Markets Follow Oil Prices Downward – 1/16/16

People are panicking as stock markets across the world tumble on the heels of oil prices. Investors are fearing that China’s slowdown and an energy industry facing unprofitable oil prices will bring about another wave of recessions as banks are forced to absorb losses on loans made to oil and gas companies. Fortunately, there are some facts to soothe worried minds. US banks are holding significantly more capital specifically to lessen their exposure to bad debts, which were a driving force behind the 2008 financial crisis when so many banks overburdened with toxic assets were forced into bankruptcy. So long as US government and American people are still ready to pile on regulatory burdens in retribution for the old crisis, there are few banks that would risk rocking the boat now that another could be close.

The major issue facing markets for the next few years will be China. After borrowing immense amounts to fund growth, the country is full of factories and luxury apartments that no one can turn a profit on. Overcapacity in real estate and industrial goods will need to be curtailed if the country is to move into more sustainable growth areas but the government is understandably hesitant to take the necessary steps with so many citizens set to lose jobs in the transition. Still, the Chinese government will not allow a hard landing while they have reserves and other options to fall back on. The government is nothing if not careful to preserve the economic security needed keep its legitimacy.

The psychological and economical threshold of $30 is breached again as Iran begins to increase output in an oversupplied market so how are the shale-oil seekers doing? Well, as oil is falls further below the $30 a barrel point, more and more high-cost producers in the US are defaulting. Companies that made the loans continue to set aside billions to cover the losses that set to emerge this year as they fear that even liquidating assets acquired from bankruptcy settlements will not be enough to cover bad loans. The goal now will now be to set suitably tough standards for the troubled oil producers to keep clients stay afloat while minimizing risks to the bottom line.

With as many as 1/3 of US oil and gas producers set to veer into bankruptcy by 2017 if prices do not rebound this year, one might think the worst is yet to come for the economy. However, with so much time to hedge risks and offload the worst of the holdings losses, profits lost due to bad energy loans should manageable though substantial for big names in finance. As a result, we are unlikely to see the bailout-heavy environment that popped up after the housing market saw collapsing prices.

As sanctions against Iran are lifted, it will seek to increase its oil sales only adding to the problems faced by already pressured US and international producers. Whether or not current prices already reflect the return of Iranian output is debatable since a lot of uncertainty surrounds the country’s strategy as it prepares to wade into an already oversupplied market. Moves to regain market share through long-term contracts are a probable first step even with oil prices closing in on a bottom. After losing ground in Eurasia to Russia and Saudi Arabia when the sanctions first came into place, Iran will come back to compete for its old portion of market share wherever it can. Remaining sanctions restricting dollar transactions and banking will still be a hurdle to US involvement in increased Iranian oil output.

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