Oil Sub-Prime – Watch This Space.
Oil fell again last night to just $28.28 at the time of writing – that’s its lowest price in 14 years and well below the GFC low of $43.78. Iran announced it will greatly increase production post sanctions and the world is literally swimming in the stuff. Demand looks set to continue to languish and the IMF yet again downgraded global growth projections last night. So what?
You will recall that the GFC came about through debt instruments on sub prime mortgages unwound by falling house prices. (BTW – if you haven’t seen the movie The Big Short yet, you must. If your friends don’t ‘get’ what you might be trying to warn them of – take them. People need to understand what happened in the GFC to know what is going to happen soon, but most likely on a much larger scale). Concerns have been growing about whether the oil price will see a similar outcome on all the debt instruments on oil producers, particularly in the US. Estimates of energy debt in the US range from $500b to $1 trillion. A lot of that is in so called ‘high yield bonds’, you might know them as junk bonds. The index of US high yield energy bond yields has just spiked to an all time high; higher than the GFC (check out the chart below and look where the 2 previous spikes happened). The market has also been abuzz the last couple of days on reports that the Dallas Fed quietly met with affected banks last week and told them not to ‘mark to market’ their energy debts. i.e. don’t book the impairments resulting from these lower prices. The Fed have denied this and it will unlikely be proven but the market seems to be taking it seriously notwithstanding a huge coincidence. The liquidity squeeze of the GFC occurred because banks feared each other’s capacity, so interbank lending stopped. The barometer of this is called the TED Spread (the interbank lending rate against US bonds). That TED Spread is surging.
Just last week Wells Fargo, one of the largest banks in the US and the largest mortgage holder, reported it has $17b of energy debt on its books. It said that was “mostly” junk bond grade and had only $1.2b in provisions assigned to it. This is just one bank. Giant Citibank reported similar issues earlier.
Keep an eye on this. The coming crash is borne of too much debt. All the focus this year has been on China’s, but the US energy debt situation is just as scary. The scarier thing is, it is all interlinked….