Oil Investing: This Could Spark the Next Financial Crisis

Oil Investing Financial CrisisThere seems to be a trending theme in today’s economy—borrowers cannot pay their debt. This time, the spotlight is on oil companies. Low oil prices have forced many energy drillers to the financial brink, and analysts fear a wave of defaults could set off another financial crisis in 2015.

Shale drilling has gained popularity among oil drillers over the last decade. Shale companies also raised a lot of debt. Recent downfall in oil prices is making shale companies suffer, as their costs are too high compared to the price of their output. Investors are now questioning whether the debt can be repaid.

Banks have lent a lot of money to energy companies. Last week, The Wall Street Journal reported that over the past five years, global banks have earned $31.0 billion in fees through financing energy companies’ stock sales, borrowings, mergers, and acquisition transactions. (Source: The Wall Street Journal, last accessed July 10, 2015.)

The plunge of oil prices since last summer has made loans to oil companies less attractive. According to Bloomberg, speculative-grade energy securities plunged more than three percent in two weeks. Yields on those debts surged to nearly 10%. (Source: Bloomberg, July 7, 2015.)

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Energy XXI Ltd. (NASDAQ/EXXI), for example, has seen the yield on its notes due in March 2020 surge to 15.8%. SandRidge Energy, Inc.’s (NYSE/SD) 8.75% notes due in June 2020 also suffered, trading at $0.87 on the dollar. The company’s stock price tumbled as well, plunging more than 88% in the past 12 months.

The problem now is that banks are holding a large amount of loans to shale companies. After lending to those companies, the banks had trouble selling these debts as no one wanted to bear the underlying risk. If some of these loans turn out to be nonperforming, there is going to be severe deterioration in these banks’ balance sheets.

Sound familiar? It should. During the most recent financial crisis, large U.S. and European banks took more than $1.0 trillion in losses on toxic assets and bad loans from 2007 to 2009. If oil prices continue to tumble, some analysts fear banks will be forced to announce another round of huge asset write-offs.