Will oil go below $20? Jeffrey Currie, the head of commodities research at Goldman Sachs, said on Bloomberg TV on Tuesday that he wouldn’t be surprised if oil dipped “into the teens.”
That would upend the financial prospects for a lot of oil and gas companies. In January, Moody’s Investors Service put 120 oil and gas companies on review for a possible downgrade as the financial positions of the entire industry continue to suffer.
Smaller companies with fewer financial resources at their disposal are more likely to have trouble with mountains of debt. In fact, the yields on speculative energy debt are spiking amid growing speculation about financial distress.
Bond yields on the Markit CDX North America High Yield Index, which tracks 100 high-yield companies, spiked to its highest level since 2012. The energy sector rose to 1,525 basis points. This is a sign of rapidly shrinking confidence in the ability of these companies to meet debt payments. Related: Rising OPEC Oil Production Worsens Glut
The problem for so many energy companies is that on top of the worst bust in oil prices since the 1980s is the fact that there are much broader concerns about the global economy.
The crash in oil prices was largely a supply-side phenomenon. Oil demand grew relatively steadily in recent years, but supply surged at a much faster clip. The overhang was what sent prices plunging by 75 percent in just 18 months.
But the lack of a strong rebound, while still evidence of persistent problems on the supply side of the equation, is also being driven by weak demand. The IEA said that demand grew at 1.6 million barrels per day (mb/d) in 2015, but will only expand by 1.2 mb/d this year. While it would be hard to repeat the strong 1.6 mb/d figure a second year in a row, one would think that oil selling at its lowest point in at least 12 years would spark stronger demand. Related: Could Gasoline Drop Below $1 Per Gallon?
In its February monthly Oil Market Report, the IEA addressed this question, but concluded that given the problems with the global economy, it maintained its projection for 1.2 mb/d in demand growth. The agency saw “no evidence of a need to revise it upwards.” Global growth of 3.4 percent this year is “heavily caveated with risks to growth in Brazil, Russia and of course slower growth in China. Economic headwinds suggest that any change will likely be downwards.”
What began as a supply-side problem for oil is still largely dictated by the vagaries of oil supply. But prices have dipped to new lows in recent weeks and months because of unexpected weakness on the demand side. In this sense, low oil prices are a symptom of a much more worrying problem with the global economy, not just oil companies producing too much. Related: OPEC Will Not Blink First
Paul Krugman of The New York Times points to plunging yields for safer areas of the bond market, which is likely not a good thing. “What plunging rates tell us is that markets are expecting very weak economies and possibly deflation for years to come, if not full-blow crisis,” Krugman wrote on February 9.
Citibank highlighted similar fears on February 4, although with greater emphasis on oil. The economy is facing a “death spiral” with various feedback loops all pushing things lower, Citibank says, exacerbated by cheap crude. "Stronger U.S. dollar, weaker oil/commodity prices, weaker world trade/petrodollar liquidity, weaker EM (and global growth)... and repeat. Ad infinitum, this would lead to Oilmageddon, a 'significant and synchronized' global recession and a proper modern-day equity bear market,” Citi analyst Johnathan Stubbs wrote in a report. Citi believes global GDP will only expand by 2.7 percent in 2016, much lower than the 3.4 percent the IMF is predicting, which is the assumption used by the IEA for its oil market projections.
No wonder the IEA sees very little reason for oil to rebound in the near-term.
ADVERTISEMENT
By Nick Cunningham of Oilprice.com
More Top Reads From Oilprice.com:
- Are We Nearing A Transition Point In Oil Production?
- No Agreement on OPEC Meeting After Venezuela Meets With Saudi Arabia
- Genel Producing Oil For $1 Barrel, Investors Still Cautious
