Commentary: Could falling oil prices spark a financial crisis?
05 December 2014
by Nick Cunningham of Oilprice.com
The oil and gas boom in the United States was made possible by the extensive credit afforded to drillers. Not only has financing come from company shareholders and traditional banks, but hundreds of billions of dollars have also come from junk-bond investors looking for high returns. Junk-bond debt in energy has reached $210 billion, which is about 16 percent of the $1.3 trillion junk-bond market. That is a dramatic rise from just 4 percent that energy debt represented 10 years ago.
As is the nature of the junk-bond market, lots of money flowed to companies with much riskier drilling prospects than, say, the oil majors. Maybe drillers were venturing into an uncertain shale play; maybe they didn’t have a lot of cash on hand or were a small startup. Whatever the case may be, there is a reason that they couldn’t offer “investment grade” bonds. In order to tap the bond market, these companies had to pay a hefty interest rate.
For investors, this offers the opportunity for high yield, which is why hundreds of billions of dollars helped finance companies in disparate parts of the country looking to drill in shale. When oil prices were high and production was relentlessly climbing, energy related junk bonds looked highly profitable.
But junk bonds pay high yields because they are high risk, and with oil prices dipping below $70 per barrel, companies that offered junk bonds may not have the revenue to pay back bond holders, potentially leading to steep losses in the coming weeks and months.
The situation will compound itself if oil prices stay low. The junk bond market may begin to shun risky drilling companies, cutting off access to capital. Without the ability to finance drilling, smaller or more indebted oil companies may not have a future. The Wall Street Journal profiled a few fund managers who are beginning to steer clear of smaller oil companies. Moody’s Investors Service downgraded the oil and gas sector on November 25 to a “negative” outlook because of falling oil prices.
If oil prices stay at $65 per barrel for three years, 40 percent of all energy junk bonds could be looking at default, according to a recent JP Morgan estimate. While that is a long-term and uncertain scenario, the pain is being felt today. The FT reported that a third of energy debt issued in the junk-bond market is currently in "distressed" territory.
That begs the question; could a shakeout of the oil industry spark a broader financial crisis? Banks and other financial institutions could be overly exposed to energy debt. The Telegraph paints a dire scenario in which the debt bubble bursts because of low oil prices, leading to a cascading 2008-style financial collapse, at least in the junk bond market.
Such a scenario may be a bit overblown. Persistently low interest rates keep demand for junk bonds high, meaning oil companies will probably be able to restructure their debt and continue to access capital. Also, drillers will not immediately face an existential crisis because many have hedged themselves, locking in prices for a certain amount of production.
But a junk bond crisis could become more likely if oil prices stay low for an extended period of time. Once a few companies begin to default, the problem could quickly spread. Another variable is how quickly the U.S. Federal Reserve will raise interest rates, which could significantly affect the attractiveness of the junk bond market.
Local and regional banks could be highly exposed as well, especially if energy loans make up a large share of their lending portfolio. The Wall Street Journal pointed out that banks like Oklahoma-based BOK Financial—with 19 percent of its loan portfolio made up of energy loans—could be the most vulnerable. Moreover, an economic downturn in regions that depend heavily on energy, such as Texas or North Dakota, could see a broader decline in demand for loans of all kinds. That could add to the pain for local banks.
Low oil prices are not just a problem for oil companies. Investment funds, hungry for yield in a low interest rate environment, have poured money into oil and gas. To be sure, we are far from a crisis at this point, but if oil prices don’t rebound, a lot of people are going to lose a lot of money.
Source: http://oilprice.com/Energy/Oil-Prices/Could-Falling-Oil-Prices-Spark-A-Financial-Crisis.html
Tough! The Oil Industry seems to want to become some kind of protection racket, going by this article; Pay our exorbitant profits or else, we'll create a financial crisis.Just as those of us whose cost of living is so negatively impacted by the price of oil see perhaps a glimmer of hope, up pops some Oil-industry shill to threaten us not to.The sooner we get rid of our dependence upon this evil stuff, the better!
Posted by: Peterww | 05 December 2014 at 04:07 AM
The good news is that only about 30% of the cost of a well is in the drilling (the rest is in "completion"), and about 30% of a shale well's production comes in the first 12 months. A slowdown in drilling and delaying completions will cut the oversupply fairly quickly.
The bad news is that people aren't realizing that the rapid production declines and small "sweet spots" of the shale plays means the current situation will be very, very short-lived.
Posted by: Engineer-Poet | 05 December 2014 at 10:33 AM
No worries, the congress and the president will once again force the American people to bail out the "too big to fail" companies. I am sure the folks working down at McDonald wouldn't mind chipping in a bit more. You know that the "drill baby drill" crowd won't help out as it's pretty well known that they are all fakery and fluff, simply actors upon the stage once tread on by Lord Reagan.
Posted by: Brotherkenny4 | 05 December 2014 at 12:49 PM
You guys should just listen to yourselves.
Do you understand what you write?
The article claims the oil glut might fail some bonds and some oil companies (mostly small).
