Back in early November, when we posted "If WTI Drops To $60, It Will "Trigger A Broader HY Market Default Cycle", it was greeted with the usual allegations of conspiracy theorism, tin-foil hattery and pretty much everything else, except rebutting facts.
Two months later, it was none other than Goldman which threw in the towel on its call from July 28 of 2014 when it said that "the long-awaited global recovery appears to be getting on track, lifting commodity demand" and scrambled to explain overnight that nothing short of a mass default wave within the shale space will end the ongoing collapse in prices, which are driven not by supply/demand fundamentals but by ZIRP, and a generation of junk bond BTFDers, who can't wait to invest in the latest 10%, 15%, 20% or higher "yielding" opportunity (ignoring that the issuer may default before even one coupon is paid). In other words, those bond holders who wish to blame someone for the collapsing prices of junk bonds, feel free to address them to Ben Bernanke and his successor, who have enabled insolvent companies to live long beyond their viable lifecycle thanks to a zero cost of capital and a generation of traders who no longer know risk.
This is how Goldman's Currie tongue-in-cheekly explained this dilemma:
[U]nlike physical stress, how low prices need to go is dependent upon the producer’s view of the future and the persistence of the current low price environment. The lower and more persistent the producer views the future pricing outlook, the quicker the restructuring. Given the optimistic nature of the oil drilling business, producer views are unlikely to change until the environment becomes extremely hostile with prices low enough such that survival becomes questionable.
The endgame according to Goldman:
We believe a new industry will be born out of this environment with lower costs driven not only by cost deflation in other commodities, currencies, rig rates and oil services but also by substantial productivity gains created by engineers facing tighter margins. Although what exactly this new industry will look like is still extremely uncertain, we do know is that cost deflation has already created a 25% reduction in expenses. Accordingly, to reflect cost deflation in the industry and its sustainability through significant efficiency gains, we are reducing our 2016 and long-term price forecasts to $65/bbl and $70/bbl for WTI and Brent from $80/bbl and $90/bb,l respectively.
Of course, the tricky part is how does the US energy industry, and its stakeholders, go from Point A currently to the Point B lower-cost and general utopia. Sadly, the answer is with lots and lots of pain.
Because as Currie also pointed out, what comes next is an absolutely epic bloodbath for the US shale industry, and its most levered companies (a list of which we showed previously).
Case in point: a chart which we affectionately call the scariest chart for the US shale industry - namely the US rig count drop, which as Goldman notes, "is faster and larger than in any other bear market."
That's not why it is scary. The reason why is that the current rate of rig collapse is nowhere near enough. In other words, before the new pricing equilibrium can be established, virtually the entire US energy sector in its current appearance will have to be wiped out!
And yes, Goldman is right that once the new cost-structure is in place, there will be only smooth sailing ahead.
The problem is how we get from just shy of 100% on the red line to a number approaching zero in the next few months without not only a bloodbath across the US energy space, for both bonds and stocks, but also without a revolution in Texas, whose recession is all but assured...