idea of energy independence, which in its grandest incarnation meant freedom from the world’s oil-rich trouble spots, has been a dream for Democrats and Republicans alike. It once seemed utterly unattainable — until the advent of fracking, which unleashed a torrent of oil. By early 2019, America was the world’s largest producer of crude oil, surpassing both Saudi Arabia and Russia. And President Trump reveled in the rhetoric: We hadn’t merely achieved independence, his administration said, but rather “energy dominance.”
Then came Covid-19, and, on March 8, the sudden and vicious end to the truce between Saudi Arabia and Russia, under which both countries limited production to prop up prices. On March 9, the price of oil plunged by almost a third, its steepest one-day drop in almost 30 years.
As a result, the stocks that make up the S.&P. 500 energy sector fell 20 percent, marking the sector’s largest drop on record. There were rumblings that shale companies would seek a federal lifeline. Whiting Petroleum, whose stock once traded for $150 a share, filed for bankruptcy. Tens of thousands of Texans are being laid off in the Permian Basin and other parts of the state, and the whole industry is bracing for worse.
On the surface, it appears that two unforeseeable and random shocks are threatening our dream.
In reality, the dream was always an illusion, and its collapse was already underway. That’s because oil fracking has never been financially viable. America’s energy independence was built on an industry that is the very definition of dependent — dependent on investors to keeping pouring billions upon billions in capital into money-losing companies to fund their drilling. Investors were willing to do this only as long as oil prices, which are not under America’s control, were high — and when they believed that one day, profits would materialize.
Even before the coronavirus crisis, the spigot was drying up. Now, it has been shut off.
The industry’s lack of profits wasn’t exactly a secret. In early 2015, the hedge fund manager David Einhorn announced at an investment conference that he had looked at the financial statements of 16 publicly traded shale producers and found that from 2006 to 2014, they spent $80 billion more than they received from selling oil. The basic reason is that the amount of oil coming out of a fracked well declines steeply after the first year — more than 50 percent in year two. To keep growing, companies have to keep plowing billions back into the ground.
The industry’s boosters argue that technological gains, such as drilling ever bigger wells, and clustering wells more tightly together to reduce the cost of moving equipment, eventually would lead to a gusher of profits. Fracking, they said, was just manufacturing, in which process and human intelligence could reduce costs and conquer geology.
Actually, no. The key issue is the “parent child problem.” When wells are clustered tightly together, with so-called child wells drilled around the parent, the wells interfere with one another, resulting in less oil, not more. (This may not surprise anyone who is attempting to be productive while working in close quarters with their children.)
The promised profits haven’t materialized. In the first half of 2019, when oil was around $55 a barrel, only a few top-tier companies were profitable. “By now, it should be abundantly clear that the current shale oil business model does not work — even for the very best companies in the industry,” the investment firm SailingStone Capital Partners explained in a recent note.
Policymakers who wanted to tout energy independence disregarded all this, even as investors were starting to lose patience. As early as 2018, some investors had begun to tell companies that they wanted to see free cash flow, and that they were tired of compensation models that rewarded executives with rich paydays for increasing production, but failed to take profits into account. As a result, fracking stocks badly underperformed the market.
But with super-low interest rates, investors in search of yield were still willing to buy debt. Over the past 10 years, the entire energy industry has issued over $400 billion in high-yield debt. “They subprimed the American energy ecosystem,” says a longtime energy market observer.
Even as the public equity and debt markets grew cautious, drilling continued. That’s because one big source of funding didn’t dry up: private equity. And why not? Private equity financiers typically get a 2 percent management fee on funds they can raise, so they are incentivized to take all the money that pension funds, desperate for returns to shore up their promises to retirees, have been willing to give them.
In the Haynesville and the Utica Shales, two major natural gas plays, over half of the drilling is being done by private equity-backed companies; in the oil-rich Permian Basin, it’s about a quarter of the drilling. From 2015 through 2019, private equity firms raised almost $80 billion in funds focused mostly on shale production, according to Barclays.
Until the capital markets began to get suspicious, private equity investors could flip companies they had funded to larger, public companies, making a profitable exit regardless of whether or not the underlying business was making money.
