Oil Glut Squeezes Small Suppliers – 12/09/15

As the oil glut continues, many investors are betting against the small, high-cost producers that have managed to survive the extended period of low prices.

Many small producers with heavy debt loads find themselves with little hope of relief as overflowing inventories dim the already faint hope for a quick rebound in prices. Since the low prices are outlasting even long term hedging positions, many producers are unable to pay down debt built up for now unprofitable projects as losses in the energy sector junk-bond market pile up and investor sentiment continues to sour. Defaults, driven by the weak bond market, are expected to accelerate.  Even support industries in storage and transport are suffering as the market responds to unrestricted production and weak Winter demand.

With the International Energy Agency reporting swollen inventories, lackluster demand, and the unlikeliness of a quick rebound, oil prices continue to fall as even oil bulls turn bearish. As we enter 2016, bankruptcies will be common in the shale oil industry but, with the oil pumping assets already in place, it is tough to say if production will drop quickly enough to have a significant effect on prices. And with oil and other commodities experiencing significant, sustained falls in price, Brazil and China are experiencing slowdowns which are only partially offset by growth in India. Meanwhile, Russia’s oil-dependent economy continues to contract due to the low prices.

As the dollar strengthens, US exports will be more expensive for foreign importers. US consumers on the other hand will benefit from cheaper prices at the pumps and relatively cheaper imports though the harm that low commodity prices are doing may outweigh benefits felt domestically as job cuts and investment reductions in affected industries become necessary. Many energy companies are already consolidating and selling off assets, such as pipelines and gas terminals, to stave off creditors. In the mining industry, metal prices have been hit especially hard by the slowdown of China, the primary driver of demand growth, and are not likely to recover anytime soon. Possibly the largest beneficiaries of cheap fuel, airlines are benefiting from low costs but face troubles ahead if slowed global growth eats into revenues. Some airlines are unable to take advantage of low fuel prices due to locked in rates that won’t expire until next year, but overall profits have been at record highs.

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