Can oil price plunge cause a financial crisis?

A look at troubled energy trader Hin Leong, to which banks have an exposure of US$3.85bil, makes us wonder how many more of such cases are lying hidden, ready to explode anytime. (A view of Hin Leong's Pu Tuo San VLCC supertanker in the waters off Jurong Island in Singapore, July 11, 2019. Picture taken July 11, 2019. - Reuters.)

THE world is “drowning in oil”. This is so often heard nowadays that one wonders how long it will take to soak up all that glut, as prices for US crude plunged to below zero.

Tankers with no storage space to unload the oil, are left afloat on the ocean, filled with the once precious commodity that had cost above US$100 per barrel.

Described as “oil Armageddon”, this price catastrophe is said to be “something we may not see again in our lifetime”; although it is still uncertain when this downturn will be followed by a recovery.

Will this nosedive in oil prices cause a financial crisis?

Crisis is part and parcel of the life triggered by Covid-19; we are already in a health and economic crisis, said Socio Economic Research Center executive director Lee Heng Guie.

As oil prices plunge by 75%, about half of the top 60 independent companies in oil and energy, may be forced into bankruptcy, said Reuters.

In fact, as many as 533 US oil exploration and production companies that had taken on too much debt, will likely file for bankruptcy by the end of next year, if oil stays around US$20 per barrel, said Rystad Energy.

Banks have already lost an estimated US$750mil to US$1bil, said JP Morgan, from charge-offs in 2019, for reserve-based lending to shale companies.

Along with the risk of defaults, financial losses are feared to spark a credit crunch elsewhere and cause a credit contagion.

More cracks are appearing in the fragile global financial system; as markets are all inter-connected, the real undercurrents may be setting up for a ‘far bigger failure’ than anticipated.

A look at troubled energy trader Hin Leong, to which banks have an exposure of US$3.85bil, makes us wonder how many more of such cases are lying hidden, ready to explode anytime.

In another three months of persistently low oil prices, there could be collapses among oil firms with high capital expenditure that had been funded by debt and equity, said Areca Capital CEO Danny Wong.(pic below)

But banks are stronger and more cautious in lending, while the US government and Federal Reserve are acting ‘fast and bold, ’ to stem any further downslide.

Some hedge funds could be caught by this fierce collapse in oil prices, but most investors have already turned cautious due to this outbreak.

Coupled with the Fed’s move to cut interest rates to near zero, it will probably be manageable, said RHB Research Institute chief Asean economist Peck Boon Soon.

Volatility, in the first place, has been more disruptive to financial markets, than these current low oil prices, said Fortress Capital CEO Thomas Yong.

Many economies are net consumers of oil, and stand to benefit.

“The plunge in oil prices will generally have a positive impact on the costs of raw and packaging materials, as well as chemicals, ’’ said Top Glove Corporation executive chairman Tan Sri Lim Wee Chai.

In the near term, price weakness is likely to persist with demand destruction and lack of storage.

Transportation accounts for 70% of oil consumption in the US; as more people work from home, demand for transportation will likely be reduced.

What was initially a price war between Saudi Arabia and Russia that saw the Saudis ramping up output, became a free fall in prices as increasing lockdowns crushed the demand for oil.

Production cuts by 23 countries led by Saudi Arabia, Russia and the US to take out 9.7 million barrels per day, have failed to stem the rapid decline in oil demand.

For the first time, the six or seven oil major oil companies known as Big Oil, are also forced to cut production.

Amidst the devastating impact on exporters, Russia is among the hardest hit as two thirds of its export earnings and 40% of its budget revenue is from oil.

Russia had earlier said it could withstand prices at US$25 per barrel for up to 10 years; last week, a barrel of Russia’s Urals oil had gone to US$8.48 per barrel.

More than one million oil workers could lose their jobs as oilfield contractors and firms cut costs, said Rystad Energy.

The havoc in the oil market worsened with political fights among producer countries, that ended up with them ‘cutting their own throats.’

While this situation may not drag on too long, countries that had under-estimated the risks of Covid-19 may suffer a further spread of the epidemic, and extended lockdowns, said Muhibbah Engineering group finance director Shirleen Lee.

Higher energy efficiency will also impact the long term demand for oil.

Columnist Yap Leng Kuen notes that price wars amidst demand shocks will be disastrous. The views expressed here are the writer’s own.

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oil , price , plunge , financial crisis , Saudi , Russia , demand , Hin Leong ,


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