Posted on 12/20/2014 8:06:02 PM PST by NKP_Vet
There has only been one other time in history when the price of oil has crashed by more than 40 dollars in less than 6 months. The last time this happened was during the second half of 2008, and the beginning of that oil price crash preceded the great financial collapse that happened later that year by several months.
Well, now it is happening again, but this time the stakes are even higher. When the price of oil falls dramatically, that is a sign that economic activity is slowing down. It can also have a tremendously destabilizing affect on financial markets.
As you will read about below, energy companies now account for approximately 20 percent of the junk bond market. And a junk bond implosion is usually a signal that a major stock market crash is on the way.
So if you are looking for a “canary in the coal mine”, keep your eye on the performance of energy junk bonds. If they begin to collapse, that is a sign that all hell is about to break loose on Wall Street.
It would be difficult to overstate the importance of the shale oil boom to the U.S. economy. Thanks to this boom, the United States has become the largest oil producer on the entire planet.
Yes, the U.S. now actually produces more oil than either Saudi Arabia or Russia. This “revolution” has resulted in the creation of millions of jobs since the last recession, and it has been one of the key factors that has kept the percentage of Americans that are employed fairly stable.
Unfortunately, the shale oil boom is coming to an abrupt end. As a recent Vox article discussed, OPEC has essentially declared a price war on U.S. shale oil producers…
For all intents and purposes, OPEC is now engaged in a “price war” with the United States. What that means is that it’s very cheap to pump oil out of places like Saudi Arabia and Kuwait. But it’s more expensive to extract oil from shale formations in places like Texas and North Dakota. So as the price of oil keeps falling, some US producers may become unprofitable and go out of business. The result? Oil prices will stabilize and OPEC maintains its market share.
If the price of oil stays at this level or continues falling, we will see a significant number of U.S. shale oil companies go out of business and large numbers of jobs will be lost. The Saudis know how to play hardball, and they are absolutely ruthless. In fact, we have seen this kind of scenario happen before…
Robert McNally, a White House adviser to former President George W. Bush and president of the Rapidan Group energy consultancy, told Reuters that Saudi Arabia “will accept a price decline necessary to sweat whatever supply cuts are needed to balance the market out of the US shale oil sector.” Even legendary oil man T. Boone Pickens believes Saudi Arabia is in a stand-off with US drillers and frackers to “see how the shale boys are going to stand up to a cheaper price.”
This has happened once before. By the mid-1980’s, as oil output from Alaska’s North Slope and the North Sea came on line (combined production of around 5-6 million barrels a day), OPEC set off a price war to compete for market share. As a result, the price of oil sank from around $40 to just under $10 a barrel by 1986.
But the energy sector has been one of the only bright spots for the U.S. economy in recent years. If this sector starts collapsing, it is going to have a dramatic negative impact on our economic outlook. For example, just consider the following numbers from a recent Business Insider article…
Specifically, if prices get too low, then energy companies won’t be able to cover the cost of production in the US. This spending by energy companies, also known as capital expenditures, is responsible for a lot of jobs.
“The Energy sector accounts for roughly one-third of S&P 500 capex and nearly 25% of combined capex and R&D spending,” Goldman Sachs’ Amanda Sneider writes.
Even more troubling is what this could mean for the financial markets.
As I mentioned above, energy companies now account for close to 20 percent of the entire junk bond market. As those companies start to fail and those bonds start to go bad, that is going to hit our major banks really hard…
Everyone could suffer if the collapse triggers a wave of defaults through the high-yield debt market, and in turn, hits stocks. The first to fall: the banks that were last hit by the housing crisis.
Why could that happen?
Well, energy companies make up anywhere from 15 to 20 percent of all U.S. junk debt, according to various sources.
It would be hard to overstate the seriousness of what the markets could potentially be facing.
One analyst summed it up to CNBC this way…
“This is the one thing I’ve seen over and over again,” said Larry McDonald, head of U.S strategy at Newedge USA’s macro group. “When high yield underperforms equity, a major credit event occurs. It’s the canary in the coal mine.“
The last time junk bonds collapsed, a major stock market crash followed fairly rapidly.
And those that were hardest hit were the big Wall Street banks…
During the last high-yield collapse, which centered around debt tied to the housing sector, Citigroup lost 63 percent of its value in the following 60 days, Kensho shows. Bank of America was cut in half.
