In “When QE Leads To Deflation: A Look At The Global Supply Glut”, we outlined, for all to see, how the monetary policies pursued by the world’s central banks have not only failed to create demand and meaningfully lift inflation expectations, but have in fact the opposite effect, creating a global supply glut and, in an irony of ironies, deflation.
The cycle, which Citi says is “how zombies are born”, is nowhere more evident than among US oil drillers. Companies who would have otherwise been rendered insolvent by plunging crude prices have been able to keep drilling thanks to i) record low borrowing costs and ii) voracious demand for corporate issuance and ‘undervalued’ equity attributable to the fact that risk free assets fetch at best an inflation adjusted zero and at worst have a negative carry.
Access to cheap cash keeps the supply coming which in turn keeps prices suppressed in a cycle that feeds on itself creating Citi’s “zombie” companies in the process. We’ve bemoaned this central bank-assisted aberration for quite a while now have variously warned that given the completely illiquid conditions that exist in the secondary market for corporate credit, the last thing anyone needs is a primary market bonanza for junk-rated borrowers. As for equity issuance, what gullible investor wouldn’t want to jump on a secondary from an otherwise insolvent producer. After all, prices will rebound eventually. BTFD, people.
Once the revolver raids start up again in October (when banks will once again assess credit lines to oil and gas producers) the defaults may be just around the corner. Then comes the rush to the HY ETF exits at which point horrified fund managers seeking to unload the underlying bonds will discover that there’s no one home at dealer desks thanks to the post-crisis regulatory regime.
Now, everyone is picking up on the narrative. Here’s WSJ on how Wall Street is keeping the sector afloat and the world awash in crude:
Wall Street’s generous supply of funds to U.S. oil drillers helped create the American energy boom. Now that same access to easy money is keeping them going, despite oil prices that are languishing around $60 a barrel.The flow of money into oil has allowed U.S. companies to avoid liquidity problems and kept American crude production from falling sharply…Helped by a ready supply of money, the flow of oil from the U.S. could keep crude prices low for the remainder of 2015 and beyond…Energy shares are lagging behind the overall stock market. Over the past year, the S&P 500 is up 9.6%, but energy stocks in the index are down 17.6%. Some investors, betting on an oil price rebound, regard energy stocks as a relative bargain.“I’ve been surprised by the amount of money that has come into the sector” since oil prices started falling, said Paul Korus, chief financial officer of Cimarex Energy Co., a midsize energy company based in Denver.Much of that stems from a fundamental belief that investors should buy now when oil prices are low, he says. “We all think there will be some sort of recovery, but we don’t know when it will recover and what it will recover to.”Cimarex is one of several outfits to tap public markets by issuing more shares. In the first three months of 2015, U.S. listed companies issued $16.7 billion of new shares and convertible bonds, the highest level since 2010, according to Dealogic.Most are using the cash to clean up their balance sheets. But Cimarex, which raised nearly $750 million in late May, plans on spending it to drill more wells in Texas, Oklahoma and New Mexico. The company had cut its rig count to six from 20; plans now call for nearly 20 rigs to be drilling again by the end of the year.Banks aren’t reining in oil company borrowing, at least not yet. Loan officers surveyed by the Federal Reserve in April said they expect an increase in energy companies unable to pay back their loans, and were preparing by restructuring agreements.Many companies have other options. Goodrich Petroleum Corp., concerned that its line of credit would be reduced, obtained a $100 million “second-lien” debt deal at a relatively high 8% interest rate.
Summing up the above in two graphics:
Trust us, this — like state governments issuing pension obligation bonds, like fund managers suggesting they will tap bank liquidity lines instead of selling assets when retail starts liquidating esoteric ETF units in a panic, and like every other example of "extend-and-pretend" which now exists in one form or another in virtually every corner of the market — will not end well.