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.

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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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