The zombie apocalypse in oil: Why it's a bad sign for all of us

The dramatic drop in oil prices has created what are called "zombie" companies, oil companies which can still afford to pay interest on huge debts, but little else. If oil prices stay low, the problem is likely to spread and become an economic zombie apocalypse for much of the industry and the communities and countries that depend on it.

Meanwhile, consumers have rejoiced as cheap oil prices have led to cheap gasoline, diesel, heating oil and jet fuel. Both households and businesses are finally getting their revenge on the oil companies after a decade of high and rising prices.

But should those consumers be so sanguine? Can the low prices we are experiencing today be extrapolated far into the future? The conventional wisdom says yes. It claims that the American fracking boom of recent years has unleashed a flood of oil that will keep prices down for many years to come. Combine that with an undisciplined OPEC that pumps flat out and you get not a temporary dip in prices, but a new era of low-cost oil and oil products.

But the same facts can be interpreted as leading to serious future supply constraints and high prices, provided the world economy does not fall into a prolonged slump that would reduce oil demand.

Cheap financing fed the fracking boom. And, even though borrowed funds are still cheap, struggling oil companies are finding their bank lines of credit reduced and a bond market that is shunning their high-yield debt. With additional funds hard to raise, many independent companies are finding it difficult to drill new wells needed to make up for declining production from existing ones, around 40 per cent per year in the two largest tight oil formations--the Eagle-Ford in Texas and the Bakken in North Dakota--where fracking is the primary technology for extracting oil.

The U.S. oil rig count stands at 524 for the week ending December 11. A year ago it was 1,546. U.S. oil production (crude oil including lease condensate) is estimated to be down about 450,000 barrels per day from the peak in early June of 9.6 million barrels per day, according to the U.S. Energy Information Administration.

While some say that a rising oil price would quickly reverse the current downward trend in drilling activity in U.S. tight oil fields, the key will be whether investors will provide the capital needed to do so. So, it's important to understand that the OPEC war on American drillers also extends to those who finance them. If the thumping investors have taken so far as result of the long, deep slide in oil prices makes them reluctant to fund new drilling in the United States when prices rise, the presumed fast ramp-up in U.S. drilling won't take place. The necessary cheap and ready credit won't be available as it has been in the past.

This may be what OPEC is counting on, that investor sentiment will be so damaged by the current price war that when world supply does finally come into balance with demand, U.S. drillers won't be back very quickly or in numbers seen at the height of the boom. Moreover, investors won't be easily fooled a second time by an industry that even at the peak of the boom saw most companies experience persistent negative cash flow.

But there is another problem. With OPEC and particularly Saudi Arabia pumping all out, there is little spare capacity to respond to shocks such as disruptions in Libya or Iraq that might reduce production. With little spare capacity, mere growth in world demand might outpace the ability to meet it. One analyst believes oil prices could be in triple digits again by 2017 for this and other reasons.

There is another scenario that is suitably apocalyptic in line with the zombie apocalypse taking place in the oil industry. In this scenario the world economy plunges into a lengthy depression brought on by years of previously high oil prices (which have sapped the strength of the world economy), bursting stock market bubbles, and a merciless debt deflation ignited in part by cascading oil industry defaults.

This scenario would keep oil prices low. But it would also prevent investment in most remaining prospects--prospects that are increasingly expensive to exploit such as tar sands, arctic and deepwater deposits. This implies that oil prices would rise even in a depressed economy, but not sufficiently to make these high-cost resources viable. Relatively high oil prices would put pressure on an already slumping economy and possibly lead to an even deeper slump.

Few people currently anticipate such a vicious circle. But the evidence suggests that none of us should be complacent as long as zombies roam the world's oil fields.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.