Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

See, OPEC: Janet Yellen knows how to do a freeze. Or, rather, a very slow thaw.

The Federal Reserve Chair's reassurance of a gradual approach to raising interest rates helped revive an oil market losing its fascination with OPEC's chatter. (Good job, too, what with Saudi Arabia and Kuwait announcing on the same day they would actually restart a field shut down in 2014. Clearly, the supply freeze is a complicated affair.)

So, too, though, is the Fed's relationship with oil. And if you want to see how frozen, low rates can wreak havoc, cast your mind back to the housing crisis.

In several recent reports, energy economist Phil Verleger has laid out the unsettling similarities between the U.S. residential construction bubble and the later surge in oil and gas drilling investment. This chart alone is pretty striking:

Dwell On This
The boom in oil and gas investment followed a similar path to construction on the way up -- and looks set to mirror it on the way down, too
Source: PKVerleger LLC
Note: Housing data is shifted forward by eight years.

We'll still be arguing decades from now about exactly why we collectively went crazy for Floridian sub-divisions and the like, but cheap and plentiful credit was clearly a big factor.

The same goes for the oil and gas boom.

High Octane
The face value of energy debt as a proportion of the BofA Merrill Lynch High Yield Index has surged
Sources: BofA Merrill Lynch, Bloomberg

Just as the housing bubble relied on faith in U.S. house prices only going up, so investors' willingness to buy the energy sector's bonds (and stocks) rested on a couple of intoxicating assumptions: OPEC would backstop prices and China would never falter (so, about that...)

American exploration and production companies weren't the only ones on a debt-and-drilling binge. Last month in London, Jaime Caruana of the Bank for International Settlements gave a speech on the interplay of "Credit, commodities, and currencies." He noted that loans and bonds outstanding for the oil and gas industry had almost tripled between 2006 and 2014 to $3 trillion, including a large slug taken on by firms in emerging markets.

Situation Developing
Debt securities issued by oil and gas companies in selected emerging markets*
Source: Bank for International Settlements
Note: Brazil, China, Colombia, Indonesia, Kazakhstan, Kuwait, Malaysia, Mexico, Nigeria, Qatar, Russia, UAE and Venezuela.

 Just as the mortgage pile-up transformed the U.S. housing market, so the legacy of the energy sector's credit craze will live on in several important -- and conflicting -- ways, for years to come.

One effect Caruana highlighted is how a high debt burden focuses the mind on generating cash flow to meet interest payments. This surely explains at least some of the sheer resilience of not just U.S. but global oil production in the face of low prices. While banks must eventually pull lines of credit from struggling oil producers, they are no doubt loath to take ownership of leases and rigs in a bankruptcy situation, putting off the day of reckoning.

If that prolongs the market's pain today, though, it also offers some hope for tomorrow. Going back to Verleger's chart above, he rightly shows that investment in new oil and gas prospects is set to plummet well below what the International Energy Agency says is needed.

Indeed, earlier this month, the IEA's head of its Oil Industry and Markets division warned that today's low oil prices are setting up a potential supply shock in the "not too distant future."  Meanwhile, at Chevron's analyst day earlier this month, the company essentially drew a line under the multi-billion dollar projects that have turned off shareholders in recent years while simultaneously talking up growth prospects in its Permian shale assets.

This re-balancing of the oil market is exactly what is being delayed by the effect of high debt and ultra-low interest rates. But any spike would have two edges.

On the same day Yellen made her remarks, Exxon Mobil came under renewed attack from state attorneys general investigating whether it misled the public about the dangers of climate change. Exxon called this "politically motivated," and it may well be right, in part.

But when has politics not figured large in the oil business? The bigger issue is that these investigations form part of a growing movement to limit reliance on fossil fuels in general. A price spike, while offering a temporary windfall, would only provide further momentum to oil's opponents, especially if it also involves social or economic collapse in an OPEC member such as Venezuela.

The lesson of 2008's spike for OPEC is that while it may want higher prices, what it really needs are stable prices that aren't too high. On that basis, rather than hoping to destroy shale with its current policy, OPEC is likely counting on it to act as something like an automatic stabilizer for the oil price in future.

The other wild card here, though, is the Fed's timing on raising rates further. When this happens eventually, it could have two very negative effects on the debt-laden oil market.

First, cheap financing is helping to keep bulging oil inventories in their tanks. Wednesday's weekly report from the Energy Information Administration showed, yet again, that stocks are far above normal levels. When oil prices rally, though, this squeezes the profits that can be earned by buying oil and storing it to sell at a future date. The spread between the cash price and the six-month forward contract has more than halved since mid-February.

Storing Up Trouble
Discount of West Texas Intermediate crude oil cash price to six-month futures price
Source: Bloomberg

You know what else squeezes a carry trade and could force those millions of barrels back onto the market? The cost of financing the trade going up.

The second impact of rising Fed rates goes back to Caruana's speech. The explosion of borrowing in emerging markets, especially when denominated in U.S. dollars, is a ticking time bomb for the global economy. When rates start rising, pulling the value of the dollar up with them, the pressure on not just oil companies but all heavy borrowers in developing markets will intensify. And it just so happens that the developing world accounts for all of the projected growth in oil demand over the next five years, based on the IEA's numbers.

Yellen's caution, like OPEC's freeze tease, bolsters the extend-and-pretend oil market. The debt always comes due at some point, though. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at

To contact the editor responsible for this story:
Mark Gongloff at