Gee, no kidding?
So Pww says; "up pops some Oil-industry shill to threaten us not to."
Not to what?
E-P says; "... the current situation will be very, very short-lived."
You're sure? I don't recall you predicting the current situation.
And I don't know if it's even safe to break into BK4's ramble.
Posted by: ToppaTom | 05 December 2014 at 01:47 PM
Don't worry, ToppaTom,and everyone else, I have an idea:
The US GOV can bail out the small-time and in-debt US oil producers by secretly quadruple, or quintuple, or sextuple the national strategic oil reserve, and buying a lot of domestically-produced oil to fill up the reserve, at currently low prices.
In the meantime, there will be expected cut back in oil drilling and exploration to heat up the prices of oil again in the future. Then the US Gov will sell off oil from those strategic reserve and make decent profits to help the National Debt, while ease the future oil price shock that will no doubt tank the future economy again like in 2008. The profit in future oil sell from the Strategic oil reserve can be used to fund the Hydrogen Economy, so that we won't have to face future oil shocks ever again!
This should be a win-win solution for everyone.
Mr. Obama, are you reading this?
Posted by: Roger Pham | 05 December 2014 at 02:25 PM
No need to increase or decrease the Strategic Petroleum Reserve for the indefinite future. There is at least 4 months US supply per bbl already, though low grade, which can be diluted with higher grade frack liquids to benefit existing refineries. By the time the full price situation shapes up, Venezuela will be desperate to sell and increase production, competing with Athabasca sands; Deep well production will have shifted from the Russian arctic to Africa; The Chinese refinery glut will actually force down retail prices, despite the tendency of low prices to benefit refiners; And tankers will be used increasingly as an immobilized strategic petroleum reserve, suggesting that a "virtual reserve" of finished oil product inventory can be ascertained and managed.
Behind all this are two facts. One is that conventional oil wells cannot be shut down and switched back on, for fear of creating problems in porosity and pressure. In some cases, maintenance of either has sunken capital which is partly responsible for the junk debt. Second, frack wells CAN be effectively switched on or off, due to the incremental approach to pressurization and extraction now favored.
There has already been great mobility in frack development, as such sites such as Tennessee Devonian have been abandoned in search of more profitable fields up north. But they can be reopened, and increased in density. Natural gas, the byproduct of any fracking economy, is the real play to supress oil prices, by using it as motor fuel or feedstock.
Posted by: kalendjay | 05 December 2014 at 03:43 PM
I agree TT, here's another mindless lunatic rant:
***"abandoned in search of more profitable fields up north. But they can be reopened, and increased in density. "
At what cost? or do Haliburton grade well leaks become suddenly O.K. when numbering in their thousands?
Posted by: Arnold | 05 December 2014 at 06:02 PM
Yes, anything can cause a financial crisis, that requires a government bailout.
Posted by: dursun | 05 December 2014 at 11:57 PM
I think the impact here will be small compared to the most recent sub-prime MBS fiasco that took down Bear-Sterns/Lehman/Country-Wide and led to the bailout of AIG/Fannie and Freddie who insured the debt against default (AIG) or guaranteed the cash flows for subsequent bond holders (Fannie and Freddie). The treasury had to step in to prevent a snowball collapse of all the other major financial players.
I think the risk is much more well understood and managed in the Oil-production market as compared to the MBS Debt & Derivatives markets. This market is hedged fairly well.
Posted by: Dr. Strange Love | 06 December 2014 at 04:27 PM
Let's not forget that USA is still one of the major Oil importer and should benefit from lower Oil prices to become more competitive in International Trades, but so will become many others.
Oil exporters, like; all OPEC nations, Iran, Irak, Russia, Venuezela, Canada. high price producers etc will be the real losers if low Oil prices last more than 3 to 6 months. Specially, it Oil price falls below $60.
Posted by: HarveyD | 07 December 2014 at 08:24 AM
I find it very interesting that the price of motor gasoline has fallen a great deal, but ULSD has not.
Posted by: Engineer-Poet | 07 December 2014 at 08:31 AM
Hey Arnold, were you referring to my 'mindless lunatic rant'?
You might at least rebut it personally to me instead of the bonafide ranter, TT.
Second, you might start reading a few articles in business and economics, instead of spouting vaseline from your nostrils.
Third, what Halliburton grade well leaks are you referring to? Do I detect yet another strait-jacket fashionista in the BushWar rant department?
The next time I source you for your supposed wisdom, remember to hold a glass under your nostrils before we squeeze your head.
Posted by: kalendjay | 07 December 2014 at 06:48 PM
From a climate point of view, when you’ve got thousands of wells all emitting (methane) during drilling, it’s not inconsequential anymore,” Ingraffea said. "To say we get a pass on natural gas is not faring up to current science. It is not a bridge fuel, there's too much leakage."
Do I detect yet another strait-jacket fashionista in the BushWar rant department?
No, I'm proudly original.