That, too, is ending, as investors in such funds have become disillusioned.
You can see how all of this is playing out by looking at Occidental Petroleum. In 2019, Oxy, as it’s known, topped a competing bid from Chevron and paid $38 billion to take over Anadarko Petroleum, which is one of the major shale companies. Since that time, Oxy’s stock has plummeted almost 80 percent in part due to fears that the Anadarko acquisition is going to prove so wildly unprofitable that it sinks the company.
On March 10, the company announced that it would slash its dividend for the first time since the early 1990s, when Saddam Hussein’s invasion of Kuwait sent oil prices plummeting.
Occidental is just one piece of the puzzle. In April, the Energy Information Administration cut its forecast for U.S. oil production, estimating that it will fall both this year and next — suggesting that the days of huge growth in production from shale are over.
On March 10, Scott Sheffield, the chief executive of Pioneer Natural Resources, a major driller in the Permian Basin, told Bloomberg that U.S. oil output could fall by more than two million barrels per day by next year if prices remain where they are today.
“This is late ’80s bad,” a close observer of the industry says.
After the United States engaged in a high-stakes negotiation with Russia and Saudi Arabia to curtail production, a tentative deal was struck on Thursday. Certainly, President Trump, who has staked so much on the American shale industry, wants to save it. “We really need Trump to do something or he’s going to lose all the energy states in this election,” Mr. Sheffield told CNBC in late March.
A deal, and higher oil prices, might help the industry. But they won’t fix its fundamental problem with profitability. Energy independence was a fever dream, fed by cheap debt and frothy capital markets.
All that’s left to tally is the environmental and financial damage. In the five years ending in April, there were 215 bankruptcies for oil and gas companies, involving $130 billion in debt, according to the law firm Haynes and Boone. Moody’s, the rating agency, said that in the third quarter of 2019, 91 percent of defaulted U.S. corporate debt was due to oil and gas companies. And North American oil and gas drillers have almost $100 billion of debt that is set to mature in the next four years.
It’s still unclear where most of this debt is held. Some of it has been packaged into so-called collateralized loan obligations, pieces of which are held by hedge funds. Some of it may be on bank balance sheets. Investors in the equity of these companies have already seen the value of their holdings decimated. Pension funds that have poured money into private equity firms may take a hit soon, too. All we know for sure is that fracking company executives and private equity financiers have made a fortune by touting the myth of energy independence — and they won’t be the ones who have to pick up the pieces.
Once the vaccine is developed, it will take at least 90 days to complete the regulatory process and potentially more to enter the marketplace.
Once the vaccine is developed, it will take at least 90 days to complete the regulatory process and potentially more to enter the marketplace.
Israeli scientists are on the cusp of developing the first vaccine against the novel coronavirus, according to Science and Technology Minister Ofir Akunis. If all goes as planned, the vaccine could be ready within a few weeks and available in 90 days, according to a release.
“Congratulations to MIGAL [The Galilee Research Institute] on this exciting breakthrough,” Akunis said. “I am confident there will be further rapid progress, enabling us to provide a needed response to the grave global COVID-19 threat,” Akunis said, referring to the disease caused by the novel coronavirus.
For the past four years, a team of MIGAL scientists has been developing a vaccine against infectious bronchitis virus (IBV), which causes a bronchial disease affecting poultry. The effectiveness of the vaccine has been proven in preclinical trials carried out at the Veterinary Institute.
MIGAL is located in the Galilee.
“Our basic concept was to develop the technology and not specifically a vaccine for this kind or that kind of virus,” said Dr. Chen Katz, MIGAL’s biotechnology group leader. “The scientific framework for the vaccine is based on a new protein expression vector, which forms and secretes a chimeric soluble protein that delivers the viral antigen into mucosal tissues by self-activated endocytosis, causing the body to form antibodies against the virus.”
Endocytosis is a cellular process in which substances are brought into a cell by surrounding the material with cell membrane, forming a vesicle containing the ingested material.
In preclinical trials, the team demonstrated that the oral vaccination induces high levels of specific anti-IBV antibodies, Katz said.
“Let’s call it pure luck,” he said. “We decided to choose coronavirus as a model for our system just as a proof of concept for our technology.”
