The uptick in initial claims is just the start

2015-01-20 9am EDT  |  #bubble #employment #energy #Harold Hamm #oil #shale

In the excitement of last week’s Swiss National Bank debacle, many financial commentators glossed over the jump in the US initial jobless claims. Although this series is notoriously noisy, the downward trend seems to have at the very least stalled over the past few months.

Even though the common narrative is that the plunging oil prices are unambiguously positive for the US economy, I am not so sure that it is so clear cut.

During this past economic cycle analysts have been perplexed at the lack of capex spending. One of the few bright spots has been the massive investment in shale energy development. From Deutsche Bank:

US private investment spending is usually ~15% of US GDP or $2.8trn now. This investment consists of $1.6trn spent annually on equipment and software, $700bn on non-residential construction and a bit over $500bn on residential. Equipment and software is 35% technology and communications, 25-30% is industrial equipment for energy, utilities and agriculture, 15% is transportation equipment, with remaining 20-25% related to other industries or intangibles. Non-residential construction is 20% oil and gas producing structures and 30% is energy related in total. We estimate global investment spending is 20% of S&P EPS or 12% from US. The Energy sector is responsible for a third of S&P 500 capex.

This massive expansion in shale energy development has driven a much higher percentage of the US growth than most economists admit. Have a look at the total amount of new jobs created since the 2008 credit crisis contrasted to those directly the result of the US energy boom.

Over 92% of the jobs that were created in this period were from the energy boom! Apart from California’s tech boom and NYC’s revival (both of which are largely being fuelled by the Fed’s expansionary policies), the US economy’s supposedly strong growth can largely be attributed to the shale energy boom. It is ironic that a President, who has been largely hostile to fossil fuel development, has presided over an economic expansion that is so dependent on this shale energy bubble.

But that is over. When you halve the price of oil in space of less than six months, it does a good job at bursting the shale energy bubble.

Not only can the US no longer count on these jobs to provide above average economic growth, but it is about to become a large drag on the economy.

The price of oil is likely to bottom and maybe even bounce a little from here, but do not mistake that for a revival of the shale energy boom. The shale energy boom was a classic bubble resulting from the mis-pricing of capital. When bubbles burst, they do not recover for many years, and often take decades to regain their former glory.

The Nasdaq Dot Com mania is a perfect example of the after math of the bursting of a bubble. It took more than a decade to shake off the excesses created during that boom. I expect the shale energy boom will prove similar.

Don’t think that there was a bubble in the shale energy sector? Recently the wife of Oklahoma oil man Harold Hamm turned down a $974 million divorce settlement offer.

This is exactly the kind of crap you see during bubbles. Almost a billion dollar divorce offer, and both sides are still fighting. I have no idea if she is justified in turning down the offer – maybe he is trying to rip her off. But I can’t help but be reminded of a famous Canadian financier who owned a large independent brokerage firm. He got divorced right before the 20078 credit crisis. His wife was awarded some big number (not a Harold Hamm size number, but big for Canada). I think it might have been in the $100 million range. When it came time to cut the cheque, the financier borrowed against his brokerage firm shares. The wife’s cheque cleared, and within the year, the credit crisis hit in full force. Suddenly his $200 million worth of shares with the $100 million loan was worth less than the loan. I only met this couple once in passing at another friend’s cottage, so I have no idea if he was a jerk who deserved this or not. But I do know that this sort of crap often marks the end of the bubble. My advice to Harold Hamm’s wife would be to cash the cheque while it still stands a chance of clearing.

The damage from this energy shale bubble bursting is going to ripple through the US economy for some time to come. There is going to be continual layoffs from this sector for many years in the future. Although the bad news about cuts has already started, there is no way the trend is going to do anything but accelerate.

And don’t think it is going to be limited to energy companies.

Citing the collapse in global oil prices, U.S. Steel Corp. will idle its plant in Lorain, Ohio, laying off 614 workers, a company spokeswoman said Tuesday. The plant makes steel pipe and tube for oil-and-gas exploration and drilling. With oil prices currently around $50 a barrel, their lowest level since 2009, energy companies have far less incentive to drill for new supply, reducing demand for the plant's products.

There is no doubt that the lower energy price is going to be a much needed boost for the American consumer. But any increase in spending is going to take a while to make its way through the economy enough to show up in the job figures. Ultimately it might be a positive for the US economy, but over the short to medium run, expect the news from the job front to get worse before it gets better.

I think that last week’s uptick in US initial jobless claims was just the start. During the bursting of bubbles there are often many optimists who claim that the damage will be contained. It never is…