Oil and gas sector a derivatives time bomb
The cascade of write-downs, defaults and bankruptcies now sweeping the oil and gas sector worldwide is well on the way to triggering the final, deadly implosion of the London/Wall Street-centred financial system. Like the smaller, 2007-08 mortgage debt bubble, the threat lies in the derivatives trades that are many times the value of the oil debts they are betting on, which are increasingly worthless.
Explaining the collapse in European bank stocks this year, including falls of 37 and 34 per cent in the stocks of Deutsche Bank and Credit Suisse respectively, Matthew Lynn reported in the 8 February London Telegraph, “Collapsing oil and commodity prices are starting to seep into the financial system, much as collapsing house prices did in 2008. The big oil and mining conglomerates have massive debts, and so do the smaller oil explorers. Hedging contracts [derivatives] on commodity prices are scattered throughout the financial system, and enormous losses may start to crystallise in the next few months.”
A swathe of smaller US exploration and production companies—42 players in the so-called shale gas “fracking boom”—already went bankrupt in 2015, with combined debts of US$17 billion. Now, bigger fish are beginning to fry. Oklahoma-based natural gas company SandRidge Energy was delisted from the New York Stock Exchange in January, laid off 440 of its 1,157 employees on 3 February, and will file for bankruptcy unless it can restructure its US$4 billion debt, which is doubtful. Large mining and energy company Freeport-McMoRan, one of the world’s biggest producers of gold and copper, had its credit rating slashed four levels—well into “junk” status—by ratings agency Moody’s, casting doubt on its ability to continue to roll over its debts.
In Australia, Woodside Petroleum has announced that it will write down the value of its assets by US$1–1.2 billion, in part due to a six-month delay to the Wheatstone liquefied natural gas export terminal in WA. Supplier and retailer AGL announced last week that gas extraction will “no longer be a core business for the company” and that it will sell its Queensland gas wells, abandon a 300-well project in New South Wales, and write down $795 million. Even BHP Billiton has seen its credit rating at Standard & Poor’s cut by one notch, with a second cut almost assured when it releases its fourth quarter 2015 report on 23 February, thanks to a multi-billion dollar write-down of its US shale assets late last year.
Major oil refiners are also suffering. Chevron, the second largest US oil company, lost US$588 million in the last quarter of 2015, and has had its credit rating cut at S&P; BP lost US$5.2 billion in 2015, its worst ever annual result; and Shell has announced that it will sell US$10 billion worth of assets, after its annual profits collapsed by 87 per cent. The Dallas, Texas branch of the US Federal Reserve described the results of its January 2016 survey of industrial conditions as an “oil depression” in every aspect equal to or worse than that of 2009, while oil industry news sites and blog posts galore are calling it a replay of the 1986 crash, only bigger. According to the US Energy Information Administration’s second quarter 2015 figures, when oil was almost twice its present price, debt service already swallowed more than 80 per cent of US onshore oil producers’ cash flow, and S&P data suggests that one third of all oil-related companies on its international listings will not earn enough this year to service their debts. With that in mind, it is worth noting that Citigroup, in its fourth quarter 2015 report, has already recorded a 32 per cent increase in non-performing corporate loans, and that several Wall Street banks are between them setting aside billions of dollars of “loan loss” reserves.
Derivatives the real danger
Just as in the US sub-prime mortgage crash of 2008, it is the major international banks’ trillions of dollars of derivative gambling that will turn an oil-led “depression” into a global catastrophe. In a 4 February Business Spectator article headlined “A derivative dilemma for the banks”, Victoria Thieberger cited Louis-Vincent Gave of Gavekal Economics who questions the banks’ claims that they are not overly exposed to the collapse in the oil industry. Gave admits in his recent report “Red Herrings, Margin Calls And Heart Attacks” that analysts—himself included—have been “looking in the wrong place to understand banks’ commodities exposures”, and asks, “Perhaps what matters is not the banks’ direct loan exposure to the sector, but instead their exposure to commodity-related derivatives?”
“In any derivatives transaction”, Thieberger explains, “one side of the deal is long and the other party is short. But the prospective rise of bankruptcies among commodity companies increases the chances that some players will not fulfil their derivatives commitments, triggering a potentially ‘catastrophic’ repercussion through the chain of derivatives holders.
“Recall that the initial trigger for the global financial crisis was about $US500bn worth of losses on US mortgages. Gave cites figures [showing] that through the magnifying effects of derivatives markets, that wiped some $US7 trillion from global GDP and $US28 trillion from global equity markets.” (Emphasis added.)
View the US$5.4 trillion “alternative energy sector” debt, mainly associated with the US fracking boom, through the “magnifying effects of derivatives” and you begin to see the scale of calamity soon to befall the world’s financial institutions.
The truth is that no amount of emergency loans, bail-outs or bail-ins can prop up the more than $2 quadrillion global debt and derivatives casino. It must be shut down, immediately, along with the banks that have created it, before it collapses—and drags the whole world down with it. Governments, not central banks, must take this action, beginning with a full Glass-Steagall separation of banking from derivatives gambling.
The GOLDEN RULE 