But after scientists sequenced the DNA of the novel coronavirus causing the current worldwide outbreak, the MIGAL researchers examined it and found that the poultry coronavirus has high genetic similarity to the human one, and that it uses the same infection mechanism, which increases the likelihood of achieving an effective human vaccine in a very short period of time, Katz said.
“All we need to do is adjust the system to the new sequence,” he said. “We are in the middle of this process, and hopefully in a few weeks we will have the vaccine in our hands. Yes, in a few weeks, if it all works, we would have a vaccine to prevent coronavirus.”
MIGAL would be responsible for developing the new vaccine, but it would then have to go through a regulatory process, including clinical trials and large-scale production, Katz said.
Akunis said he has instructed his ministry’s director-general to fast-track all approval processes with the goal of bringing the human vaccine to market as quickly as possible.
“Given the urgent global need for a human coronavirus vaccine, we are doing everything we can to accelerate development,” MIGAL CEO David Zigdon said. The vaccine could “achieve safety approval in 90 days,” he said.
It will be an oral vaccine, making it particularly accessible to the general public, Zigdon said.
“We are currently in intensive discussions with potential partners that can help accelerate the in-human trials phase and expedite completion of final-product development and regulatory activities,” he said.
For a month, American journalists and public-health experts havepraisedthecoronavirusresponse of South Korea and Singapore above all others. On Tuesday, Singapore will close its schools and most businesses to guard against an out-of-control outbreak; South Korea just extended its social-distancing policy. In the early months of this pandemic, the most developed parts of Asia have visibly outperformed the rest of the world — a differential that has produced a string of viral charts showing the benefits of mask-wearing and universal testing. But in recent days, Hong Kong and Taiwan, noting a rise of new cases arriving via international visitors, have shut their borders. Cases are spiking in Japan, and a second wave of infections is feared in China, as well. Which means that, all told, many of the nations desperate Americans have spent the last few months praising as exemplary models of public health management do not actually have the virus under control — or at least not to the degree it appeared a few weeks ago, or to the degree you might be hoping for if you expected a (relatively) quick end to quarantine measures and economic shutdown followed by a (relatively) rapid snapback to “normal” life and economic recovery.
If the countries held up as models for how we should proceed can’t figure it out, what does it mean for the U.S., which is saddled with broken institutions and has already bungled and delayed its response at nearly every stage? Here in New York, we are about to enter our third week of sheltering in place; in San Francisco and Seattle, the social-distancing orders have been in effect even longer. Yet there is no clarity to be found from the federal or state or local level for how long these measures will last. And there is no public or concrete plan for, and little visible discussion about, what it would mean to sunset them: how and at what point and in what ways we will try to exit this temporary-but-indefinite wartimelike national bunkering almost all 330 million of us now find ourselves in. What, exactly, is the endgame here?
Some of this ambiguity is inevitable — it may be hard to remember, given the way the coronavirus has distended our sense of time, but this crisis is just a few months old and the scientific and public health wisdom just as preliminary. But while it may not be possible to pinpoint a date, or a month, at which point we can expect to transition out of bunker living, no one seems to have any sense of how we’ll arrive at that determination, how much we will have wanted to contain the outbreak, at what levels, before moving forward, and what steps moving forward would then entail. That there is no coherent federal plan to deal with the outbreak as it currently stands is horrifying enough — an absolute evacuation of presidential leadership that has already cost thousands of lives and will likely cost tens of thousands more. But the fact that there is also no planning to speak of for how we might leave behind the present crisis means all we can see looking forward from the darkness — is more darkness.
Last week, Helen Branswell of Stat news reported that public-health experts in the U.S. are increasingly worried that the public is underestimating how long the coronavirus “disruptions” are going to last — with many Americans assuming a sort of national reopening will begin in early May and most public-health experts expecting at least a month beyond that. Possibly more, even considerably more.