I understand that some of this information is too technical for a lot of people, but the bottom line is this…
Watch junk bonds. When they start crashing it is a sign that a major stock market collapse is right at the door.
At this point, even the mainstream media is warning about this. Just consider the following excerpt from a recent CNN article…
That swing away from junk bonds often happens shortly before stock market downturns.
“High yield does provide useful sell signals to equity investors,” Barclays analysts concluded in a recent report.
Barclays combed through the past dozen years of data. The warning signal they found is a 30% or greater increase in the spread between Treasuries and junk bonds before a dip.
If you have been waiting for the next major financial collapse, what you have just read in this article indicates that it is now closer than it has ever been.
Over the coming weeks, keep your eye on the price of oil, keep your eye on the junk bond market and keep your eye on the big banks.
Trouble is brewing, and nobody is quite sure exactly what comes next.…
Yeah, me too. But back then, $.25 would buy what costs about $2.25 today.
Think back to what a loaf of bread or a pound of hamburger cost back then.
Also, think back to what a three-minute coast-to-coast telephone call cost back then.
And of course - back then - the richest man in the world couldn't have an iPhone, or an MRI.
So how much more glut do we have than we had a year ago? So much that the price drops 50%? Really?
Its traded on an open market among persons that buy it. That's not really an open market. I mean... you're not out there buying barrels of oil are you? I'm not. I mean you and I might buy 100 barrels as an investment. You and I can't move the market.... but the real traders can move the market. And in oil and gas, a lot of the real traders are governments.
They tell you there is a glut of oil and so the price drops 50%. They also tell you that North Korea hacked into Sony. Do you really believe both of those? Do you really believe either of those?
Remember what happened?
Um, we paid less for gas?
I’m frustrated that enough of the financial wizards that write columns like this didn’t see the OPEC response to fracking from a LONG WAYS OFF. Even I did. This is not the same set of circumstances as 2008, so it is foolish to adjust one’s crystal ball by economic markers like the fall of crude price.
Sure I have, but it's not possible to do that with a market as big, and with as many moving parts as the oil business. There are way too many large players involved, and some of them are even governments. Wars get started over stuff like this.
No, the price has fallen because of increased supply - nothing more. Now, you can call that 'price fixing' on the part of the players involved, and perhaps it is, just not in the common understanding of the term.
Who says it won't? As long as the price per barrel justifies it, it'll go on.
Yep. If there's profit to be made, it will be made.
There are geo-political factors affecting supply and demand, but it’s still supply and demand moving the market.
Which will create an environment for startups...
OPEC is cutting their price because the market demands it.
...and how have they been able to get all these market participants to come together, and keep it a secret from a government that would love to catch then at it?
In other words, What can the Saudis achieve other than an interruption of fracking?
It's called a price war. The Saudis want to push the price so low that it kills the fracking boom in the U.S. If they can do that, then sales (if not the price) of their product will rise in America again. If they can keep the price low, (they think) they can keep all those petrodollars flowing in their direction.
Thing is, they're so rich, they can afford the hit to their bottom line. They're willing to take it, too, if they can kill their competition.
This is one of the few instances when you want government to engage in taxing.
Any person advocating government intervention in markets should explain why this time would be different than any other... Why their good ideas and good intentions would survive the political process in any recognizable form...why the predictable and inevitable unintended consequences wouldn't swamp whatever benefit might survive.
For purposes of government intervention, markets are best understood as a means of communication. Intervention is best understood as an attempt to shoot the messenger.
Oil markets (as are all markets) are a huge machine with many moving parts and bells and whistles. Its rare to impossible to point at any one factor and say, this is what is controlling the machine.
At best, one can say that one particular factor outweighs the others at some particular point in time.
So, no, it's not always about demand...and, no, it's not always about supply. Especially not in a season where a cartel has effectively lost the ability for control price.
Demand is not increasing as fast as the recent past. Supply is growing by leaps and bounds. The OPEC swing producer cannot adjust production enough to stop the tide.
You started well, but wound up agreeing with me, and contradicting yourself in your last paragraph.
The increased supply of crude oil (due to fracking and the steady output of other nations) is most definitely responsible for the falling price at the pump.
The law of Supply & Demand remains in force.
Contradicting myself? How?
Seriously? Go back and re-read your entire post.
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