Why would you need to source your wisdom from me, it took all of three minutes to find reliable referances.
http://energyblog.nationalgeographic.com/2014/02/13/methane-emissions-far-worse-than-u-s-estimates-but-study-concludes-natural-gas-still-better-than-coal/
http://rt.com/usa/methane-emissions-fracking-underestimated-epa-024/
http://news.nationalgeographic.com/news/2010/10/101022-energy-marcellus-shale-gas-overview/
or this from
http://www.huffingtonpost.com/2014/04/16/methane-leak-natural_n_5161247.html
From a climate point of view, when you’ve got thousands of wells all emitting (methane) during drilling, it’s not inconsequential anymore,” Ingraffea said. "To say we get a pass on natural gas is not faring up to current science. It is not a bridge fuel, there's too much leakage."
The study says there is an urgent need to identify and plug methane leaks in shale gas production nationwide.
But identifying and shutting off all the leaks in the natural gas production and distribution system in the U.S. could be costly.
Or closer to home for me
The Montara oil spill was an oil and gas leak and subsequent slick that took place in the Montara oil field in the Timor Sea, off the northern coast of Western Australia. It is considered one of Australia's worst oil disasters.[1] The slick was released following a blowout from the Montara wellhead platform on 21 August 2009, and continued leaking until 3 November 2009 (in total 74 days), when the leak was stopped by pumping mud into the well and the wellbore cemented thus "capping" the blowout.[2][3] The West Atlas rig is owned by the Norwegian-Bermudan Seadrill, and operated by PTTEP Australasia (PTTEPAA), a subsidiary of PTT Exploration and Production (PTTEP) which is in turn a subsidiary of PTT, the Thai state-owned oil and gas company was operating over on adjacent well on the Montara platform. Houston-based Halliburton was involved in cementing the well.[4] The Montara field is located off the Kimberley coast, 250 km (160 mi) north of Truscott airbase, and 690 km (430 mi) west of Darwin.[5][6][7] Sixty-nine workers were safely evacuated from the West Atlas jackup drilling rig when the blowout occurred.[6][8]
Keeping on going
Lead Commission Investigator Says Halliburton Knew ...
www.salem-news.com/articles/october292010/haliburton-obama.php
Oct 29, 2010 - ... testing should have raised doubts about cement used to seal the well. ... Investigator Says Halliburton Knew Cement Would Allow Oil Leaks.
Halliburton pays $1.1bn to settle Gulf of Mexico oil spill ...
www.telegraph.co.uk › Finance › News by Sector › Energy › Oil and Gas
Sep 2, 2014 - Halliburton, the American contractor that worked on BP's Deepwater ... of barrels of oil to leak from the Macondo oil well into the sea, in the ...
Halliburton Denies Destroying Evidence in BP Oil Spill Case ...
www.bloomberg.com/.../halliburton-denies-destroying-evidence-in-bp-o...
Jan 4, 2012 - Halliburton Co. denied BP Plc's accusation that engineers destroyed ... about the cement job Halliburton provided to seal the well against leaks, ...
Methane leaks during the fracking process likely cancels out any benefit ... Act) is a House bill intended to repeal the Halliburton Loophole and to require the ... The problems typically stem from poor cement well casings that leak natural gas as
Posted by: Arnold | 08 December 2014 at 01:28 AM
Arnold, you are such a "proudly original" Huffand Puff Po-ista, that you draw scientific conclusions without careful analysis, balance, or even inquiry. To whit:
>Wood is still the most widely used fossil fuel in the world, and supplies are dwindling, even as land is denuded and greenhouse gas sinks are lost,
>Forests and algal bloom produce vast amounts of methane, along with lakes and ocean floors. You might look up some recent conclusions about the Atlantic-US shelf, which needs no Halliburton to produce its very high levels of methane,
>If the earth is warming, enough methane will be released from Siberian and Alaskan tundra to account for 150 years of manmade CO2 emissions!
>Rice cultivation, which has been touted as the most efficient system of agriculture, releases vast quantities of NOX, an extremely potent greenhouse gas. Barely any progress has been on NOX containment from auto exhaust, especially since biofuel production only increases it,
>Airborne particulates are only beginning to be studied for their climatological effects. They are arguably more pernicious than greenhouse gases because of their tendency to cover snowpacks and aggregate in the lower atmosphere. They do not wash out easily in the rain -- Any chemistry professor will tell you that sunsets are red because of manmade soot collected over millenia, not prismatic effects on low angle sunlight,
>Gas is far more environmentally friendly than oil or coal, but if you really despise gas, you might remember H2O is a far more potent greenhouse gas than CO2, and two parts H2O are produced for one of CO2!
So what shall we do for the foreseeable future without oil and gas, and some cheap stuff insofar as some of us can barely afford to live? I would gladly warm my home with all your Halliburton and Bush news clippings.
Posted by: kalendjay | 10 December 2014 at 04:28 PM
At the end of 2014 it became clear that the collapse of oil prices had a significant impact not only on the position of the oil sector, but also led to unintended consequences in other areas of the fuel and energy complex.
Posted by: Frank Young | 03 January 2015 at 02:03 PM