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How Wall Street Helps US Oil Producers Extend-And-Pretend

Tyler Durden's picture




 

In “When QE Leads To Deflation: A Look At The Global Supply Glut”, we outlined, for all to see, how the monetary policies pursued by the world’s central banks have not only failed to create demand and meaningfully lift inflation expectations, but have in fact the opposite effect, creating a global supply glut and, in an irony of ironies, deflation. 

The cycle, which Citi says is “how zombies are born”, is nowhere more evident than among US oil drillers. Companies who would have otherwise been rendered insolvent by plunging crude prices have been able to keep drilling thanks to i) record low borrowing costs and ii) voracious demand for corporate issuance and ‘undervalued’ equity attributable to the fact that risk free assets fetch at best an inflation adjusted zero and at worst have a negative carry. 

Access to cheap cash keeps the supply coming which in turn keeps prices suppressed in a cycle that feeds on itself creating Citi’s “zombie” companies in the process. We’ve bemoaned this central bank-assisted aberration for quite a while now have variously warned that given the completely illiquid conditions that exist in the secondary market for corporate credit, the last thing anyone needs is a primary market bonanza for junk-rated borrowers. As for equity issuance, what gullible investor wouldn’t want to jump on a secondary from an otherwise insolvent producer. After all, prices will rebound eventually. BTFD, people.

Once the revolver raids start up again in October (when banks will once again assess credit lines to oil and gas producers) the defaults may be just around the corner. Then comes the rush to the HY ETF exits at which point horrified fund managers seeking to unload the underlying bonds will discover that there’s no one home at dealer desks thanks to the post-crisis regulatory regime. 

Now, everyone is picking up on the narrative. Here’s WSJ on how Wall Street is keeping the sector afloat and the world awash in crude:

Wall Street’s generous supply of funds to U.S. oil drillers helped create the American energy boom. Now that same access to easy money is keeping them going, despite oil prices that are languishing around $60 a barrel.

 

The flow of money into oil has allowed U.S. companies to avoid liquidity problems and kept American crude production from falling sharply…

 

Helped by a ready supply of money, the flow of oil from the U.S. could keep crude prices low for the remainder of 2015 and beyond…

 

Energy shares are lagging behind the overall stock market. Over the past year, the S&P 500 is up 9.6%, but energy stocks in the index are down 17.6%. Some investors, betting on an oil price rebound, regard energy stocks as a relative bargain.

 

“I’ve been surprised by the amount of money that has come into the sector” since oil prices started falling, said Paul Korus, chief financial officer of Cimarex Energy Co., a midsize energy company based in Denver.

 

Much of that stems from a fundamental belief that investors should buy now when oil prices are low, he says. “We all think there will be some sort of recovery, but we don’t know when it will recover and what it will recover to.”

 

Cimarex is one of several outfits to tap public markets by issuing more shares. In the first three months of 2015, U.S. listed companies issued $16.7 billion of new shares and convertible bonds, the highest level since 2010, according to Dealogic.

 

Most are using the cash to clean up their balance sheets. But Cimarex, which raised nearly $750 million in late May, plans on spending it to drill more wells in Texas, Oklahoma and New Mexico. The company had cut its rig count to six from 20; plans now call for nearly 20 rigs to be drilling again by the end of the year.

 

Banks aren’t reining in oil company borrowing, at least not yet. Loan officers surveyed by the Federal Reserve in April said they expect an increase in energy companies unable to pay back their loans, and were preparing by restructuring agreements.

 

Many companies have other options. Goodrich Petroleum Corp., concerned that its line of credit would be reduced, obtained a $100 million “second-lien” debt deal at a relatively high 8% interest rate.

Summing up the above in two graphics:

Trust us, this — like state governments issuing pension obligation bonds, like fund managers suggesting they will tap bank liquidity lines instead of selling assets when retail starts liquidating esoteric ETF units in a panic, and like every other example of "extend-and-pretend" which now exists in one form or another in virtually every corner of the market — will not end well.

 

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Mon, 06/01/2015 - 13:07 | 6152163 Arthur Schopenhauer
Arthur Schopenhauer's picture

Let them eat cake during their earthquake!

 

Oklahoma is latest state to prevent local fracking bans Posted on May 29, 2015 | By Associated Press OKLAHOMA CITYOklahoma cities and counties would no longer be able to ban hydraulic fracturing or other oil and gas operations within their boundaries under a bill signed into law on Friday by Gov. Mary Fallin. Pushed hard by the oil and gas industry, but fiercely opposed by municipalities and environmental groups, the bill specifically prohibits cities or towns from banning operations such as drilling, fracking, water disposal, recovery operations or pipeline infrastructure. Fracking is the practice of high-pressure injection of water, sand and chemicals underground to free deposits of oil and gas, which has led to a boom in U.S. energy production. A similar ban was signed into law last week by Texas’ Republican Gov. Greg Abbott, as energy producing states push back against efforts by local governments to limit the practices. Fallin and other Republican supporters say the bill reaffirms the three-member Oklahoma Corporation Commission as the regulator of the oil and gas industry and prevents a patchwork of inconsistent regulations across the state. “Corporation commissioners are elected by the people of Oklahoma to regulate the oil and gas industry. They are best equipped to make decisions about drilling and its effect on seismic activity, the environment and other sensitive issues,” Fallin said in a statement. “The alternative is to pursue a patchwork of regulations that, in some cases, could arbitrarily ban energy exploration and damage the state’s largest industry, largest employers and largest taxpayers.” But critics note the energy industry is among the primary contributors to the political campaigns of corporation commissioners and that the regulatory panel has done little to restrict practices such as wastewater injection wells, which have been linked to a dramatic increase in earthquakes across Oklahoma. Earthquake activity in Oklahoma in 2013 was 70 times greater than it was before 2008, state geologists reported. Oklahoma historically recorded an average of 1.5 quakes of magnitude 3 or greater each year. It is now seeing an average of 2.5 such quakes each day, according to geologists. “At the very time local governments really need to have the ability to address a serious safety issue in their communities, the state is stepping in and taking that very authority away from them,” said Johnson Bridgwater, director of the Oklahoma Sierra Club. Norman Mayor Cindy Rosenthal said she’s most concerned that cities may not have the authority to regulate the disposal of wastewater into the drainage basin that leads to Lake Thunderbird, the primary water supply for as many as 200,000 people in several metro-area communities. “There’s nothing in the bill that says cities can have the authority to protect local drinking water supplies,” Rosenthal said. “There’s never been a discussion in the City of Norman about banning drilling. It has taken place and it does take place.” The Oklahoma bill, which takes effect in 90 days, does allow municipalities or counties to enact “reasonable” regulations concerning road use, traffic, noise and odors incidental to oil and gas operations. It also authorizes the establishment of requirements for fencing around oil and gas drilling sites and how far away from homes or businesses a well site can be located.

