Ed Wallace

The Disruptors

For some time now, the world’s economies have been going through a strange period. Strange enough that it has a handle for the new darlings of capitalism: “disruptive” corporations.

Ironically, most companies still follow the old guidelines for capitalism. Under those, in order to succeed one must have at least as good or better a product, widget, or service as those already on the market; and said offering’s price must be attractive to the current market — or, failing that, be reasonable and offer the end user much better service or convenience. If those criteria are met and there’s a natural demand for the product, service, or widget, your company would be successful, even if your success beggars your neighbor.

Think of Henry Ford and his decade-long drive to lower the price of his vehicles, which still had to be made durable enough to conquer a rural America that had few good roads and no highways. Doing that required starting a profitable business, designing a car that could handle anything, and in time adapting the moving assembly line to increase production, allowing him to achieve that affordable lower price for his vehicle. But at no time along the way was the Ford Motor Company bleeding red ink or forced to recapitalize itself constantly.

Ford did the converse, in fact. He managed to get key suppliers, such as the Dodge Brothers, to accept stock in the company in lieu of cash payment for their parts. That lowered Ford’s up-front cost of production, so it could stay in the black, while making the Dodge Brothers even richer on the backside. John D. Rockefeller made many an oil man and refiner wealthy by buying their firms and consolidating that industry — and doing so with stock in Standard Oil instead of cash.

“Disruptor:” Bigtime Panhandler

Today the new industries receiving the greatest hype and attention are praised as disruptors, as if all “improvements to capitalism” do exactly that, disrupt someone else’s success. Yet after reading, studying, and writing about this phenomenon for over a decade, I’ve concluded that when Wall Street tags a company with that moniker, a “disruptor”, what they really mean is that this firm is not just unprofitable, but it may never make a profit. But investors who understand a truly negative corporate outlook aren’t likely to invest in its stocks or bonds. So a clever PR label is created, that of a “disruptor;” in the same marketing ploy as a certain man’s shirt size is referred to as “classic,” because the term “porky” wouldn’t sell many expensive shirts.

But we’ve discussed corporations such as Uber and Lyft, Twitter, Tesla, Lime Scooters, Spotify, and long before them, Amazon.com — they’re companies we are told to admire, but that are generally just money pits for investors. (Amazon is finally net positive after 25 years.) To be fair, a study from the Journal of Economic Perspectives in 2017 pointed out that in 1975 there were 4,819 public firms, but just 109 of them earned half of all corporate profits for a publicly traded company. That same report showed that in 2015 there were only 3,766 public companies, and only 30 of them accounted for half of all corporate profits. Never before in our history, possibly aside from the earliest decades of the railroads, have we seen so many companies lose billions and yet be considered the cream of our crop.

However, there is something worse, closer to home, that potentially could harm the entire world’s economic system, including your family’s budget for your vehicles. The fact is that our shale boom, also called the disruptor to the world’s energy-producing countries, has done little but bleed red ink since its creation. Unlike the business media’s often fawning reports on the other so-called disruptors, the financial reporting on shale has been mixed at best and often downright hostile to the business model for years — certainly since the collapse in oil prices a few years ago.

A May 2018 column by Justin Mikulka, published at Naked Capitalism, linked to the September 2016 report by Moody’s Investor Service, which wrote that “The financial toll from the oil bust can only be described as catastrophic.” True enough; most oil firms in Texas well understood “catastrophe” when oil fell from almost $100 a barrel down to $30. What the article left out, however, is where these losses were taken. On the other hand, Texas oil companies are used to that boom and bust mentality.

True, many oil companies had purchased hedges on their production so they would be covered if something as tragic as a price collapse happened. One reasonably large energy company in Dallas informed me years ago that in the first year of the collapse they were hedged to $75 a barrel for their crude. In the second year they could only find hedges in the mid-50s range; therefore, in year one they did well, and in the second year they likely broke even. But where were the billions upon billions of dollars in oil losses from banks, oil, and derivative traders from that first year’s collapse in price?

That Humming Sound is Headlines Spinning

Even before Mikulka’s column the Wall Street Journal had run one under the headline, “Wall Street Tells Frackers to Stop Counting Barrels, Start Making Profits.” That column pointed out that “Since 2007, shares in an index of U.S. producers have fallen 31 percent ... Energy companies in that time have spent $280 billion more than they generated in profits from operations on shale investments.”

That column went on to report that Pioneer Natural Resources claimed in 2016 that its production cost per barrel at some wellheads was a mere $2.25 a barrel, yet in 2016 Pioneer lost $556 million because it was spending $1.24 for every dollar it earned in revenue. Now that story might have been an eye opener, if not for the fact that the WSJ had covered the exact same ground five months earlier — but with a different spin. That headline read, “Wall Street Cash Pumps Up Oil Production Even as Prices Sag.”

Got that? First the Wall Street Journal points out that Wall Street is pumping big bucks into the shale revolution, the disruptor of OPEC; and five months later it reports that Wall Street is coming down hard on shale producers and their demand for working capital, telling them to tighten up their operations and get profitable. For the record, both columns were primarily written by Bradley Olson. And guess who shows up again with another column in February of this year? This one is headlined, “Frackers Face Harsh Reality as Wall Street Backs Away.” Isn’t that what his column 15 months earlier promised?

Oh, and the month before that, Bradley Olson wrote a column discussing how thousands and thousands of shale wells have never produced the volumes of oil or natural gas the fracking companies promised investors. Worse, he writes about the serious and fast decline rate of fracked wells. Along the way many articles, including at the Wall Street Journal, have pointed out just how many hundreds of billions of dollars in losses the fracking industry has accumulated in the past 20 years.

Into this mix, reporter Bethany McLean published her short book, Saudi America, which took a hard look at the shale industry and the possibility that it will never be profitable enough to cover all the money that’s being thrown at it. Before you write her off, McLean is the former Fortune magazine reporter who brought down Enron; everyone else in the business media was cheering them on as the next big thing, until she exposed them as just a hollow house of cards.

Illegitimate Capitalism

Just remember this, in the end business fundamentals will win out. One day the hype will disappear; the many individuals and institutions that lost their investments will go public, and the bloom will come off the rose or the thistle, depending how you see things. At that point, when they’re unable to borrow anymore to cover their massive losses, these so-called disruptive companies will fade away. Alternatively, some may find ways to finally make money — while others may choose bankruptcy instead, to rid themselves of their debt obligations in order to maximize future profits.

Does anyone really care whether Uber, Tesla, Lyft or Twitter go away? There will still be taxis and other electric cars on the market. Some future president might have to use a different messaging app; big deal.

If shale oil fails, however, that’s a different story completely. Prices for crude won’t stay in the mid-fifties, and shale’s power to mitigate OPEC’s and Russia’s moves in the oil market is considerable. Maybe for that reason alone the government should subsidize shale production, just to keep the economy humming with cheap refined fuels. If you look at the historical record, cheap gasoline apparently does more to expand an economy than cheap interest rates.

But here’s the scarier reality: For two decades shale has been our nation’s greatest hope for a secure energy future — yet also mostly a black hole that siphons money from investors and operates at a loss. So Texas’ shale is no more a legitimate capitalistic venture than Uber, Lyft, Tesla, Spotify, Lime Scooters or Twitter. Bummer.





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