Jim Bianco: Energy Industry 'Dead-Man Drilling' Into Bankruptcy

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by: Financial Sense

By FS Staff

After one of the worst starts of the year on record, Financial Sense spoke with Jim Bianco of Bianco Research to get his outlook on the stock market, China, Fed policy and more.

"Earnings are off," he said. "I know it's very early in the season right now, but the expectations are (that) on a year-over-year basis, we're going to have negative earnings."

The Federal Reserve is still insisting on four more rate hikes this year, and with little to no earnings growth and a tightening Fed, we have the perfect backdrop for a declining market, said Bianco.

At 2pm Eastern Wednesday the Federal Reserve will release another policy statement on the US economy. The most likely scenario, Bianco said, is the Fed alters course and doesn't raise rates as much as it has telegraphed. The market is pricing in one more rate hike by the end of the year, while the Fed is insisting on more, he said.

"Unless or until that happens, I think the market is going to stay difficult," he said.

Oil Woes

There's still a lot of bullishness and optimism in the market, and that probably still has to be shaken out for things to change, Bianco told listeners. In looking at sectors that have been crushed, such as energy and high-yield debt, Bianco said he finds it worrisome that in the case of energy, we're talking about a biblical market correction.

"It's astounding to me that these investors watched a market lose 60 percent of its value in 18 months, and did nothing but buy all the way down...and lose astronomical sums of money," he said.

Because investors have been so bullish, we're likely going to experience a lot of pain going forward, he said. Part of the reason crude is at $30 right now is weak hands haven't been shaken out, and markets need capitulation to clear out these positions.

The typical energy investor has probably lost half their money, Bianco noted, but these same investors are more worried about missing a market rebound to $100/barrel.

"Dead-Man Drilling"

"The price is going to stay here until we get bankruptcies - until we get massive liquidation," Bianco said. "The industry is going to have to go through some kind of a gut-wrenching change, on the order of what the mortgage market went through."

Risks are to the downside, and Bianco thinks the biggest change on the margin that has really killed the oil industry has been the inability to understand demand has fallen more than anticipated.

That fall in demand is coming from China, he noted. The other major problem in the oil sector is producers' financing structure has exacerbated this problem.

Most oil companies borrowed in the high-yield market and have monthly or quarterly cash flows to meet, Bianco said. As a result, they have no choice to keep pumping, which only adds to the supply problem, and they can't back off or cut production, or they're out of business. This self-defeating situation has been coined "dead-man drilling" by those in the industry, said Bianco.

Chinese Headwinds

Another major issue facing world markets is the status of the Chinese economy, noting a record amount of capital outflows leaving the country in response.

"I think the elites and the wealth in China have lost confidence in the government," he said. "They want their money out, and they want their money out in a big way."

Chinese authorities have botched management since the decline started in 2015, and the public is panicking, he said. They don't trust the government anymore, they want their money out, and that's why the Yuan is weakening.

There's one of two ways to fix this, Bianco said: The Chinese can change their government, which isn't very likely to happen, or they can pound the markets down so far that entry is worth the risk.

China is a high-growth emerging market, and a recession there may not look like a recession in the United States, Bianco explained.

"Some say growth can go down to 5 percent in China, and that we'd be lucky to have 5 percent growth (in the US), so (if that happens) there it's no big deal," Bainco said. "Five percent growth in China would be the lowest growth rate they've had since Tiananmen Square - and by the way, it was a 5 percent growth rate that caused Tiananmen Square."

"The bottom line is, the United States may be the cleanest dirty shirt, but it can't help but be in the hamper with the rest of the dirty shirts, and it's going to get more dirt on it as we move forward," Bianco said.

Listen to this full interview with Jim Bianco of Bianco Research by logging in and clicking here. For a complete archive of our broadcasts and podcast interviews on finance, economics, and the market, visit our Newshour page here or iTunes page here.