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Oil Crash Only The Tip Of The Iceberg

We may be enjoying amazingly low prices at the gas pump, but as oil prices continueing to slide we must also remember the catastrophic events that have followed almost every drastic oil price slump in the past.

At this point, it’s not likely a question of ‘if’, or even ‘when’, the next financial crisis will hit. It’s more likely just a question of how big it will be.

In the early ‘80s, OPEC members—Saudi Arabia aside—were producing oil above the agreed upon caps. By 1986, Saudi Arabia, frustrated with all the cheating, gave up on limiting its own production. It flooded the oil market and sparked a 55% freefall in prices. Not so long after, the stock market plummeted 22.6% in a single day—the single biggest loss in the market’s history. Related: Analysts See 2016 Oil Price Rise, While Traders Bet On Fall

And then there was the 2008 housing crash, which came after a pattern of reckless lending and inflated housing prices. Housing prices collapsed, leaving the banks holding unrecoverable debts. Gradually, the crisis expanded into The Great Recession. Again, oil played a role here, having dropped more than $40 per barrel in less than six months in early 2008.

The common denominator here has always been falling oil prices.

And so here we are again—on the brink of another disaster in the wake of plummeting oil prices, rampant OPEC production, and skittish investors.

The Dallas Fed estimates that the actual cost of the 2008 recession was somewhere near $14 trillion. Ominously, today’s oil prices are well below the 2008/2009 lows, now down more than 75% from their highs just 18 months back. Related: Why The Oil Price Crash Is Killing The NHL

In January 2015, Goldman Sachs said that at $70/bbl, around $2 trillion of future investments all over the world were at risk. Today’s prices are hovering between $28 and $30 per barrel.

A total of $180 billion of debt is at default risk, according to Standards & Poor’s rating services. S&P also estimates that 50% of debt issued by oil companies is at risk. Without a quick risek in oil prices, we will see more major defaults.

Oil and gas companies have laid off some 250,000 workers worldwide, according to industry consultants, Graves & Co. If prices remain low, that number will rise significantly. All companies related to the oil industry will struggle to survive, and many will resort to massive job cuts to lower expenses.

Those workers laid off will also find it difficult to pay off debt, and job losses could slowly spread to other sectors. Related: Risk Premium Returns To Oil Markets As Geopolitical Tensions Rise

The amount of debt issued to the shale oil industry over the years is anywhere between $500 billion and $1 trillion, according to various estimates. Banks are likely to end up with bad debts on their books again. Problems will come to the fore once the big companies start defaulting.

(Click to enlarge)

Major financial institutions were debt-laden in 2007, and the biggest central banks of the world are now in the same situation.

During the 2007 crisis, central banks the world over made a coordinated effort that pumped large amounts of liquidity into the system, easing the pressure. However, since 2009, these same central banks have followed an easy monetary policy, inflating balance sheets to scary levels, as shown in the chart above. They will find it difficult to handle any future crises caused by low oil prices. They are now out of ammunition.

The current oil crisis will see regime changes in strategic places, and a currency crisis is in the offing. The world is staring at deflation. And while the 2007 crisis started in the US and then spread around the world, today’s crisis is affecting all major nations simultaneously. All are struggling due to low oil prices—some directly because of lower revenues, and others because of deflationary pressure.

The next crisis will be larger and longer and it will hurt a lot more than the last one. The windfall at the gas pump is a dark harbinger.

By Jen Alic for Oilprice.com

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Leave a comment
  • N on January 25 2016 said:
    Whats this girl smoking? Oil went from 100 in Jan 2008 to 148 in early 2008, unlike this article that says it dropped 40 dollars in early 2008~!. It didn't drop till the S&P had already dropped 20%! into Jul of 2008! High oil prices drive the market, not the other way around!
  • kris on January 25 2016 said:
    The facts are not right here,energy is cheap that means the cost of manufacturing and transporting of goods is low,food and consumers staples already more affordable,so what if a few American oil companies going out of business.the cost of producing oil in middle east is less than $10/bl and we were paying more than $140/bl for it,with that huge profit margin the big oil companies and oil producing nations became richer and the rest of us left behind,with the oil price this low the oil giants don't want to reduce the price at pump even a penny,because they are so greedy.worst case scenario is some CEOs bonuses might drop from $20 million to $15 millions I am sure they will survive.in terms of the stock market it always bounces back, after all it's just a casino like game.
  • Lee Grove on January 25 2016 said:
    "The windfall at the gas pump is a dark harbinger."
    What windfall? In California you would never know the oil has been tri-sected! We've got some serious criminal monopolies out here...
  • David Thomas on January 25 2016 said:
    Hard to take any article seriously that include this in the first couple of lines: "but as oil prices continueing to slide".
  • Santa on January 25 2016 said:
    I agree with Kris.
  • thenry on January 26 2016 said:
    Jen, your facts are out of whack. The biggest issue is some malinvestment in key comodities including oil, which will crater some U.S. companies but will hurt Russia and OPEC more. Over the coming year, lower energy costs (and other comodity costs) will benefit consumers and as oil prices rise, 80% of U.S. oil production will move to breakeven then substantial profit. Every business cycle has excess which hets erased by a downturn, this one won't be as bad as the last for the U.S.
  • Ken A on January 31 2016 said:
    The longer that the low oil prices last, the longer that very high prices will persist in future years due to the extreme drop in spending on current exploration. For deep water, the time frame from initial exploration discovery to production of oil ranges from 5 to 10 years. The only production that could be brought back on line fast is shale oil, but without the extremely low interest rates caused by government meddling, shale drilling will be much more expensive in the future. Enjoy the cheap fuel prices while they last because they will get much higher than they would have been in the future due to the huge current drop in exploration!
  • Cmac on February 02 2016 said:
    Not a good article at all. The author is making a really crappy argument based on past trends and isn't even doing the must fundamental statistical analysis. Yes - low oil prices are often correlated to a shitty economy, but that has everything to do with demand losses and very little to do with a supply glut. If there was a financial collapse in the near future, it's likely not caused by low oil prices. In this particular scenario - the slowdown in china and tech could potentially cause some economic issues, but again, that's loosely related to the extent at which oil prices have fallen so far. Problems will come if bubbles appear in both realms (likely), but these bubbles are probably much more related to corruption in china and low interest rates in tech.

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