But the bigger question isn’t how long our shutdown will last; it’s what will follow it. In theory, lockdowns of the kind that are now in place in much of the country are designed to contain an outbreak before it gets out of control — this is why China instituted its shutdown in January. But even relatively modest spread of a disease requires more than simple lockdown; it requires an aggressive program to identify those infected, isolate them, and monitor those they may have come into contact with, to be sure those people aren’t themselves spreading the disease. This is the “test and trace” method of pandemic containment; among public-health experts, it is the ideal. But in the U.S., and indeed throughout Europe, as well, the pandemic has progressed much too far for this approach to work. And so — again, in theory — the current lockdowns could provide another opportunity, as well: buying the country time to ramp up a comprehensive testing regimen. We would shelter in place until such a program was ready to go, then reenter “normal” life through that portal of medical surveillance. This program would be a dramatic change to American life — obligatory temperature checks, intrusive testing, andmandatory isolation in quarantine camps for anyone who’d even come into contact with a positive case — but it is the fastest path out of our current predicament. Beyond Twitter, the periodic suggestion from Trump’s executive pals that we should “reopen” the economy, and a few op-ed pages sketching out vague pathways, there is no sign of any real plan to do it at any level of government.
The Nobel Prize–winning economist Paul Romerhas suggested that, while imperfect, an aggressive testing regime without “tracing” would also be effective, at the population level, allowing a country like the U.S. to emerge from shutdown without imposing quite as aggressive a medical surveillance state. That is potentially promising, since the latter would be enormously challenging at the logistical, legal, and cultural levels here. But the U.S. is very far from instituting that kind of testing regimen. The only COVID-19 testing being done anywhere in the country is of symptomatic patients coming to doctors and hospitals. Nowhere are we doing the kind of “community” testing Romer envisions, nor are we testing for coronavirus antibodies to confirm how many people have already had otherwise undetected cases of COVID-19. And since we are still so hopelessly short on testing equipment needed to even test all the patients complaining of symptoms, we are very, very far from being able to even imagine a massive nationwide rollout of testing that would allow us to not just swab everyone but continue to swab everyone pretty regularly over the next few months. On top of which, the tests we are using may have a failure rate of about 30%. That means about one in every three people being tested could be getting the wrong result. You can’t build any kind of public-health response on top of information that faulty.
In this context, the complete absence of federal leadership I’ve written about before is especially conspicuous. The White House has offered no meaningful guidance, best-practices advice, or coordinated support to those states and communities around the country living either in fear of the arrival pandemic or in its grip already. Absent a federal policy or public plan, all we have are vague and poorly informed hopes: for a vaccine, which may take a year or more, though tests are already underway (no vaccine for any coronavirus has ever been created, and 18 months would mark the fastest production of any vaccine of any kind in medical history); for treatment (at the moment, we have no drugs proved to help cure the disease, despite the president’s premature endorsement of chloroquinine); for herd immunity (which may take as long to develop as a vaccine); and for seasonality (which could dampen the spread come summer but which most epidemiologists suspect won’t radically alter the trajectory of disease).
So we have no idea how long “this” will last and how it will end. In the meantime, all we have is a daily White House press conference starring a shortsighted, uninformed, and self-contradicting showman of a president, with multiple competing response teams occasionally emerging from the shadows to reveal a basic ignorance about the meaning of federalism. Neither Jared Kushner nor Donald Trump seem to understand what it means for the federal government to act as a backstop, or what the purposes of a federal medical-supply stockpile could be (given the comparatively tiny size of that government), and how few medical supplies could ever be required by its workforce.
“The notion of the federal stockpile was, it’s supposed to be our stockpile,” Kushner said Thursday. “It’s not supposed to be states’ stockpile, which they can then use.”
The more troubling interpretation of that statement is that it isn’t ignorant but strategic and sadistic. The continued messaging from the White House is that at every stage of this pandemic, states and governors will be left to do their own work rather than rely on federal support and — critically — guidance. About a particular untested treatment, the president said on Friday, literally, “What do you have to lose? Take it. I really think they should take it. But it’s their choice … Try it, if you’d like.” Those rolling their eyes this weekend about the fact that both the Republican governor of Georgia and the Democratic mayor of New York seem only to have learned, in the last few days, that asymptomatic people can still spread the disease — a fact familiar to anyone following the story since January — is less an indictment of those two men than the vacuum of guidance from Washington, which requires every state and local leader to piece together their own understanding of the disease.
