Over the last several weeks, the stock market and the economy have been moving in opposite directions, diverging reality.
While stock prices rally near record highs, corporations are still defaulting on debt and filing for bankruptcy at a pace last seen during the financial crisis of 2008.
The oil sector has been one of the hardest hit, as a 60% slide in oil prices “since mid-2014 erased as much as $1.02 trillion from the valuations of U.S. energy companies,” as noted by Retuers. “This has already surpassed the $882.5 billion peak-to-trough loss in market capitalization from the Dow Jones U.S. Telecommunications Sector Index in the early 2000s.”
In the first four months of 2016, we’ve seen the amount of bankrupt energy debt skyrocket. Total secured and unsecured defaults soared to $34 billion, doubling the $15 billion for all of 2015.
In April 2016, 11 companies filed for bankruptcy, the most recorded in a single month over the last two years, according to Forbes. Ultra Petroleum, buckled under with $3.9 billion of debt, and Energy XXI, which had a debt load of $2.9 billion, were forced to file.
Another four oil and gas companies owing more than $8 billion are nearing default, as well, including Breitburn Energy and SandRige Energy (which owes $4.1 billion).
Creditors are raising doubts about SandRidge’s ability to stay in business, and Breitburn Energy, which owes $3 billion, just missed its April interest payment and is in talks with creditors.
Linn Energy just filed for protection after reaching a deal with lenders to restructure $8.3 billion in debt, and obtain $2.2 billion in new financing.
Even as oil rallies well off a low of $26.05 to its current $45+ level, it’s not enough to save a lot of those cash starved companies. Many of those companies are finding it impossible to raise capital. Banks are cutting credit lines, too.
And, according to tax firm, Deloitte, another 175 companies are at risk of insolvency. Other experts are convinced that 30% to 50% of oil companies will file this year alone.
$45 Oil Cannot Stop the Pain
While the International Energy Agency (IEA) believes the global oil glut could ‘shrink dramatically’ as wildfires disrupt Canadian oil output, and as demand in India soars, we think it’ll take quite some time to work off the excess supply and new supply likely to come online from Iran.
In Canada, wildfires forced a production curb, which could result in oil supplies falling to just over 3.7 million barrels a day. That’s a million barrels less per day than at the start of the New Year. However, Iran’s production has increased quicker than anticipated, as April production increased to 3.6 million a day.
While many oil companies may not be helped by $45 a barrel oil, the ‘standout’ companies may turn profitable and bring further supply online when oil moves up to $50 a barrel. Oil needs to be at $60 a barrel before we will probably see a sustained turnaround in sector profitability.
To make money from this crisis, we must wait for the shakeout to end. Once that happens, we can look for companies with respectable cash positions, debt, book value, revenue and income. Finding quality, undervalued companies has been our secret to success for over 34 years.