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One of the biggest risks to the world’s financial system is the $3 trillion of debt owed by oil and gas firms

Consumption

[ Yet another “crash coming soon” post, if it hasn’t happened already (I scheduled this article and others to appear a year or more later, since crashes always take longer to happen than you expect.

Alice Friedemann   www.energyskeptic.com  author of “When Trucks Stop Running: Energy and the Future of Transportation”, 2015, Springer and “Crunch! Whole Grain Artisan Chips and Crackers”. Podcasts: Practical Prepping, KunstlerCast 253, KunstlerCast278, Peak Prosperity , XX2 report ]

Denning, L. March 30, 2016. The extend-and-pretend oil market. Bloomberg.com

In several recent reports, energy economist Phil Verleger has laid out the unsettling similarities between the U.S. residential construction bubble and the later surge in oil and gas drilling investment.

We’ll still be arguing decades from now about exactly why we collectively went crazy for Floridian sub-divisions and the like, but cheap and plentiful credit was clearly a big factor.

The same goes for the oil and gas boom.

The face value of energy debt as a proportion of the BofA Merrill Lynch High Yield Index has surged from 6% in 1997 to 16% today.

[ My comment: When oil and gas cause the next financial crash, it will not only be “dumb money” middle class Americans who are plowing their money into high-yield bonds and stocks to make back their money from 2008, but also foreign countries who’ve invested $450 billion in debt securities such as Brazil, China, Colombia, Indonesia, Kazakhstan, Kuwait, Malaysia, Mexico, Nigeria, Qatar, Russia, UAE and Venezuela.

Just as the housing bubble relied on faith in U.S. house prices only going up, so investors’ willingness to buy the energy sector’s bonds (and stocks) rested on a couple of intoxicating assumptions: OPEC would backstop prices and China would never falter (so, about that…)

American exploration and production companies weren’t the only ones on a debt-and-drilling binge. Last month in London, Jaime Caruana of the Bank for International Settlements gave a speech on the interplay of “Credit, commodities, and currencies.” He noted that loans and bonds outstanding for the oil and gas industry had almost tripled between 2006 and 2014 to $3 trillion, including a large slug taken on by firms in emerging markets.

Just as the mortgage pile-up transformed the U.S. housing market, so the legacy of the energy sector’s credit craze will live on in several important — and conflicting — ways, for years to come.

One effect Caruana highlighted is how a high debt burden focuses the mind on generating cash flow to meet interest payments. This surely explains at least some of the sheer resilience of not just U.S. but global oil production in the face of low prices. While banks must eventually pull lines of credit from struggling oil producers, they are no doubt loath to take ownership of leases and rigs in a bankruptcy situation, putting off the day of reckoning.

If that prolongs the market’s pain today, though, it also offers some hope for tomorrow. Going back to Verleger’s chart above, he rightly shows that investment in new oil and gas prospects is set to plummet well below what the International Energy Agency says is needed.

Indeed, earlier this month, the IEA’s head of its Oil Industry and Markets division warned that today’s low oil prices are setting up a potential supply shock in the “not too distant future.”  Meanwhile, at Chevron’s analyst day earlier this month, the company essentially drew a line under the multi-billion dollar projects that have turned off shareholders in recent years while simultaneously talking up growth prospects in its Permian shale assets.

This re-balancing of the oil market is exactly what is being delayed by the effect of high debt and ultra-low interest rates. But any spike would have two edges.

The lesson of 2008’s spike for OPEC is that while it may want higher prices, what it really needs are stable prices that aren’t too high. On that basis, rather than hoping to destroy shale with its current policy, OPEC is likely counting on it to act as something like an automatic stabilizer for the oil price in future.

The other wild card here, though, is the Fed’s timing on raising rates further. When this happens eventually, it could have two very negative effects on the debt-laden oil market.

First, cheap financing is helping to keep bulging oil inventories in their tanks. Wednesday’s weekly report from the Energy Information Administration showed, yet again, that stocks are far above normal levels. When oil prices rally, though, this squeezes the profits that can be earned by buying oil and storing it to sell at a future date. The spread between the cash price and the six-month forward contract has more than halved since mid-February

You know what else squeezes a carry trade and could force those millions of barrels back onto the market? The cost of financing the trade going up.

