With the fall in oil prices I find the relevance of U.S. shale company defaults will grow leading to a panic in junk bonds and bank balance sheets.

What goes up - must come down.

Thoughts of a Speculator: Turn of the Tide?

The question seems more prominent now than ever: do investors ever learn from what history has to show? In regards to oil— they should.

A brief history lesson from yours truly. In 1973, the Organization of Petroleum Exporting Countries (OPEC for short) had implemented an embargo against Israel and any of its supporters, i.e. United States, following the brief Yom Kippur War. As expected, oil rose dramatically, starting from $3.50 in 1972 to $11.25 in 1974 (inflation adjusted in 2015 dollars—$19.75/72 to $51.30/74). Consumers felt the impact almost immediately with oil becoming scarce. The decoupling of the dollar from the gold standard in 1971 did not help consumer prices either.

The 1970s oil embargo was harsh and unfavorable times, that is, if one wasn't in the oil service business.

As the basic investor understands, if there are high prices in a sector, then there are consequently higher profit margins to be made. Thus, the speculators and entrepreneurs seized the opportunity to enter the oil business. Texas and North Dakota and Oklahoma all became booming cities. Employment in capital intensive businesses grew just as fast as state tax revenues did. Investors in oil futures and oil producers laughed all the way to the bank— passing the mile long line of individuals trying to get their gasoline ration from the pump.

This is what was seen; but intelligent investors are keen on noticing what isn't seen. And that is, those high prices will be the cure for high prices.

Intelligent investors made the observation that the oil embargo would be temporary— making prices artificially high. They also understood that higher prices during a period of double digit inflation would limit consumers from using more than the bare minimum required of oil. They also knew that the artificially high prices attracted marginal wells and production of oil to come online, increasing the supply. Thus as demand decreased and supply increased, intelligent investors ignored euphoria in the oil sector and set up for the big short. In 1985, the U.S. oil industry flatlined. Prices went into free fall. The once booming oil states shut down. Banks and investors that lent to these oil companies turned from laughing to crying. Defaults ensued in the oil services. But for the consumer these were grand times of cheap and plentiful oil.

One can assume that in 2007-14 many investors either forgot about the 1970s-'80s or were not even born yet. The prior seems more likely.

Investors know that fancy technology (fracking) and cheap money (0% rates) mix as well as coke and whiskey.

Thus those same oil states are booming just as before. Tax revenues are up from the employment and business. And stock market speculators were thriving. It doesn't help that this time yield starved investors and a tidal wave of $4.3 trillion dollars, courtesy of the Fed’s printing press, and 0% rates are pushing junk bonds to unjustifiable levels (from 2012, oil producer debts have increased over 55%). 

Just as before, the second half of 2014 and 2015 is plagued by a crashing oil price. The reasons? Many.

Pension funds and insurance companies and investor portfolios are littered with toxic debts.

The likely outcome? Dire. •