To the extent Washington is providing help, it is providing it, already, in disproportionate ways: more aid to those states considered friendly to the president, and less to those considered hostile. As the crisis grows, that leverage will become even more brutal, which is to say, for a president like Trump, even more tempting — medical resources used to punish and torture rather than heal. One hopes the White House won’t be that naked, or extreme, in treating desperate states and municipalities as political hostages in the middle of deadly and economically devastating pandemic. But this is, at present, the closest the White House seems to be to an exit strategy or end-game.
Before the coronavirus, a false narrative arose that the economy was healthy, as measured by:
growth in the stock market and a
reduction in the unemployment rate
when in fact the recovery from the 2008 financial crisis was weak and the facade of strength was masked by low-interest rates which enabled governments, corporations, and individuals to achieve the illusion of prosperity through increased borrowing.[footnote]Finance-types refer to borrowing as “leverage” because, like a ‘lever’, it amplifies your effort.[/footnote]
1901 Cartoon depicting JP Morgan as Bull
But there is more to the economy than the stock market and unemployment rate. The bond market is larger and “smarter” than the stock market. When assessing the pre-coronavirus economy, one must also take into account the stagnant profits[footnote]You might wonder why this Federal Reserve chart looks different than upward sloping graphs you are used to. The first reason is that this graph uses pre-tax figures that do not include the boost that corporate tax cuts gave to the stock market. The other reason is that this graph is based on total profits, rather than earnings per share. In the rest of this article, you will learn how corporate debt artificially inflated earnings per share.[/footnote] corporations disguised by borrowing in the bond market to fund purchases of their own stock, artificially inflating the stock market.
Like an Injured Athlete taking Pain Killers
The US economy was like a professional football player who had been “playing hurt” for many years.
The economy used debt like the football player uses pain killers. The debt masked the economy’s problems[footnote]The fallout from the prior 2008 financial crisis was not dealt with. The government bailed out the system and assumed the debt. Most Americans’ wages had stagnated and healthcare and education expenses have gone up dramatically. In order to compensate for week customer demand, companies had begun to borrow money and buy back their own stock. Even with a deficit of $1 trillion/year, pre-coronavirus, the economy grew at a rate of 2.1% and was projected to fall to 1.6% by 2024.[/footnote] and allow it to perform at a higher level than otherwise would have been possible had pain-killers not dampened the brain’s ability to perceive reality. But unfortunately, an economy is not like an athlete in that it can’t retire at the end of a 15-year career.
Featuring: The Seven Dwarfs
The story I’m about to tell is intended to illustrate how corporations borrowed money and then used that money to buy their own stock, inflating the stock price.[footnote]Now with the coronavirus crisis, the federal reserve is buying some of that debt, as well as allowing corporations to issue additional debt at artificial prices.[/footnote] In finance jargon, this is called “leveraged stock buybacks”.[footnote]”Leveraged” is just a fancy term used to indicate that financial activity is amplified by borrowing.[/footnote] Corporations have used stock buybacks as a major strategy to boost their share price but many corporations didn’t have enough profits to buy back their stock because the overall level of (pre-tax) corporate profits has been flat since 2012.[footnote]Pre-tax Corporate profits peaked in 2014 and have been roughly flat since 2012. The perception of growth is mostly due to the additional debt (share buybacks) and the 2017 tax cuts (federal government debt).[/footnote]. While some companies may have been able to legitimately afford to buy their own stock with real profits, over 50% of those buybacks were done using borrowed money.
I illustrate how this market manipulation works using a fairy tale featuring the seven dwarfs and their mining company “7 Dwarfs Mining, Inc.” Early in the story, the dwarfs seemed to have discovered an easy way of making money until an unforeseen emergency struck and disrupted their carefully laid plans.
It is commonly known that emergencies reveal.
This story illustrates what emergencies can conceal.
After a number of years in business together, the mining company was valued at $7 million[footnote]The value of all the stock is equal to the value of all the company’s assets minus its liabilities.
( total stock shares = number of shares x share price) [/footnote] and generated $700,000 in profit per year, which they split 7 ways.[footnote]I picked round numbers for this. If you want to help me improve the numbers, see the excel doc in the footer and edit it.[/footnote]
