Why Oil In The Low $40s Is The Danger Zone


Oil was down another 2% today, getting just two bucks away from the important $40 level. Remember, oil in the low $40s is the danger zone for the shale industry and oil producers, and it quickly escalates to banks and the broader economy. As I said yesterday, if oil continues lower, banks will ultimately follow. Bank stocks were down today, led by Wells Fargo, which was down almost 2%.

The first signs of stress last year, when oil was dumping, was in insurance companies–a sector that tends to have investments in high yield debt. In this case, exposure to the high yield debt of the oil and gas industry. With that, today Prudential shares were down 2.5%. MetLife was down 1.8%. Hartford Financial Services Group was down 1%. Lincoln National was down 2.8%. Meanwhile broader stocks were mixed to flat.

On the other side of that high yield debt–the issuers. And one of the biggest to watch is Chesapeake Energy (CHK). The stock was hit for as much as 10% today.

Last year, CHK was perhaps THE catalyst that got central banks moving to respond to the dangers of the oil price bust. In early February rumors hit that Chesapeake Energy, the second largest producer of natural gas and the 12th largest producer of oil and natural gas liquids in the U.S., had hired counsel to advise the company on restructuring its debt (bankruptcy). The company denied that it had any plans to pursue bankruptcy and said it continues to aggressively seek to maximize the value for all shareholders. However, the market was pricing bankruptcy risk over the next five years at 50% (the CDS market). Oil bottomed just days later. Chesapeake bottomed at the same time and quadrupled in a month.

While gold and the broad stock market are showing no signs of risk–the risk in low oil prices must be respected here. The interest rate market seems to be taking it seriously. The yield curve is as flat as it’s been in ten years, which is indicating bets are being made on recession. Of course, ten years ago was 2007–that yield curve flattening predicted the bad times that followed.

But again, as I said yesterday, despite this oil price slide, the inventory report this morning showed yet another drawdown on supply. That’s 10 of the last 11 weeks! That argues oil should be going up not down.

Source: Forbes

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