The second impact of rising Fed rates goes back to Caruana’s speech. The explosion of borrowing in emerging markets, especially when denominated in U.S. dollars, is a ticking time bomb for the global economy. When rates start rising, pulling the value of the dollar up with them, the pressure on not just oil companies but all heavy borrowers in developing markets will intensify. And it just so happens that the developing world accounts for all of the projected growth in oil demand over the next five years, based on the IEA’s numbers.

Yellen’s caution, like OPEC’s freeze tease, bolsters the extend-and-pretend oil market. The debt always comes due at some point, though.

Cries of agony: energy’s bad debts.  Economist.

One of the biggest risks to the world’s financial system is the $2.5 trillion of debt owed by oil and gas firms. After a year from hell, prices of commodities, and the shares and bonds of the firms that produce them, have bounced in the past month. But the evidence of financial pain is all around. Last week Energy XXI, an explorer with $4 billion of debt, filed for bankruptcy in Houston. And JPMorgan Chase, Wells Fargo and Bank of America complained of rising energy-sector bad debts in their first-quarter results. Only 5% of global energy debt sits on the balance-sheets of America’s biggest three banks. A further 34% of global energy debt comes in the form of US-listed bonds. The majority of global exposure is hidden in smaller banks or beyond America’s borders. With a Saudi-led attempt to curb oil output ending in failure yesterday, expect more yelps.



10 Comments on "One of the biggest risks to the world’s financial system is the $3 trillion of debt owed by oil and gas firms"

  1. Outcast_Searcher on Thu, 24th May 2018 11:34 am 

    Let’s pretend oil prices are no different than in March, 2016.

    And let’s pretend that the big oil companies aren’t raking in $billions of profits in recent quarters.

    If this is the best the energy skeptic has (old FUD), I’m very skeptical of them.

  2. MASTERMIND on Thu, 24th May 2018 11:51 am 

    Outcast

    Don’t you ever get tired of spending all of your life trying to refute every single thing on a doomer blog? I mean you are nonstop on the forum section as well..Where you have to censor others to win arguments..its obvious you think if you just refute every single claim than everything will be okay..I think renewable s and religion are scams..but the last place you would ever find me is on sites devoted to them..Why? Because I really believe they are scams..I don’t need to win arguments with others who believe in them.

  3. jawagord on Thu, 24th May 2018 11:53 am 

    Ya, $30 a barrel oil and bank debt is a problem, $70 a barrel oil and it’s would you like to borrow some more!

  4. MASTERMIND on Thu, 24th May 2018 12:16 pm 

    Jawgord

    Oil averaged 50 dollars in 2016..Which is only 15 dollars higher than its averaged this year..
    That helps but its not a game changer..

    https://oilprice.com/oil-price-charts/block/1

  5. jawagord on Thu, 24th May 2018 2:20 pm 

    I’m sure it moves the bar significantly, $15 dollars on average of 90 million barrels per day is a lot of dinero.

  6. deadly on Thu, 24th May 2018 4:56 pm 

    3 000 000 000 000/7 500 000 000=30 000/75=2 000/5=400

    The US gov can issue a check to everybody on earth, the checks can be signed over to the CBs and pay the money owed by the oil companies.

    It’s only money, Purdy much worthless stuff these days, so who cares? Don’t really need it that bad.

    Not a problem to print three trillion dollars.

    Pallet up thirty billion hundreds and deposit them at Goldman Sachs.

    Well, give a trillion to the Pentagon and forgive a trillion of the debt.

    Everybody on earth has to pay their fair share and it is imperative to make sure there is enough for defense too.

    A guaranteed income dedicated to pay the costs of oil debts.

    Once the debts are paid, the oil companies will be paid a two trillion dollar payment from the guaranteed income trust fund, the Pentagon will receive one trillion each year in perpetuity.

    You can’t just give 7.5 billion people 400 dollars each, most will drink it up.

    The money will be in the right hands. That will be the oil companies and the Pentagon.

