Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Quantum AI Stocks Investing Priority - 26th Jan 22
Is Everyone Going To Be Right About This Stocks Bear Market?- 26th Jan 22
Stock Market Glass Half Empty or Half Full? - 26th Jan 22
Stock Market Quoted As Saying 'The Reports Of My Demise Are Greatly Exaggerated' - 26th Jan 22
The Synthetic Dividend Option To Generate Profits - 26th Jan 22
The Beginner's Guide to Credit Repair - 26th Jan 22
AI Tech Stocks State Going into the CRASH and Capitalising on the Metaverse - 25th Jan 22
Stock Market Relief Rally, Maybe? - 25th Jan 22
Why Gold’s Latest Rally Is Nothing to Get Excited About - 25th Jan 22
Gold Slides and Rebounds in 2022 - 25th Jan 22
Gold; a stellar picture - 25th Jan 22
CATHY WOOD ARK GARBAGE ARK Funds Heading for 90% STOCK CRASH! - 22nd Jan 22
Gold Is the Belle of the Ball. Will Its Dance Turn Bearish? - 22nd Jan 22
Best Neighborhoods to Buy Real Estate in San Diego - 22nd Jan 22
Stock Market January PANIC AI Tech Stocks Buying Opp - Trend Forecast 2022 - 21st Jan 21
How to Get Rich in the MetaVerse - 20th Jan 21
Should you Buy Payment Disruptor Stocks in 2022? - 20th Jan 21
2022 the Year of Smart devices, Electric Vehicles, and AI Startups - 20th Jan 21
Oil Markets More Animated by Geopolitics, Supply, and Demand - 20th Jan 21
WARNING - AI STOCK MARKET CRASH / BEAR SWITCH TRIGGERED! - 19th Jan 22
Fake It Till You Make It: Will Silver’s Motto Work on Gold? - 19th Jan 22
Crude Oil Smashing Stocks - 19th Jan 22
US Stagflation: The Global Risk of 2022 - 19th Jan 22
Stock Market Trend Forecast Early 2022 - Tech Growth Value Stocks Rotation - 18th Jan 22
Stock Market Sentiment Speaks: Are We Setting Up For A 'Mini-Crash'? - 18th Jan 22
Mobile Sports Betting is on a rise: Here’s why - 18th Jan 22
Exponential AI Stocks Mega-trend - 17th Jan 22
THE NEXT BITCOIN - 17th Jan 22
Gold Price Predictions for 2022 - 17th Jan 22
How Do Debt Relief Services Work To Reduce The Amount You Owe? - 17th Jan 22
RIVIAN IPO Illustrates We are in the Mother of all Stock Market Bubbles - 16th Jan 22
All Market Eyes on Copper - 16th Jan 22
The US Dollar Had a Slip-Up, but Gold Turned a Blind Eye to It - 16th Jan 22
A Stock Market Top for the Ages - 16th Jan 22
FREETRADE - Stock Investing Platform, the Good, Bad and Ugly Review, Free Shares, Cancelled Orders - 15th Jan 22
WD 14tb My Book External Drive Unboxing, Testing and Benchmark Performance Amazon Buy Review - 15th Jan 22
Toyland Ferris Wheel Birthday Fun at Gulliver's Rother Valley UK Theme Park 2022 - 15th Jan 22
What You Should Know About a TailoredPay High Risk Merchant Account - 15th Jan 22

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

This “Bubble” Is Set to Kick Off New Energy Profits

Commodities / Oil Companies May 15, 2015 - 05:15 PM GMT

By: ...

Commodities

MoneyMorning.com Dr. Kent Moors writes: The tide is beginning to turn for crude oil prices.

Following some nice recent gains and despite leveling out yesterday, the market currently remains at just above $60 a barrel for West Texas Intermediate (WTI) crude oil futures in New York. 

The recent rise in prices would seem to be just what the smaller operators in the U.S. need to avoid a sector meltdown.


A few months back, when prices were pushing lows of $40 a barrel, there was widespread talk of a wave of bankruptcies coming in the oil patch. The picture is now better, given a recovery in crude prices.

But there is another shoe about to fall in the ongoing fight by smaller companies to survive.

Here’s my take on the disaster that’s brewing… and the opportunities it may bring…

Here Comes the Next Debt Bubble

A major energy debt bubble is rapidly forming. Moving forward, it will put significant pressure on the sector.

Make no mistake: There will be fewer oil producers in the U.S. at the end of the year than there were at the beginning… even if the overall pricing trajectory remains pointed up.

Now, that is not necessarily a bad thing from our investment standpoint. Well-positioned and well-managed producers will acquire choice drilling assets and leases at discount. That will raise both their bottom lines and our profitability.

But the terrain is changing.

