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Toxic Mix Blows up: Oil Price Collapse & Junk Bond Insanity
Wolf Richter www.wolfstreet.com www.amazon.com/author/wolfrichter
It’s now called a “collapse”: The US benchmark light sweet crude plunged 4.6% to settle at $81.84 a barrel on Tuesday, the lowest since June 2012. In London, Brent made a similar journey to $85.04, its lowest level since November 2010. Explanations abound why this is suddenly happening, after years of deceptive calm.
Is it some harebrained plot to punish Russia by destroying its economy? Signs of success are everywhere. The ruble is in free fall despite the central bank’s efforts to prop it up. Yield on Russia’s 10-year note is nearly 10%. The government’s budget, heavily dependent on oil revenues, is in trouble. And every unit of foreign currency that isn’t nailed down is fleeing the country.
Or is it a plot by Saudi Arabia to squash the US shale oil boom? In November last year, the Saudi Gazette published an editorial on the “successful, wise, and balanced OPEC strategy” that led to “unprecedented” stability of oil prices for the past few years of around $106 a barrel. But couched in words such as “skeptics are demanding,” it uttered the threat to raise OPEC production until the price would drop “below $70 a barrel” to “remove the shale oil from the world oil production map….”
Or is it the combination of surging production in the US and sagging demand around the world, particularly in China and Europe?
Demand for oil would inch up this year at the slowest rate since the terrible year of 2009, the IEA predicted. OPEC might not be willing or able to lower production, it said. Why? Because of the US shale boom. And so, “Further oil price drops would likely be needed for supply to take a hit – or for demand growth to get a lift.”
Whatever the reasons for the market chaos, we already know what it has accomplished in the US: Investors who were long when they sleepwalked into this new era that started in late June have had their heads handed to them. WTI gave up 21% in less than four months. Over the same period, the SPDR Oil & Gas Equipment & Services Fund (XES), a basket of the largest oil- and gas-related stocks, plummeted 33%. Shares of smaller oil and gas companies have gotten demolished.
Reason for this mayhem: the toxic mix of high debt and plunging oil price.
The oil and gas sector is capital intensive. Drillers have borrowed phenomenal amounts of money, which was nearly free and grew on trees, to acquire leases and drill wells and install processing equipment and infrastructure. Even as debt was piling up, the terrific decline rates of fracked wells forced drillers to drill new wells just to keep up with dropping production from old wells, and drill even more wells to show some kind of growth. One heck of a treadmill. Funded in part by junk bonds [read... Where Money Goes to Die: How Fracking Blows Up Balance Sheets of Oil and Gas Companies].
Junk bond issuance has been soaring as the Fed repressed interest rates and caused yield hungry investors to close their eyes and take on risks, any risks, just to get a teeny-weeny bit of extra yield. Demand for junk debt soared and pushed down yields further. And even within this rip-roaring market for junk bonds, according to Bloomberg, the proportion issued by oil and gas companies jumped from 9.7% at the end of 2007 to 15% now, an all-time record.
While the overall high-yield market is down 2.3% since the end of August, oil and gas junk debt has dropped 4.6%. But it hides the bloodletting beneath the surface.
Samson Investment, an oil and gas explorer headquartered in Tulsa, OK, owned by private equity firm KKR, extracted $2.25 billion of new money from gullible investors in July. In early August, these junk bonds still traded at 103.5 cents on the dollar. Then reality sank in, and that formerly low-risk paper plunged to 77.5 cents on the dollar.
Not just in fracking la-la land. Paragon Offshore, an offshore driller, completed its spinoff from Noble in early August. Its stock started trading at $17.50 a share and immediately plunged and is now down a cool 68% in the first 10 weeks as an independently traded company. In July, it also sold $580 million in 10-year junk bonds to your conservative-sounding bond fund at 100 cents on the dollar. Now they trade for 77.3 cents on the dollar.
Hercules Offshore, a Houston-based drilling company with the appropriate ticker HERO, saw its shares plunge 81% since July last year to $1.47 on Tuesday. In March, it had the temerity to sell – or rather investors had the Fed-induced idiocy to buy – for 100 cents on the dollar $300 million in junk bonds that now trade at 66 cents.
This is what happens at the tail end of a credit bubble. Investors still lust for high-risk debt because it offers a little more yield in the era of ZIRP, but that yield did not compensate investors for the risks they were taking on. Companies and Wall Street did what the Fed had wanted them to do: issue junk and push it into retirement portfolios where it can quietly decompose. And bamboozled investors – thinking that the Fed was the greatest thing since sliced bread – took this debt with a desperate grin.
Now that the bottom is falling out, it is getting more expensive for these companies to borrow. Newly awakened investors are demanding to be compensated at least a little for the risk, and that risk has now been exacerbated by the collapse of the price of oil. That’s the toxic mix.
If the money stops growing on trees, the jig is up for many of these over-indebted companies, and the American fracking boom may well do what other oil booms have done before, and what OPEC would like it to do: grind to a halt. And investors who’ve done what the Fed had wanted them to do – take on risks with their eyes closed – would lose their oil-stained shirts.
