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Oil Price Plunge Can Trigger a 'Sub-Prime' Crash

Dec. 1, 2014 (EIRNS)—During the last decade's "shale oil boom" which has propelled the United States toward the world lead in oil production, oil companies here and in Europe have taken on record levels of debt. This is true both of the independent shale oil producers and of the long-established oil majors, although for different purposes. The repayment of that debt requires prices for a barrel of (Brent crude) oil which range from $80-85, to $120.

Therefore the Saudi-triggered plunge in oil prices from $115/barrel this past Summer to $70 now, will have one of two results: Either the price will shoot abruptly back up in 2015, or the collapse of energy debt can trigger a financial crash.

The point is made by economics columnist Liam Halligan in the Telegraph today. His colleague Ambrose Evans-Pritchard has written several data-loaded columns since July, comparing the petrochemical sector currently to the mortgage sector in 2006-07. It is overloaded with debt whose basis is an appreciating oil price. This, despite persistently depressed demand since the 2008 financial collapse.

The International Energy Agency (IEA), in a report of July 29, 2014, made clear that the oil industry has been borrowing about 20% of the cash it needs since 2008, or about $120 billion a year, net new debt. Its total debt has rocketed to about $1.6 trillion with revenues of under $600 billion a year at $115 a barrel average price. That would be $1.6 trillion in debt based on less than $400 billion in revenues (a ratio perilously close to the definition of "unsecured leveraged lending" in banking terms) if the oil price remained in the $70-75 range.

Financial columnist Andrew Critchlow found, in the Telegraph on Nov. 14, that oil shale drillers had reached nearly one-third of all "high-yield, sub-investment grade" (sub-prime) borrowers in the United States. And that if the oil price stayed in the $60s, where it was earlier this week, 30% of high-yield B- and CCC-grade borrowers would default: "A shock of that magnitude could be sufficient to trigger a broader high-yield market default cycle."

And Evans-Pritchard wrote in September, when the oil price was in the $90s,

"The world's leading oil and gas companies are taking on debt and selling assets on an unprecedented scale to cover a shortfall in cash, calling into question the long-term viability of large parts of the industry.... Companies appear to have been borrowing heavily both to keep dividends steady and to buy back their own shares, spending an average of $39 billion on repurchases since 2011."

So, either the price will shoot back up, or another crash trigger is added to record levels of junk bonds, leveraged loans, sub-prime auto loans, and above all, $750 trillion or more in derivatives exposure.