more on same topic of much reduced capex spend re hydrocarbons. Meanwhile POO fell another 2% overnight.
It’s particularly interesting that in the US, zero interest rates, low oil prices and quantitative easing have done little to spur consumption or even consumer confidence. What would happen to consumption if oil prices rose and could they?
We have recently written about Moody’s warnings of the record junk bond debt maturing in the next four years as well as the doubling of defaults in 2015. Most of the debt stress exists in the energy sector and while we might dismiss that, favouring a broadening of defaults across other industries as a bigger cause for concern, it is worth reflecting on the impact of the defaults occurring in the energy sector itself.
According to the Financial Times, $50 billion of debt, issued by 46 companies, has already defaulted this year and half were in the energy and mining sector. Weak commodity prices have the largest detrimental impact on the financials of upstream companies, forcing explorers and producers to cut capex. According to the energy consultancy firm, Wood Mackenzie, around $400 billion worth of energy projects have been scrapped following the crude oil market crash. Separately, Bloomberg quoted new data from the Norwegian consultancy firm Rystad Energy, which predicts that legacy production will tip the supply balance into the negative in 2016 for the first time in years.
Rystad Energy also estimates that the combination of a crash in oil prices and the associated cut in capex, will cause natural depletion rates to overwhelm the paltry new sources of supply in 2016. Existing fields will lose about 3.3 million barrels per day (mb/d) in production this year, while new fields brought online will only add 3 mb/d. This does not take into account rising oil demand, which will soak up most of the excess supply by the end of the year.
If oil prices were to rise, this combined with higher minimum wages in the US, could easily push inflation expectations, if not inflation itself, above the targets set by central banks.
One can only imagine the tidal wave of bond selling that would occur – from zero and negative interest rates – if inflation emerged to shock those who remain entrenched in a lower-for-longer mindset.
Perhaps surprisingly, Japan last week announced its steel manufacturers would raise prices despite very weak demand and excess supply globally. Iron ore and coking coal prices – key ingredients in steel manufacture – have risen and China is importing record quantities of copper, zinc and nickel.
Investors would be wise to carefully watch for changes in the price of oil.
Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.
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