The current trend of oil prices, which have fallen to a near six-year low, is benefitting consumers as they saved approximately $1 billion last year, but it’s also creating a tremendous collapse in the energy sector, resulting in shutdowns, loan defaults and significant job losses.
CNN Money ran a story earlier this week profiling several individuals who worked in the North Dakota boom. Many of them were hopeful that this would be a long-term trend for them – they worked at $8 per hour jobs and then started earning as much as $30 in the oil fields – but unfortunately they were let go because oil prices starting plunging.
“All my friends and family keep talking (positively) about low prices. When I say, ‘We’re all out of jobs now,’ they say ‘Oh,'” Jeff Sharpe told the website. “I don’t think they realize what’s going on in the big picture.”
This has been rather prevalent in the energy sector.
Over the past few years, energy companies took out massive loans to help boost production levels and keep their firms afloat, but this also cause them to fall into deep debt. Their borrowings have risen 55 percent since 2010 to close to $200 billion.
Unfortunately, with falling oil prices and crude oil barrels trading for less than $50, it has been very difficult to pay back these loans. In fact, producers are only pumping out the oil in order to service their debts. This may not suffice, however, as revenues continue to lag their borrowings, which is in turn causing defaults.
Here is what the Wall Street Journal reported on one Austin, Texas-based company:
“But signs of strain are building in the oil patch, where revenue growth hasn’t kept pace with borrowing. On Sunday, a private company that drills in Texas, WBH Energy LP, and its partners, filed for bankruptcy protection, saying a lender refused to advance more money and citing debt of between $10 million and $50 million.”
Energy analysts warn that this could become a ubiquitous problem and many more defaults are expected to arise.
Prior to the collapse in oil prices, companies attempted to leverage their debt to obtain leases and drill wells, something that also meant outspending their incomes. According to the business newspaper, this also means that higher borrowing costs will lead to diminishing oil production levels. Firms are conceding that they’re cutting production by about one-third.
As per ZeroHedge, the credit market is already preparing for such a thing to transpire.
Indeed, Saudi Arabia is just biding its time and maintaining its current levels of production because it knows that a lot of the shale revolution is rather expensive for businesses. With the trend continuing, firms will have no other choice but to file for bankruptcy, which will inevitably lead to soaring oil prices once again. Whether it’s this year or next year remains to be seen.
Of course, much of the blame can be placed on the Federal Reserve because an enormous sum of cheap money flowed into this market and helped form bubbles.
Here is what Ben Casselman wrote on the Fed’s involvement in the oil boom:
“One thing I learned in my years covering the industry is that oil companies, and especially small oil companies, will keep drilling for as long as they can get the money to do so. That means the key variable in forecasting oil production isn’t drilling costs or even oil prices; it’s Wall Street.
“In recent years, investors have handed energy companies half a trillion dollars in loans. That’s partly because of all the promising new oil fields in North Dakota and Texas, but it’s also because with interest rates near zero, investors are hungry for returns wherever they can find them. Now the Federal Reserve is talking about raising interest rates, which could kill the bond bubble, even as falling oil prices make those loans look riskier than they used to. If Wall Street turns off the money spigot, drilling will slow down no matter what oil prices do.”
What else is new? Whenever a financial problem occurs, there is always a Fed hand in there.
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