The Emerging-Market Debt Bomb Ticks For Oil
Oil doesn't just float on water. It's pretty buoyant on debt, too.
My colleague Lisa Abramowicz wrote earlier this week about the flood of money into emerging market debt this year. Just as investors are now willing to take negative yields on trillions of dollars in developed-economy sovereign debt, the premium they demand for bonds from riskier parts of the globe has shrunk to almost nothing.
Such exuberance is both the making and breaking of the oil market.
Oil producers in developing countries borrowed heavily when oil prices were in triple digits.
That is perfectly reasonable: The value of all that black, sticky collateral in the ground soared, so why not borrow against it? The problems emerge when oil prices collapse -- due in part to a glut of supply from a U.S. shale boom that also owed a lot to easy credit.
OPEC's net oil export income this year is forecast by the Energy Information Administration to hit its lowest level since 2003 in real terms. Suddenly finding yourself saddled with huge debts and savage cuts to your income understandably leaves you feeling depressed. And when oil producers get depressed, they don't retreat -- they pump more oil.
As Jaime Caruana of the Bank for International Settlements laid out in a speech earlier this year:
Highly leveraged [oil] producers may attempt to maintain, or even increase, output levels even as the oil price falls in order to remain liquid and to meet interest payments and tighter credit conditions. Second, firms with high debt levels face stronger imperatives to hedge their exposure to highly volatile revenues by selling futures or buying put options in derivatives markets, so as to avoid corporate distress or insolvency if the oil price falls further. If financial constraints contribute to keeping production levels high and result in increased hedging of future production, the addition to oil sales would magnify price declines.
So yes, those reports of Saudi Arabia ramping up supply even further and rivals such as Russia muscling into places like India reflect a battle for market share in a generally more competitive oil market. But they also speak to an intense need for dollars to fund obligations built up in the good times.
That rush of money into the likes of the iShares JPMorgan USD Emerging Markets Bond ETF helps to keep the pumps going, delaying further the rebalancing of the oil market bulls have been seeking for well over a year.
This isn't confined to just emerging markets, either. Take California Resources, an oil producer spun off by Occidental Petroleum in late 2014 1 , which currently sports net debt of 8.5 times Ebitda. Earlier this week, it secured a new $1 billion five-year loan at an eye-watering cost of Libor plus 10.375 percent. The point isn't the cost. The point is that they got the loan.
There is massive stress throughout the global oil-supply chain, from the likes of relatively small E&P companies such as California Resources to supermajors borrowing to fund massive dividend payments. And the oilfield-services sector faces a $110 billion debt wall in the next five years, according to Moody's, and is saying it can't afford to cut prices for its E&P clients any further.
As and when investors lose their taste for riskier debt -- Fed policy is the gorilla here -- bits of that supply chain will buckle and start crashing into one another.
For oil bulls focused on supply, that is actually a hopeful outcome -- but only on a short-sighted view. Why? Emerging markets, some of which rely heavily on oil receipts, account for all of the expected net growth in oil demand next year. Stuff gets messy when something blows up.
By the way, if there was an award for "Most Fortuitously Timed Spin-Off," Oxy would definitely be in the running with this one. Oil was still in triple digits when it was announced.
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Liam Denning in San Francisco at email@example.com
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