Mon, 06/01/2015 - 13:20 | 6152185 remain calm
remain calm's picture

Ahhhh Hello, THe Yen is crashing Tyler. This is significant. Can you get some lacky to do a story on what could be the black swan. Oh wait, someone will come in and save the day and buy the Yen. LMAO. Hello?

Mon, 06/01/2015 - 13:57 | 6152339 NotApplicable
NotApplicable's picture

Borrowing at 8% to drill for oil at these prices?

That's like stupid at least to the third power, if not fourth!

Doesn't Iran oil come back into the market this month as well?

Mon, 06/01/2015 - 14:04 | 6152370 Jack Burton
Jack Burton's picture

They are doing it in the vain hope of a mass rebound in oil prices. It's desperate and mad, but they want to live to be pumping when oil skyrockets. That is their gamble, and why they borrow at mad rates to fund operations, while losing money on every barrel produced. Lots a banks gonna suffer losses IF the oil price rebound isn't in the cards within 12 months or less.

Mon, 06/01/2015 - 13:11 | 6152172 Kreditanstalt
Kreditanstalt's picture

Not only oil drillers.  All reality needs to come charging through is for some entity, somewhere - a bank, corporation, government, borrower, LBO, investment fund whatever - to go INCONTROVERTIBLY, OPENLY and UNDENIABLY BANKRUPT for all to see.  

If that happens, said entity will be unable to cough up the expected passive income stream that the other players count on.  BANG: no moe "growth".

And, remember...today "investing" is limited in definition to "buying a debt paying an income stream".

The governments - naked themselves - are constantly extending, pretending, faking, delaying, hiding and lying to prevent ANY insolvency appearing to happen...

Future and realty AVOIDANCE.

Mon, 06/01/2015 - 14:06 | 6152382 Jack Burton
Jack Burton's picture

And, remember...today "investing" is limited in definition to "buying a debt paying an income stream". Indeed! +100,  With fixed assets at zero to negative, everyone is looking to buy a debt vehicle. And YES, when one stream is shut down by BK, the chain of investments goes tits up.

Mon, 06/01/2015 - 13:10 | 6152173 Bill of Rights
Bill of Rights's picture

Free markets bitches!

 

https://www.tradingview.com/x/PASSi0Ec/

Mon, 06/01/2015 - 13:11 | 6152176 KnuckleDragger-X
KnuckleDragger-X's picture

Oilmen and optimists both playing in the oil patch. The oilmen who have been in the game a long time are still drilling their best leases and sitting back, waiting for the optimist's, who are punching holes and hoping for a payback, to tank, so they can buy up the best leases...cheap.....

Mon, 06/01/2015 - 13:46 | 6152276 Bangin7GramRocks
Bangin7GramRocks's picture

Goldman said, "it's all Greek to me."

Mon, 06/01/2015 - 13:54 | 6152326 Osmium
Osmium's picture

None of this is important.  NASDAQ set to punch through 5100

Mon, 06/01/2015 - 14:09 | 6152396 Jack Burton
Jack Burton's picture

Oil is by definition boom and bust. But we have also NEVER seen oil markets and producers react to the modern QE and ZIRP world. In short, the past action of oil markets may NOT be a guide to what happens in the 2015 oil markets, oil has never been in a QE and ZIRP world of central bank liquidity dumping. So just about anything can happen. Finance and central banks are driving all markets in a way that is not free market, that is not price discovery. Those days are over.

Mon, 06/01/2015 - 15:17 | 6152689 fremannx
fremannx's picture

"In short, the past action of oil markets may NOT be a guide to what happens in the 2015 oil markets"

OIL markets are on the same long deflationary road as equities, commodities, bonds, futures and precious metals...

http://www.globaldeflationnews.com/oil-light-sweet-crudeelliott-wave-upd...

Mon, 06/01/2015 - 15:12 | 6152673 fremannx
fremannx's picture

"...the era of easy money has in fact led to deflation."

As has been argued here for years. If there was any doubt left as to whether inflation or deflation is most influencing the global economy, that argument no longer supports the inflation camp.

http://www.globaldeflationnews.com/inflation-vs-deflation-part-1which-on...

Do NOT follow this link or you will be banned from the site!