AS oil traded at around US$35 a barrel this week for the first time since the financial crisis, there is a bet that crude prices may decline below US$30 and possibly at or below US$25 in the first quarter as global supplies grow next year.
London-based hedge fund manager Pierre Andurand, who’s been betting on falling prices since September 2014, expects global supplies to expand by 1.6 million barrels a day and in Opec (Organisation of Petroleum Exporters) nations by 900,000 barrels a day in the first half of 2016.
Demand growth around the world will slow, and begin to decline around 2022, said The Sydney Morning Herald (SMH), quoting Andurand.
Oil prices have plunged by two-thirds since June 2014 amid a worsening global supply glut. The drop has continued in December as the Opec abandoned output limits at a meeting this month and the first interest rate increase by the Federal Reserve in almost a decade have boosted the dollar and reduced the appeal of commodities traded in the US currency, said SMH.
West Texas Intermediate (WTI) for January delivery fell 42 US cents, or 1.2%, to US$34.53 a barrel at 1.24pm on Friday on the New York Mercantile Exchange. The contract dropped to US$34.29 earlier in the day, the lowest since February 2009.
Quoting Andurand, SMH said there was a large probability of Iranian production returning to the market in March or April starting at 400,000 barrels to 500,000 barrels a day.
Andurand Capital Management manages US$615mil in funds. The hedge fund, which posted a 38% gain last year, has risen 8% this year through Dec 11, said SMH, quoting a person with knowledge of the returns.
Goldman Sachs had earlier predicted that crude oil price would hit US$20 per barrel. If Andurand is correct, the US$25 per barrel he expects by early next year could be a precursor to Goldman’s bet of US$20 per barrel.
Even after a steady drop in energy prices through the second half of the year, banks in the US are being lenient with cash-strapped companies rather than set tougher lending constraints, said The Wall Street Journal (WSJ).
Most lenders were relatively generous in setting credit lines, while also insisting on more protections, including holding more collateral against the loans, said WSJ, quoting bankers and others familiar with the process.
Banks were also optimistic in their projections for future oil prices, forecasting that the US oil benchmark WTI would average US$47.36 in 2016, said WSJ, quoting a late-October survey of 32 banks from Macquarie Capital Inc. The banks predicted the price would continue rising in the following years.
Banks were hesitant to take harsh steps, because doing so could set off a chain reaction in which their borrowers ultimately fail and banks could end up owning the assets.
Previous energy busts, like the one in the 1980s, resulted in major losses at banks, with painful ripples through the broader economy. Quoting experts, WSJ said that seems unlikely to happen this time around, given that US banks have ceded some of their share of the energy-lending market over the last decade to non-banks and foreign banks, particularly to the riskiest companies.
Still, projections for losses on energy loans keep rising broadly – and some banks have started to increase their own forecasts for such losses.
Quoting a November regulatory report, WSJ said the number of loans rated as “substandard, doubtful or loss” among oil and gas borrowers almost quintupled to US$34.2bil of total classified commitments, versus US$6.9bil in 2014.
The “carnage” from oil-related loans is to be managed with expertise and extreme patience, given the number of times banks have to adjust their forecasts of oil price. More headache is to come if the price of oil does not rebound as expected.
With the price of crude oil consistently down, credit problems for mutual funds that invest in high yield debt are not going away any time soon.
Third Avenue Focused Credit Fund recently announced it would suspend investor redemptions for a year after it suffered nearly a 50% loss in value since June 2014.
While announcing the US rate hike, Fed chair Janet Yellen said the assets of Third Avenue were heavily invested in companies with high credit risk.
Yahoo Finance had indicated that US$27bil invested over 29 mutual funds may also be at risk, with two of them suffering larger losses than Third Avenue.
Credit markets have been under pressure recently mainly due to problems in emerging markets and the decline in the price of crude oil, said Yahoo Finance.
The marginal producers of crude, especially shale oil companies, are capital-intensive enterprises that issue high-yield debt to finance their operations.
In such a situation, fire sales of fund assets is something to watch for. When risk markets are roiled and funds need to raise cash, the markets for their worst investments become extremely illiquid.
Funds are then forced to sell better quality assets, which in turn, causes those markets to become illiquid.
During the financial crisis of 2008, both gold and US Treasuries, seen as safe havens, experienced precipitous drops as investors scrambled to sell the assets to raise cash, said Yahoo Finance.
Carl Icahn, the billionaire activist investor, told CNBC the junk bond market was “a keg of dynamite that sooner or later will blow up.”
However, some think otherwise. “The Third Avenue situation is unique,” Gary Cohn, president of Goldman Sachs, was quoted as saying by The New York Times (NYT).
“They owned really low-credit-rated products compared to the typical high-yield fund. The long-term impact of rising rates remains a big question mark. But no one thinks that the collapse of Third Avenue is going to contaminate the world,” said Cohn, who had been in frequent contact with clients.
It’s too soon to say the worst is over for investors, or even that the junk bond crisis is over, said NYT.
It took over a year for the earliest signs of serious problems in the mortgage bond market to metastasise into the collapse of Lehman Brothers and a full-blown financial crisis (in 2008), said NYT.
People are keeping their fingers crossed that the junk bond problem would be contained and that the US Securities and Exchange Commission is in time to implement measures to address liquidity and maturity mismatch of these funds.
The problem in the US mutual fund industry is that investors in the funds can withdraw their money with a day’s notice, yet the investments of the mutual funds themselves are oftentimes illiquid and not immediately available for sale.
Columnist Yap Leng Kuen sees transport companies and airlines benefiting if oil prices continue falling, as expected by some quarters.