    The printing presses are in full swing right now.

  7. Sissyfuss on Thu, 24th May 2018 8:20 pm 

    With all that oily debt accrued by Wells Fargo it’s no wonder they’re constantly ripping off every customer they can.

  8. Free Speech Forum on Fri, 25th May 2018 4:09 am 

    Americans are whistling down to the concentration camps and you’re going to say nothing?

  9. Davy on Fri, 25th May 2018 6:00 am 

    Elevated debt is pervasive now. Oil is only part of this. It is all part of the Ponzi economics that underlies our system. This includes a huge transfer of wealth from sectors and classes. We should keep this energy debt in perspective to other debt. We should also realize the importance of this debt in stimulating demand. Peak oil may be talked about as dead but let’s see what happens when shortages come for whatever peak oil dynamic pops up. Renewable transition is nowhere in sight yet and likely will only be an extender.

    This Ponzi economics is now hardwired into the system. It appears loosely coordinated globally by central banks. This means that they realize their freedom of movement is limited individually but it is still a high stakes poker game. These banks can ruin the game or they can cooperate. This is much like the socio political arrangement in other areas of civilization. We are in a competitive cooperative world driven by price and profit but also interests and emotions. This civilization appears in decline and decay but there is still plenty of growth. This growth is not sound in all cases and this then becomes part of the Ponzi. We extend and pretend what must be to ensure the scheme continues.

    It has always been this way because humans are not long term sustainable. It is just that now the process is speeding up as we approach limits. Time is speeding up so actions have greater impact and problems build quicker. This oil debt is just one sector where debt in the form of yield seeking of risk has occurred. Globally low interest with liquidity in search of yield as it turns out is not necessarily productive. Much of the corporate world is insolvent if rates normalized to pre-08 levels. It can’t happen so it won’t and if it does it is over. We can’t clean this up anymore it is too big. It is similar to carbon and the climate. The numbers are too large now.

    Since this is the new normal let’s try to be aware we can’t reminisce about the past and compare it to now except as an indulgence. Don’t think you can bring back that reality. There is no going back because the door is closed. There are consequences and in the end pain and suffering but there is also the here and now. So let’s make the best of it now. Maybe we have a decade or two but “this” can’t last. Go ahead and whine about debt levels. Cry crocodile tears over the dollar. BOOHOO China and their astronomical credit levels. One day that government and all others will be insolvent. That is the law of the numbers when exponential.

    Let’s be happy about shale or drink your Jim Jones Kool-Aid because oil still drives the global economy. Some of you hate oil so buck up and drink sucker. This article brings up the other point that this oil debt is not only shale related it is the entire global oil complex. Higher prices will help for a time but higher prices will over time lower investments too. Economies are damaged by rising prices. That is a no-brainer but what is unclear is what happens now with high prices in this new normal? That is not a no brainer. Is there a goldilocks range anymore? With price discovery and real debt service levels obscured what is a proper price for consumer and producer?

    Personally I think we are kissing goldilocks now. Yet, we know prices never stay where they should. If it goes higher of course damage will be done but what damage? We know what low prices did because we were there. Now what will higher prices do in an economy where easing is being tightened? Will debt just build elsewhere as the balloon is squeezed? Debt is hitting limits now so where can it go? So how high can prices go? The central banks will have no choice but to act because this is not their game really. The system is now the master. We opened the door on something we don’t really understand. It will seek its own level like water regardless of what central banks think they are doing. Oil is stuck in this rock and a hard place. It is vital so it will likely be the last man standing in the final battle. Get used to these weird anomalies when reminiscing about the old days.

  10. MASTERMIND on Fri, 25th May 2018 6:25 am 

    Mapping the rising tide of suicide deaths across the United States

    Rates in rural Western counties start off high and rise even higher. A swath of the country running from Oklahoma through the Appalachians stands out, as well.

    https://www.washingtonpost.com/news/wonk/wp/2018/05/24/mapping-the-rising-tide-of-suicide-deaths-across-the-united-states/?utm_term=.2a74f591a760

    Peckerwoods with those high iq’s are dropping like flies..

    LMAFO!!!!!

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