The broader market has, let’s say, some issues: “Too many poorly understood structural changes have created unstable markets. Now comes the dismount.” Read… Why the Market Swoon May Become “Disorderly on a scale not seen since the crash of 1987”
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I'm so crazy my natural impulse today would be to short ZB, the long bond contract; because it's too high. different markets behave differently, and this one likes to throw peaks and reverse. The trouble is; even if you get in short okay; where are youi going with it? there's not enough air under the price to make it worth any risk. You couldmake, 3000$ a contract; maybe; or you could get stopped out at $2,000/contract. so I doesn't make any sense. but I believe it will trade down for a couple of days.
Thank you for a couiple of old-time real ZH comments. Nice!
no no! saddle up there is work to be done and please bring the wheel gun....
Okay; so he's saying the same thing I been saying for a week now; it's a bear market now; not a bull market; so just sell rallies and don't buy any dips. I like this guys blog; he's smart and he stays connected to the real world; he's not a tin-foil hat type. Or, as I keep saying; you could open a futures account and use that to short the index when you wanted to; in the meantime watching for dumbness fully expressed; which you then go opposite to. (counter punching). A few years ago Corn went up to $9 and change, because of the "climate change weather" and there was going to be any more food, and so forth and so on; and at some point you see there's way too big an open interest in this contract and the price is just stupid; so you take a chance on it and short it for Dec. And what happens is it rains some, and things are n't as bad as they were said to be and you make some money; but corn stays too high for the following year; so you short it again and it goes down all year long and finally you end up with some thing like $15,000 per contract on 825$ corn contracts. It just took a long time for the anxiety to wear off. Just have an open ended idea; let it go as long as it wants; put in a zero loss stop if you're entry was goodand you get a little wind under your wings, and forget about it. You can't predict the future, but you can profit from it. The futures market is 20 times better regulated and charts ten times better than the stock market. The one exception of the century, John Corzine, who because of the breakdown of law, was able to steal clients money; but that normally does not happen.
"Now comes the dismount."
Overdue, way overdue.
I got off the nag in 2009.
Walmart never in Boston. There is actually no Walmart East of I 495 in the state of Massachusetts. And the uber yuppie crossfit crowd would be kicking and screaming should a Walmart ever appear within 30 miles of rt 128
In the Boston area you have all these snob yuppies from Belmont, Watertown and Brookline who love Target. It is acceptable discount for this uber yuppie crowd and many are the offspring of the top 2% surprised many voted for Obama out of guilt. Mitt Romney is from Belmont MA which is as snooty as Wellesley, Newton and Brookline
Basically after the failed NATO-CIA-State Dept. failure via Victoria Nuland's idiotic actions and failed,pitiful attempts at bringing nuclear armed missiles up to the borders of Russia through the Ukraine,they've said to the Russians "go ahead and produce everything you've got to the max.Saudi will roll over first,not Russia.It's a game of chicken but the U.S. will first destroy the ecomies of their corrupt Arab allies.Pretty stupid.
I've never seen such a poorly planned operation by the CIA.The 5 billion dollar wasted plan to take the Ukraine and put it with the EU was worse than theCuban invasion that went wrong.Putin saw and knew years ahead that they'd attempt to also take the Crimean Black Sea Naval Facility as well.It didn't work for the right wing neo nazis in the U.S. State Dept.Very incompetent plan by NATO partners that dragged along like blind and dumb sheeple.
I see this incident as the catalyst for the market sell off that also brought down Germany.
Well, maybe; but the Bay of Pigs wasn't the product of any genius, I can tell you that for sure. Jack Kennedy was going to close the place down, and had already fired it's director when they shot him. it shouldn't take you longer than 3 minutes to figure out that rogue elements in .gov shot JFK. the CIA has somehow been way too influential in all foreign policy ever since then.
Makes you wonder what Ambassador Stevens was doing to earn that sentence, for whom, and who should be next.
Just let me know when to get in NG futures.
Gas wars, yay!!
The price goes up, the price goes down. More hyperbole, "collapse".
The price of gas at the corner is still above $1.
Once the Saudis wash out frac oil in the US, the oil price recoil is going to be epic.
Putin is a patient man, and revenge is a dish best served cold. Very cold.
What would be the point? The big oil guys would just start fracking away the second it becomes profitable again.
Maybe. Only IF there's capital to start the fracking machine up again. Let's say you are a drilling company selling junk and the bottom drops out. When the price rebounds (and it will), assuming you're still around to float another bond offer, who's going to be buying? The once-fooled? I don't think so.
yeah; it's an interesting story;but so what? I'm particularly bad at trading Crude; I only made money off it a couple of times; once when I bought it at $11/barrel. Admittedly that didn't take a computer to figure out. Something to have opinions about, I guess.
Short airlines ? fracking companies?
are you seriously looking for trading ideas? why do you just think about stocks? go look at CME.com. there's lots of markets; some of them are guaranteed money makers, and your stop loss will get executed well. it actually works.
yippee...no more fracking and creating toxic water supplies.
Kudlow will be livid!
Maybe Kudlow will explain why this was part of the discussion between Kerry and the Saudis?
Is hurting Russia important enough to hurt your own industry?
Is this what Putin meant when he said that the US would "cut off your nose in spite of your face"?