Session 136 - Collapsing Crude Prices = Systemic Risk?

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Includes: BNO, CRUD, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Bill Kort

Though I am not certain that this will be the case (in fact I believe it won’t be), I’m willing to bet that this is the spin (systemic risk) that the media will begin to attach to rapidly falling oil prices. Why? Because there is potential to come to very negative conclusions about the impact of oil’s collapse, to raise the specter of and to speculate about "dire consequences." And, as we all know, in the financial media, as is the case with most media, "if it bleeds, it leads"; and the energy sector is really bleeding.

How bad is it?

“How bad was it!?”

(only readers of a certain age will get the import of this photo)

To answer this question I provide a quote and a clip (Will OPEC bankrupt U.S. shale producers?) from a CNBC interview with Neil Beveridge, Senior Oil Analyst at Sanford C. Bernstein (The Beveridge interview is the number “3” clip in the article and worth your attention):

“While production growth is very strong [in North America], remember if you look at the debt situation for a lot of these companies, there is a lot of distressed debt,” said Beveridge.

“$68 a barrel is not economical for a lot of these shale oil wells. CDS [credit default swap] spreads and yields on some of the debt are rising very quickly, because at these kinds of oil prices you are going to see producers go bankrupt,” he added.

According to Beveridge, 15% of the high yield (so-called distressed debt) market is energy related. In preparation for this post I searched for current data on the high-yield market. Unfortunately the most recent was in an article quoting S&P as of March 31, 2013 at $2.2 trillion. If you assume 15% of the earlier total, the junk debt (high-yield) portion would approximate $330 billion.

I think it is important to be armed with these numbers as the potential media rhetoric heats up, even if the number of junk energy credits outstanding is double the $330 billion above. First of all, some junk-issuing producer will go broke (most won’t). Second, regulators are keenly aware of industry loan concentrations, which should impact positively the exposure of the to-big-to fail (TBTF) money center banks. This would also apply to sovereign debt issued by oil producers a la Venezuela.

Speaking of the impact on oil producers

The drop in prices could create instability among those countries who require higher oil prices to keep the lights on… places like Iran, Russia (“OPEC decision spells trouble for Russia”) and the aforementioned Venezuela. But this could be a good thing. In the case of Russia, Mr. Putin may not be as inclined to retaliate against sanctions by the U.S. and others by curtailing natural gas sales to Europe or the Ukraine. He may also think twice about escalating his Ukrainian adventure. Regarding Iran, they won’t have as much dough to send to their friends in Hamas, maybe giving some brief stability to the Israeli/Palestinian conflict. And, as to Venezuela, I’m not sure what the country is up to in the wake of Hugo Chavez passing, but lower oil prices may lead to a regime that is more friendly with the United States.

What about Texas and North Dakota

Unfortunately for them, they will have to struggle. On the bright side, they have just endured five or six years of unprecedented BOOM TIMES while the rest of the world struggled. I hope they put some money away for a rainy day.

One last Caveat

Although the pundits are calling for this current drop in oil prices to last for some time, it may not. And the more people that join the camp of prolonged low oil prices, the less likely it becomes. So, pay attention to what the choir is singing, you may be able to make money going the opposites direction.

Bottom Line

My opinion is there are six or seven billion of us that will reap great benefits from these price declines, however long they should last. Regardless of the media spin, this does not look like a systemically dangerous event.

What do you think?

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