The oil price has recently slipped down to $53 for a barrel of WTI. At the same time a large percentage of corporation debt risks being downgraded and the risk of rising financing costs may put severe pressure on the heavily-indebted shale oil industry.
The Thanksgiving turkey probably blamed the Fed for the November surprise as interest rates have been rising continually over the last two years, and another rate rise of 25 bps is expected in December. Market observers have been diligent in recording the downturns and have correctly noted that oil prices are extremely important for the global economy. Lance Roberts has seen this very clearly in a good Seeking Alpha article “Oil Sends A Crude Warning”
The extent of the debt crisis in the fracking industry has been noted by many market observers. Steve St Angelo has clearly shown that shale oil production in the US can be considered a Ponzi scheme. This can be seen in the picture below.
There is little liklihood of shale oil producers ever being able to pay back their debts, and now with rising interest rates it will be increasingly difficult for them to service their debts. They need high oil prices in order to survice.
What is of prime importance, however, is the price of oil.
It is clear that trading oil is a risky business as the price can vary considerably and depends on many factors. The recent announcement that Qatar will be withdrawing from OPEC and that Russia and Saudi Arabia will be producing what they want to produce would seem to indicate that Donald Trump`s request for low-price oil is being satisfied. This means that traders should reckon with an oil price possibly going below $50 a barrel. That would mean serious problems for the US shale oil industry, which is heavily indebted and which would have difficulty in rolling over debt when their cash flow is negative. The situation will only be exacerbated with continuing Fed interest rate hikes. Many US oil companies will be likely to default if oil prices remain where they are now.
Supply does not seem to be the problem. With a slowing global economy, demand will slacken off, and that will probably drive the price down further. Oil producers will not want to lose market share and will continue to pump black gold for all that it is worth. With Russia and Saudi Arabia hinting that they will not curb production all that much, the oil price is likely to stay close to #50 a barrel, which is bad news for American shale frackers.
The message for investors is that shares in American shale oil producers are probably going to suffer massive losses if the oil price remains low. Since there is a large amount of debt that will have to be refinanced in the next few years (see the picture above), many companies will either have to pay much higher interest for refinancing or fold if they cannot get the financing. For investors this means that high-yield bonds issued by shale producers are likely candidates either for default or significant losses on paper when the crowd rushes for the exits. Getting out now means that one can avoid the fire sale.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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