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Oil Sector May Not Cause Financial Apocalypse After All

Oil Sector May Not Cause Financial Apocalypse After All

Across the oil patch, banks are starting to close off their exposure to some of the riskiest oil drillers.

A new monthly survey from the Federal Reserve finds that banks that have issued loans to oil drillers are projecting some of them to go bad. Over the course of 2015, the Fed says that oil loans could “deteriorate” and that banks “expected delinquency and charge-off rates.” At the same time, the overall exposure to such loans remained small.

Around 80 percent of the banks surveyed by the Fed indicated that their exposure to shaky oil companies accounted for less than 10 percent of their commercial lending. In that sense, a wave of defaults across the oil and gas country would appear unlikely to ripple through the financial industry. Still, over half of the banks who made loans to drillers expect their loan quality to deteriorate. Related: Is This The Top For Oil Prices For Now?

In recent months, the biggest banks have stated that they have cut lending as they begin to see losses on the horizon. Citigroup and JP Morgan Chase, among others, have set aside around $100 million each in order to cover the losses they expect from oil and gas lending.

To shield themselves, banks are starting to restructure loans, cut credit lines to drillers, require more collateral, and stiffen their terms for new loans, the Fed survey finds. In other words, they are withdrawing somewhat from lending to fossil fuel companies, but for the new and existing loans that are on offer, banks are also exacting a higher price. Related: 5 Solar Stocks That Should Be On Your Radar

That will make it more difficult for drillers that are struggling to meet debt payments as it is, let alone attract new debt financing. For the smallest drillers, having a credit line cut could mean the difference between making payroll and going out of business. April is a unique month in which many credit facilities are evaluated and adjusted, a period known as “credit redetermination.” With access to finance threatened to be cut off, many drillers took out more loans in the weeks leading up to April. The first quarter, in fact, was a huge period for oil and gas fundraising. Drillers tapped both equity and debt markets at rates not seen in years. In January and February, an estimated $63 billion in new oil debt was issued, with the majors accounting for a record $31 billion. That underscores the trouble exploration companies find themselves in, but also the enormous appetite there still is on behalf of finance to issue new loans.

The Fed survey indicates some banks are beginning to pullback because the sector is starting to look less attractive, but it also suggests banks are not too worried about getting burned by oil and gas. A new Moody’s report backs up the notion that finance is less exposed than some may have thought. Canada’s banks, which lend heavily to Alberta’s oil sector, would find that even some of the worst losses would be manageable. In its “severe stress” scenario, Moody’s estimated that losses to the financial sector would reach $4.58 billion, amounting to just half of the sector’s first quarter earnings. Related: A Potentially Massive Win For Fracking In Texas

For lenders (and drillers), there is even a reason for optimism. Oil prices have rallied quite a bit over the last month. Since the end of March, WTI has jumped by more than 36 percent. That provides a lot of breathing room to a lot of companies relative to where they were just a few weeks ago.

But it is unclear if the rally is here to stay. The price rise could induce more drillers to complete a backlog of wells, bringing new production online. Moreover, oil prices are nearing levels in which fresh drilling could once again make sense. EOG Resources, a top driller in Texas, announced that it would restart drilling if prices hit $65 per barrel and stay there. It could even add new rigs by July. That would bring further output online, putting downward pressure on prices.

By Nick Cunningham of Oilprice.com

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  • Brian B. on May 06 2015 said:
    Reading the end of the article, the position of EOG makes no sense what so ever. If oil hits $65 and seems to have stability there, it makes no sense for EOG (or any other oil company for that matter), to finish off their unfinished wells, and then start pumping more oil. Prices will just simply collapse, and we will be right back to where we were a couple of months ago, with prices in the 40's. It is insane. The oil companies need to wait until we have cut about 500,000 bpd off of the domestic production in order to offset any added production by finishing these wells. Otherwise they will assuredly drive the price of oil back down where it is clearly unprofitable.

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