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The Saudis Almost Pushed The Globe Into A Recession, But Not Quite - Bank Of America Merrill Lynch

  • A radical Saudi oil supply policy shift starting in 2014 has exacerbated the fundamental dislocation created by the advent of shale technology. In recent months, the oil price drop may have even contributed to push down inflation expectations, indirectly affecting global interest rates. This joint meltdown in oil and rates has in turn fed into energy and financials and can explain about 62% of the $4.6tn drop in global equity market values since July 2014. Similarly, US energy corporate bond values have dropped by $170bn, mostly via a big jump in yields. The scale of the damage also extends to sovereign debt, with Venezuela sitting at the top of the list, followed by Brazil, Colombia, and Russia.
  • Energy producer-weighted CDS risk is now over 2009 levels. With cash on balance sheet falling for many corporates and oil producer FX reserves coming off rapidly, global energy capex continues to implode. Turmoil in energy seems far from over, despite the recent price bounce. Defaults are rising across smaller oil & gas producers and risks are rising for larger ones too. Total energy debt in default has now reached $18bn, suggesting the credit cycle will mark a floor on oil prices. At present, the largest 25 US oil producers, comprising 4.1 million b/d, face an implied risk of default of 27%. Meanwhile, global energy output-weighted CDS risk is now well above 2009 levels.
  • Lower oil hurts assets, but will not cause a global recession: Are we about to see a global recession? Looking back, the global financial crisis came as a result of excess credit growth in real estate combined with a massive spike in oil to$147/bbl. US real estate debt amounted to $13tn in 2008, defaults exceeded 10% of this number, and losses neared $750bn. Today, most of the energy sector losses have come in the form of lower equity valuations for now. So the oil collapse has increased broad credit risk and equity fragmentation, but not equity volatility. Given the lower levels of leverage, we think the energy credit crunch will thus be mostly felt on oil output itself. Put otherwise, lower supply is priced in. Higher oil prices are not.
  • OPEC output freeze should help the market find a floor. To sum up, energy credit is upside down, risk capital has been scarred, trillions of dollars of equity wealth have vanished, and deflation fears have risen. The Saudi shift may have almost triggered a global recession. But not quite. Losses are highly concentrated and non-OPEC supply will likely now drop. Also, the OPEC accord to freeze output is an important step to stabilize oil prices or even global markets. With Saudi domestic demand surging 450 thousand b/d from winter to summer, exports may drop by a similar amount by July. Coupled with a $3tn a year wealth transfer from oil producers to consumers, we still see a strong summer driving season ahead and $47 oil by the end of June.

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