E Deducing The Crash In Oil: How Would Sherlock Holmes Drill Beneath The Headlines?

And what will the ripple effects be? How many of the newly unemployed will soon have to put their houses on the market as they will no longer be able to pay off that mortgage?

What about all the property taxes local governments will lose because of the loss in wages and property taxes? 

And what about all the banks now struggling to unload a mountain of bad oil loans?

Citigroup Inc., Goldman Sachs Group Inc., UBS AG and others will see millions of dollars in losses on loans they made to energy companies last year.

The banks intended to sell the loans to investors but have struggled to unload them even after cutting prices, thanks to a nine-month-long plunge that has taken Nymex crude futures to their lowest level since 2009.

Investment banks helped fuel the oil-and-gas exploration boom of the past decade by making loans valued at about $1 trillion to companies in the energy industry, most of which they sold to investors.

Junk bonds in the US energy sector are getting crushed, after a boom that peaked in 2014. Energy companies sold $50 billion in junk bonds through October of last year. That's 14% of all the junk bonds issued in the full year. But junk-rated energy companies trying to raise new money to service old debt or to fund costly fracking or off-shore drilling operations are now running on empty.

And the leveraged loans, the poor cousins of junk bonds, caused Janet Yellen to single them out recently in her report to Congress since they involve banks and represent risks to the financial system. Regulators are investigating them, and trying to curtail them through austere means, such as cracking down on banks, as opposed to raising rates. And what the Fed has been worrying about is already happening in the energy sector: leveraged loans are getting mauled. 

So far, we see this plunge is oil rocking the sector, and  the US economy overall and the banks, but as we "Sherlocks"  dig even deeper, we ask, what will it do to the stock market? 

Exxon earnings reported on Friday  were a whopping 50% lower than this same quarter last year. Sales were down 33%. 

So  here's the bottom line. There are 29 oil companies in the S&P 500. That's a lot of energy weight in the Index. Here's a dire prediction from an analyst at RBD Capital Markets: for every 10% drop in oil, S&P 500 earnings are cut by 1%.

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Leslie Miriam 1 year ago Member's comment

Fun article, you should write more.

Currency Trader 5 years ago Member's comment

Not a good time to be a $XOM or $CVX shareholder.

Carol W 5 years ago Author's comment

well the charts today would agree..is the bottom in? perhaps..cheers and thanks for reading..

Dr. Duru 5 years ago Contributor's comment

I think the analysis should also take into account what happens to the savings consumers gather from the cheaper gasoline and other petroleum-based products. Even if they are not spending the money on other goods, they are likely using it to pay down debt. That alone can relieve a lot of stress for a lot of non-oil families. Let's see which effect is the bigger. I have an article coming out soon summarizing the amazing results of LGI Homes whose base is in Texas and saw crazy sales numbers in Houston.

The increase in rig count in Canada may not be so good if all it does is add supply to an over-supplied situation.

I am also surprised you didn't weave in the demand side. Could it be that the persistent weakness in oil prices is also revealing how weak the global economy is in general, in particular China? I believe oil demand in the U.S. is already on a secular decline...

But overall, I loved the article as usual. Great narration weaving Sherlock in there!

And now imagine what is going through the collective mind of the Federal Reserve. I think it would be unprecedented to start tightening policy in the face of such a collapse in prices in this large a part of the economy!

Carol W 5 years ago Author's comment

I don't think they're paying off their mortgage cause they saved 2 bucks at the pump. maybe an extra burger this week or an imported beer over domestic! cheers! look forward to your atricle LGI also does a lot of building in California no?

Dr. Duru 5 years ago Contributor's comment

LGIH post up: seekingalpha.com/.../3409056-a-breakout-performance-and-increased-guidance-send-lgi-homes-higher-as-texas-delivers. TPH is the regional with a lot of building in California. They are also undervalued.

Carol W 5 years ago Author's comment

thank DOC..you rock..good points...I could have gone on and on..cheers

Carol W 5 years ago Author's comment

And remember, any one who registers by leaving a thoughtful comment on TalkMarkets is automatically entered into their contest to win an iPad Air 2! More details here: http://www.talkmarkets.com/ipad-contest

Anastasija Janevska 5 years ago Member's comment

Nice article Carol W!

Carol W 5 years ago Author's comment

thank you so much Anastasija

Brett Fromme 5 years ago Member's comment

Great article as usual. I enjoy your writing style as much as the content.

Even though oil prices are dropping, why does US oil production stay firm and why have oil rig counts stopped falling? I think the answer is that the oil producers have huge debts to service and they need the revenue to make the interest payments.

If oil drops low enough, oil producers will start to miss payments, default on bonds. and be forced into bankruptcy. Only then will we see a temporary drop in oil production as assets move from the weak hands to the stronger hands.

But as you pointed out, this will be quite painful for the companies, their workers, the bond holders, the banks and the communities that feed off the oil industry.

I think the wildcard in all this is how well the financial system will be able to handle the bond defaults. In 2008 the defaults on bonds based on worthless sub-prime mortgages almost caused the entire financial system to collapse.

The question is, what is the magnitude of impending bond defaults from the failing oil companies? You state that it is 1 trillion in loans, and 50 billion in bonds or 14% of last year's total junk bond market through October. But what is the total size of the bonds and loans issued to oil companies at risk of default? Is it as great as the sub-prime debacle that nearly caused a systemic collapse? How can we even know the magnitude of the impending bond defaults when they have been repackaged and sold to bond funds? In addition,what is the magnitude of the derivatives that have been generated off of those junk bonds?

Could the US oil company implosion equal the magnitude of the 2008 sub-prime mortgage melt-down? This is where more digging needs to be done, and soon.



Leslie Miriam 1 year ago Member's comment

I agree!

Carol W 5 years ago Author's comment

thanks you your insights and compliments..have a great day

Alexa Graham 2 years ago Member's comment

I miss your work and your comments, Carol. Hope to see you again soon.

Wendell Brown 5 years ago Member's comment

I think Sherlock would be hesitant to use that one small clue as an indicator, but he certainly would file it away for future reference! It's a tiny blip in an otherwise downward slide but to mix metaphors and fictional characters ... 'curiouser and curiouser!" Thanks for all this info.

Carol W 5 years ago Author's comment

hahaha...thanks..cheers Carol