As oil prices wallow near multi-year lows, it’s becoming increasingly clear that the new cartel controlling oil prices is not OPEC but world credit markets. From Saudi Arabia’s record $100 billion deficit to shale oil’s continuing reliance on cheap credit funding, it’s clear that no major oil producer or company in the world right now is economically self-sufficient based on oil revenues alone. This situation has left the flow of oil and the decision on when to stop pumping the increasingly tarnished black gold in the hands of banks rather than oil men.
The idea that bank loans to oil companies may be in trouble is not new but there are increasing signs of late that these distress energy loans could end up defaulting and leaving banks with a mess to deal with. At the national level, countries like Saudi Arabia won’t forfeit their assets to creditors of course, but their ability to keep running deficit funding is going to increasingly depend on bond market appetite for energy related debt. That could be problematic in 2016. With the Federal Reserve starting to raise interest rates, bond investors may find that they don’t need to invest in energy debt to garner yield as they have in 2015, and this in turn could start to crimp oil production.
Economists often like to cite cartels as having the power to control production, but at this point it looks like the only group with any ability to actually curtail (or expand) production are the major banks that direct capital market flows. Of course that production power is indirect, but it is real nonetheless.
Banks are not required to disclose the loans they hold to investors and Federal regulators don’t disclose this data either as it would potentially risk a run on certain banks, but regulators are definitely taking note of energy related loans in bank portfolios. That attention may start to change the lending game in 2016 as banks look to pull back from energy production. For some banks that are large enough, it is even possible that a broad pull back in lending could lead to markedly lower production levels across many U.S. firms in particular which in turn might help boost marginally prices. To the extent that banks act in concert to do this, the effects on prices might be more than marginal.
Some big banks have acted preemptively to dispel investor concerns over the size of their loans to banks. According to third quarter data, Citigroup holds $22 billion in energy loans compared to a total loan portfolio at the bank of $632 billion. JP Morgan Chase holds $44 billion in energy loans against a portfolio of $791 billion in total loans. Bank of America has $22 billion in oil & gas loans against a total portfolio of $886 billion in loans. Wells Fargo has $17 billion in oil & gas loans against a total portfolio of $888 billion.
The total amount of loans outstanding to the energy sector is a little under $4 trillion, so these banks make up only a small 3 percent of the total outstanding loan market. In fact, U.S. banks are currently only holding about 45 percent of the total U.S. loans to energy companies, with around 30 percent held by foreign banks operating in the U.S., and 25 percent held by non-bank entities like hedge funds.
But the banking market is very much an oligopoly and where the likes of Citi and Wells Fargo lead, smaller banks will follow. So far, banks have not been acting in a cartel like fashion and are more worried about their individual loans than they are coordinating credit decisions to try and help salvage loan recovery rates across the industry. But with the increasing chaos in the energy sector, 2016 could force banks to change their tunes as they did in the housing industry in 2009 which in turn would lead to a very interesting 2016 for energy prices.
By Michael McDonald of Oilprice.com
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