Energy stocks are reeling for a second day, as crude oil futures collapse to lows not seen since 2009. The bloodbath in the energy sector has been dragging down the market as whole this week. The contract for West Texas Intermediate crude fell below $37 a barrel this morning for the first time since February 2009. This continues the trend from yesterday, when US crude prices fell 5.8% to close at $37.65 a barrel. Brent crude closed at $40.73 a barrel Monday for a loss of 5.3%.
A Line in the Shale?
That closing under the psychological level of $40 a barrel accelerated bearish sentiment. The markets generally consider $40 to be the break even point for the remaining shale fracking drillers. Traders are bracing for a wave of defaults and bankruptcies in the shale fields if prices remain this low. The market valuation of most of the big oil companies in the West was predicated on an oil price of $60 a barrel. This means that most of these companies will see a substantial drop in their value as earnings are revised drastically downward.
This would be the endgame that Saudi Arabia has been playing for, for over a year. OPEC members have been enduring the pain of low oil prices in order to strangle their competitors focused on offshore and shale drilling. OPEC's meeting last Friday ended with Iran and Iraq both strongly blocking any attempt to set quotas at all.
How Low Can Crude Go?
With oil prices now below the level where almost no one is making a profit, the question becomes "How low can crude go?" The wealthy Persian Gulf monarchies have enough foreign reserves to operate at present levels for a few more years, at least. The smaller OPEC producers, such Algeria and Venezuela, are facing domestic crises as government revenue dries up. Some analysts are warning that oil could drop to $20 a barrel after WTI crude fell below solid support at $40/bbl. Many traders believe that scenario is unlikely, but one of those calling for $20 oil is Goldman Sachs.
In the short term, the winner is the public, which will see lower gas prices. Lower fuel prices will also help airlines and transportation companies. Another winner is the oil storage industry. Global storage capacity is near 100%. If there's no place to store the crude, then the oil producers will have to shut down their wells, depriving them of any revenue at all. Heavy oil importers like India are also big winners. Oil is the #1 import for India, and lower prices have allowed it to shrink its current account deficit.
Regions dependent on spending by the oil drilling companies are already hurting, and it will only get worse. Food riots have been breaking out in Venezuela, where a coalition of opposition parties wrested control of the national legislature from the Socialist ruling party. domestic unrest in other minor OPEC nations is on the rise, as governments have had to drastically slash budgets. Even Saudi Arabia is posting a budget deficit, but is burning through its cash reserves to keep the extravagant welfare state running as usual.
Things will only get worse for petroleum producers when the US Federal Reserve starts raising interest rates. This will make the dollar stronger, which will depress the price of oil.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.