• 3 hours The Best Way To Ride The Gold Rally
  • 24 hours Corn Industry Reeling After Shocking Ethanol Decision
  • 2 days Gold Miners Eye Further Upside
  • 2 days Alibaba Exec Sets Record With $3.5 Billion Brooklyn Nets Purchase
  • 3 days Smart Contracts: The Tech Reshaping Entire Industries
  • 3 days Protests Threaten $5 Billion Peruvian Copper Mine
  • 4 days Why Wealthy Kids Are Getting Into College For Free
  • 4 days Is Is Too Late To Get Into The New Gold Boom?
  • 4 days Solar Tech Breakthroughs Spark Surge In Adoption
  • 5 days These Rare Stones Are About To Become Priceless
  • 5 days Why Silver Miners Aren’t Living Up To Expectations
  • 5 days WeWork Reveals Huge Losses Ahead Of IPO
  • 6 days American Education Continues To Fall Behind China
  • 6 days EV Sector Needs 250% More Of This Metal By 2030 Just For Charging Stations
  • 6 days Why Gold Prices Are About To Skyrocket Even Higher
  • 7 days Scientists Create The World’s First 2D Gold
  • 7 days The Key To Commercial Fusion
  • 7 days Inflation Is Creeping Up In Consumer Goods
  • 8 days U.S. Healthcare Industry Could Be Decimated By The Trade War
  • 8 days Washington's $400 Billion Emissions Plan
Billionaires Are Pushing Art To New Limits

Billionaires Are Pushing Art To New Limits

Welcome to Art Basel: The…

The Problem With Modern Monetary Theory

The Problem With Modern Monetary Theory

Modern monetary theory has been…

Market Sentiment At Its Lowest In 10 Months

Market Sentiment At Its Lowest In 10 Months

Stocks sold off last week…

Oilprice.com

Oilprice.com

Writer, OilPrice.com

Information/Articles and Prices on a wide range of commodities: We have assembled a team of experienced writers to provide you with information on Crude Oil,…

Contact Author

  1. Home
  2. Markets
  3. Other

Could Falling Oil Prices Spark a Financial Crisis?

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 fromjunk-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 dramaticrise 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 orderto 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 relentlesslyclimbing, 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 steeplosses 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 becauseof 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 iscurrently 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, atleast 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 hedgedthemselves, 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 attractivenessof 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 oilprices 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

By Nick Cunningham of Oilprice.com

 

Back to homepage

Leave a comment

Leave a comment