We continue to closely monitor the oil and gas industry. Just as we identified potential problems earlier in the year in China, we also believe there could be some contagion from the oil markets on the overall economy.
Oil prices have fallen almost 60% since last summer. Future oil prices continue to be guided lower for the upcoming year as reality sets in for the energy market. Analysts now expect prices to stay lower for longer than anticipated due to a build-up in inventories. The build-up is a result of increased exports from Iran and OPEC along with Russia. These countries refuse to scale back production for fear of losing future market share and immediate income.
According to Standard and Poor’s, 16 U.S. oil production companies have already defaulted in 2016 and eight oil producers have about a year or less of available cash reserves. The impact hasn’t been limited to oil companies as notable gas companies such as Alpha Natural Resources and Walter Energy have declared bankruptcy.
Although oil companies continue to cut costs to bring down operation costs, they are still losing money at under $50 per barrel of oil. If oil prices stay below $50 a barrel, we expect to see further defaults in the industry.
The decline in the oil industry has had an impact on high yield bonds leading to a divergence between high yield bond returns and equity market returns. This should be a warning sign for equity investors.
There are many facets (oil included) that can have an unexpected ripple effect across markets that are unforeseen. Just as we saw a small number of negative factors in China earlier this year, we also see contagion and weakness across various market sectors at the present moment.
We have been unable to pinpoint the contagion that may cause a market correction, although we have identified a handful for you that the market, in general has half-heartedly taken into consideration.