This week, a bout with rising bond yields has once again put pressure on the Achilles’ heel of most small operators. Most American E&P (exportation and production) companies have been cash poor over the past decade, regardless of the price of oil.

Essentially, this means it has cost them more to fund ongoing operations than they have realized in revenues. When prices for oil have been $75 or higher, this spread has made little difference. In such an environment, it is usually better to fund the bulk of forward operations by rolling over debt than by tapping cash.

Especially if the company is publicly traded. In a higher (and stable) oil pricing situation, cash proceeds translated into a higher offered dividend constitute a better return for the company’s share value than a rapid retirement of debt.    

Why Producers Are Still Making Less

Yet this remains all about the price commanded for the commodity.

Remember, the price flashing in the corner of your TV screen is a futures contract. The company taking the oil out of the ground makes a lower price.

The first pricing stage is at the wellhead. This comprises the transfer of oil coming out of the ground to a distributor. That is what the operator realizes as revenue, but it is hardly the final price. Rather, the price is then adjusted upward as it transits to a refinery (the primary end user of the raw material crude) and then onto retail consumers as finished oil products.

Depending on the grade of oil produced (based on factors such as weight, sulfur content, and impurities), the producing company is making a lot less. At $60 a barrel, the average U.S. producer is making somewhere around $50.

And that means even with overall prices improving they are not rising fast enough to avoid an oncoming squeeze.

Energy debt is found at the upper end of the high-yield debt curve. That is often referred to as “junk bond territory” – issuances below investment grade. Since this debt has a higher risk of default, it provides a lower face value and a higher interest rate.

That is simply a risk premium – the issuing company realizes lower funding and has to pay more to receive it. To stay afloat, leveraged oil companies need to be able to roll existing debt over and access debt markets for additional funding

Unfortunately, as oil prices retreated some 60% between August 2014 and February 2015, the yield curve exploded. As junk bond yield rates increased, energy yields expanded even quicker, as shown in the following chart of high-yield (HY) energy spreads.


The current recovery in oil prices has helped a little, but the pricing floor it is not rising quickly enough for the most vulnerable companies.

Currently, there is almost $1 trillion in such oil company junk bonds outstanding. And the interest commanded on new issuances is accelerating. As of last week, oil company annualized interest rates stood between 12% and 15%. As bond interest rates in general were rising this week, energy bond rates were deteriorating even more. 

High-Risk Interest Rates Trump Safety

How bad is this deterioration? Aggregate figures are not always indicative of what is really happening in the debt market, except in this case. Bond interest rate changes are quoted on basis points. Each 1% revision is divided into 100 basis points. That allows us to calculate a convenient yardstick of how one particular component of the market is faring against a broader spectrum of debt.

My estimates as of close of trade on Tuesday are indicating a significant bubble forming in indebted oil companies’ abilities to weather the debt storm. Each 1 basis point rise in investment grade debt yield has translated into a (quite generalized) rise of almost 2 basis points in junk bonds.

But the rise is almost twice that for energy junk bonds.

The conclusion is direct: High-risk interest rates are almost doubling over safer bonds, while the energy portion of the junk market is experiencing a rise approaching four times safer debt.

Of course, much of this is a function of a massive re-pricing in global debt, with at least some of it due to the market deciding (not always for the best of reasons) to do the Fed’s job for them. The continuing acceleration in debt yields, therefore, is not likely to continue at such a pace for much longer.

But it has already done some significant damage to the most exposed oil producers.

How Companies Will Survive… And We’ll Profit

To survive during periods of low prices, companies need to hedge. That means they will take out futures contracts on their own forward production. But actual market prices for the product at contract expiration need to match the hedge (and the combined series of options companies will take on that contract).

And for that to happen, the breakeven for the cost of operations versus the market price of the oil produced must be at a level allowing for the debt load to remain manageable.

That is becoming more difficult. My current projections put the breakeven at about $74 a barrel by July for the bulk of shale and tight oil production in the U.S. This is the primary contributor to the new production surpluses experienced.       

My expected market (not wellhead) price by the end of July is only $65-68 a barrel. Most companies will still be able to hedge forward for another eight to 12 months. However, unless we have a rapid rise in oil prices during the second half of this year, the cost of hedging will become prohibitive and the range unpredictable.

By the end of December, I calculate that the breakeven price for shale/tight oil production will be about $76 a barrel, while the WTI market price will be between $73 and $78. That will allow the resumption of more normal hedging and more workable bond yields.

Unfortunately, there will be casualties well before we reach December. Expect a rising bankruptcy rate and a robust mergers and acquisitions (M&A) cycle to kick in by summer.

The M&A will provide us with some nice opportunities to make profits from the energy debt bubble.  

Source :http://oilandenergyinvestor.com/2015/05/this-bubble-is-set-to-kick-off-new-energy-profits/

Money Morning/The Money Map Report

©2015 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in