We are at the brink of financial disaster and nobody on mainstream media is reporting it. Nobody in finance media are reporting is (save ZeroHedge, maybe). All the banks and global institutions deny it. But boy, is it coming.
We all know of the 2008 crisis, the event to destroy the global economic system as we know it. Ben Bernanke called it a crisis greater than the great depression and the some of the longest standing financial institutions had to close their doors when it came falling down.
The 2008 event was a crisis created by a web of factors but there are some primary causes for what happened. While the banks were of course bundling together mortgage backed securities and peddling mortgages to people who clearly could not afford it, the real danger came from how exposed banks were to one another. In the modern world, governments, businesses, and financial institutions are leveraged out the fucking ass.
Now, I’m not against businesses and governments taking loans in order to create growth, that’s a healthy part of any economy. What becomes unhealthy is when we have so many loans to one another that if one person topples over we see a domino effect of rolling defaults from more people suddenly becoming unable to pay their interest. This very thing happened in 2008 with the subprime mortgage crisis when regular home owners could not afford their mortgages any longer, and when banks began to collapse from devaluation of assets and losing revenues streams.
So what could take us to a second round of a 2008 type financial crisis? Simple.Risk exposure once again to one another, and risk exposure to the energy industry.
Consider the following. In 2008 we had $295.185 billion in write downs of loans, MBS, and CDOs from the subprime mortgage crisis. $144.676 billion of those were from American banks. For bankrupty risk in 2016 alone, we have more than $150 billion of debt stemming from only energy companies. Of which ZeroHedge estimates that creditors may only get 15 cents back on the dollar through asset liquidation. That’s a whopping $127.5 billion in unsecured debt from ONLY American energy companies at risk of default in 2016. This is only the tip when it comes to the risk we’re at, but let’s focus on one systemic risk at a time.
Enter 2016. We’re on the countdown to ground zero once again.
State of the Game: Market Situation
Before we continue on to discuss more about oil, let’s have a quick look at the current situation in the market.
Now, I also know what a lot of people are saying out there. We’re in a fantastic bull rally with the bottom of oil found! You’re an absolute idiot for not buying while we’re at the bottom :^)
If only markets were so simple.
To start things off simply, the charts below should explain to you 90% of what you need to know.
The S&P 500 and by extension the entire market is overvalued as hell.
EBITDA vs S&P 500
Baltic Dry Index
As it’s plainly obvious, there’s a tremendous discrepancy between earnings and GDP growth and the value of the market. Not to mention global trade has utterly collapsed despite commodities being at an all time bargain bin price and liquidity is down to pre-pants-shitting-crisis levels.
This unprecedented bull market rally that we’ve been in since 2011 has been nothing but a creation through quantitative easing.
So given these charts, we know a few things. The global financial system is on shaky legs and has been for a long time. We’ve been accumulating tinder beneath our feet for the last half a decade and we’ve been waiting for the spark to set it off. That spark is now oil.
Default Risk in Oil
So, let’s get back to oil. I mentioned the default risk in 2016, now let’s have a look at that. Deloitte warns that “The roughly 175 companies at risk of bankruptcy have more than $150 billion in debt”. Not to mention there are still over 60 companies that are negative cash flow accounting for $325 billion of debt.
So where does that leave us? Well, bringing this back to the 2008 crisis, banks began to collapse because of risk exposure to one another and asset devaluation. But get this, since 2008 among the 25 largest banks, exposure to derivatives have gone from $184 TRILLION in 2008 to $247 TRILLION in 2015. That’s a whopping 34% of growth since 2008.
Why is this a problem? Because these banks are all betting on continued future growth, as these financial institutions grow in exposure to one another and increase their exposure to future downturn, we can easily fall into another crisis as soon as some part of the system pops. Right now, that risk is coming from oil.
A number of OPEC nations face bankruptcy risk and a ton of American energy companies face the same. Citigroup has revealed that it had recorded at 32% rise in non-performing corporate loans primarily from the energy sector, and Wells Fargo reports that net charges increased to $831M in Q4 up from $731M in Q3. Also mainly from energy sector. Banks are in a situation where they must actively hedge their risk against the oil sector at ALL costs in order to avoid the current dangers from rolling bankruptcies. This also comes in the form of market manipulation but I’ll talk about that at a later time.
Market Conditions in Oil
But anyways, given the frail state of the energy sector, how much of a risk are we currently in? Oil is going back up and rebounding after all. We should be seeing $50-60 oil again in no time.
The price of oil is an interesting little game at the moment. From my personal speculation, I think that the market is being highly manipulated as seen by the tremendous and sustained divergence from market fundamentals. But I’ll get to that in a moment.
The biggest thing against the case of rising oil is basic supply and demand. As it stands, global oil supply is in a glut of 2 million barrels per day with stockpiles building globally. Global supply stocks stand at 3 billion barrels (in comparison, global demand is approximately 30 billion annually). However, the major focus when it comes to supply should be shifted towards the United States.
America divides the nation across various zones of petroleum administration. The primary zones to note are PADD 2 and PADD 3. The majority of refineries are located in PADD 3 (~49%) whereas the majority of distribution stems from PADD 2 which is capable of supplying 85% of consumer demand. In terms of storage and distribution, PADD 2 and by extension PADD 3 are the breaking point indicator.
So let’s have a look.
As we currently stand with Cushing at 66.95 million barrels (~80% capacity) in storage Cushing is already turning away lower grades of crude and are actively piping oil down to PADD 3 for storage. Genscape reports that Cushing only has a 4-5 months of storage remaining unless this glut goes away.
PADD 3 is also at high capacities at 58% capacity as of Feb 19th down from the all time high of 62% due to storage expansion. In fact, the glut is getting so bad that people are beginning to turn to rail tank cars to store oil. I shit you not.
What matters here is the divergence between oil price and oil glut. As seen from any indicator or study, the oil glut is not going away— it’s getting larger. While we aren’t at the breaking point just yet, we are rapidly approaching it. The increase in bullish speculation in the oil market is dangerous and a divergence the market fundamentals. Be wary of any rally until the market fundamentals have shifted, as we stand the conditions have not yet improved.
When zoomed out a little..
So in a long and roundabout way, where does this end up leaving us? At a potential brink of a massive asset write down from the banks and a series of domino-ing debt defaults. The issue with the 2008 crisis was due to the number of poor loans that were being issued out, this round, it’s the size of the bad loans being lent out. While I don’t know if we have anything like significant credit default swaps that will add onto costs of defaulting loans, I do know however know that the cost of the cheap oil can be just as significant.
If we look beyond American institutions however, the risk extends far greater. With oil dependent nations budgeting based on continued oil revenue, we see even greater systemic risk of national loan defaults with nations like Russia, Brazil, Nigeria, and Venezuela looking to be prime candidates for further recession.
As credit becomes increasingly available and as nations become increasingly dependent on debt to balance their budgets, if a significant enough piece of the puzzle crumbles under cheap oil, we could see more potential of global recession.
The global economy is in a sorry state, with recessionary indicators flaring up globally. We’ve been living in an era of false economic growth created through economic stimulus, and we may be on the cusp of a very significant credit down cycle.
For all the bulls out there, you can only defy fundamentals for so long.