Oil Is Going to Fall by 50%… Again

We’ve talked about the massive Debt Supercycle and why it can only end in the market crash I’m now predicting. (If you want a refresher, download my “Super Crash Report.”)

But there’s one connection we haven’t made yet.

The same thing just happened in the energy market.

The 50% collapse in WTI crude oil spot prices over the second half of 2014 caught most investors by surprise. It wiped out billions of dollars of value from the accounts of investors who owned energy stocks and junk bonds. But if you knew the reality of the debt situation in energy, the outcome was clear as day.

This is one of the reasons my institutional and high net worth clients didn’t own a single energy stock or bond at that time. We’re going to be, of course – there’s a window approaching where we can make a killing in energy, and I’ll show you when – but 2014-2015 was not a good time to be long in a highly speculative and leveraged energy market.

And it’s about to happen again.

Today I want to show you exactly how debt crashed the energy market. It’s a story few investors understand, and it’ll really put this whole “Debt Supercycle” concept in sharp relief for you.

And then get ready. First thing next week you’ll get my immediate profit protection plays… the key indicator to tell when oil has hit bottom… and see how we could make 300% riding it back up.

How Oil Prices Got So High in the First Place

First it is necessary to understand how prices got so high in the first place. After all, a little more than a year ago, WTI crude oil was trading well over $100 per barrel. And it had only flirted with $80 per barrel a couple of times since the 2008 financial crisis, when it hit $82 per barrel in 2011 and $83 in 2012.

How did this happen? The Federal Reserve’s Herculean post-crisis efforts to lower interest rates in order to revive the U.S. economy was occurring at exactly the same time that a new technology for extracting oil from the ground came into existence. This new technology was called fracking, and it revolutionized the U.S. oil industry.

The combination of endless amounts of cheap money and new technology is something we have seen before. For example, in the late 1990s, the Fed opened the monetary spigots at the same time that the first phase of the Internet came on the scene. Many Internet and telecom companies used cheap debt to finance themselves – and ended up borrowing themselves into bankruptcy.

Corporate managers prefer to finance themselves with debt rather than equity in order to keep the value of their company for themselves. Low interest rates allow them to do this more easily. Again, I saw this first-hand during the Internet Bubble when companies that had limited revenues were able to borrow hundreds of millions of dollars from gullible investors to build Internet hosting facilities or enough cables to wire the universe.

The same thing happened in the energy industry since the financial crisis.

The “Financial Mania” of Fracking

Charles Kindleberger was one of the greatest financial historians of the 20th century. The energy cycle fits the classic scenario that Professor Kindleberger described in his classic history of financial manias, Manias, Panics and Crashes:

“The nature of the displacement varies from one speculative boom to the other.  It may be the outbreak or end of a war, a bumper harvest or crop failure, the widespread adoption of an invention with pervasive effects – canals, railroads, the automobile – some political event or surprising financial success, or a debt conversion that precipitously lowers interest rates. But whatever the source of the displacement, if it is sufficiently large and pervasive, it will alter the economic outlook by changing profit opportunities in at least one important sector of the economy.”

There is little question that technological development of fracking constituted a “displacement” that distorted energy markets and enabled energy companies to raise an enormous amount of equity and low cost debt.

Everyone believed that oil prices would stay at $100 per barrel forever. This expectation was based on the bogus belief that the global economy was strong, when in fact it was very weak and was only growing because central banks were printing trillions of dollars/euro/yen/yuan of money. Even worse, their governments were in many cases the biggest buyers of that new debt in massive Ponzi schemes that are now coming home to roost.

When these schemes started to reach their limits in 2014, the global economy hit a wall and commodity prices – including oil – started to collapse. (Supply and demand factored in too, of course.) We saw the impact of this almost immediately in U.S. markets.

When WTI hit a low of $44.12 per barrel on January 29, 2015, the consensus figured that prices had hit bottom. And for a while it looked like they were right. WTI rallied back up to $61.36 per barrel on June 10, a strong 39% recovery.

In the interim, a large number of energy companies raised billions of dollars of new equity and debt in order to try to survive the worst oil downturn in decades. And they found willing investors who believed that oil prices couldn’t possibly go any lower.

I am sorry to report that all of these bright minds were 100% wrong. There was never any doubt that oil prices were going lower – much lower than their January 2015 prices.

And predictably, as we speak, WTI is back at $45 per barrel.

energy

Energy companies comprise about 17% of the U.S. high-yield bond market (roughly $200 billion face amount of debt). In the summer of 2014, the average yield on the energy sector of the Barclays High Yield Bond Index was roughly 5% but by the end of the year, the yield had moved above 10% for the first year and it is now higher. Many bonds dropped by more than 50% and thus far at least eight companies have filed for bankruptcy.

But believe me, there is going to be much more blood in the water.

The Dollar’s Effect on Oil

 

There is another big reason why oil has not reached a bottom – the U.S. dollar is going to keep getting stronger.

Again, the U.S. dollar is likely to continue to strengthen against other major currencies, including the euro, the yen, and the yuan. China has begun devaluing its currency. Europe and Japan are engaged in major QE programs that will devalue their currencies. The Brazilian real is plunging. The world is engaged in a massive currency war and the dollar will be the winner among all the paper currencies (gold will be the ultimate winner but that’s a topic for another day).

Oil is traded in dollars and a stronger dollar means lower oil. You cannot be long the dollar and long oil – they move in different directions.

Instead you may want to be long the dollar and short oil (as I’ll show you next time). These two trades fit together.

Oil Is Likely to Fall Another 50% from Here

Right now bankers are reviewing the loans secured by oil and gas assets, something they do twice a year. With oil prices back down at their January lows, banks are likely to limit the amount they are willing to lend to the industry. Even worse, regulators are breathing down the necks of bankers in a well-intended but misguided attempt to substitute their judgment in determining how much credit to extend to energy companies in the current environment. The Office of the Comptroller of the Currency is unqualified to make such decisions yet has the power to prevent banks from extending additional credit to energy companies and is aggressively asserting that power. The result is likely to be to push companies that could survive into bankruptcy unnecessarily, which will put further downward pressure on oil prices.

The price of oil (WTI) is likely to drop into the $20s before the current cycle ends.

And that’s when we pounce.

I’ll be back with you Monday. Don’t miss this one.

9 Responses to “Oil Is Going to Fall by 50%… Again”

  1. Marshall B. Rowland

    Historically the US oil industry have embraced a pricing policy geared to consume foreign oil. They loved the Cartel fore the burden of pricing fell on them. At present there exist 9000 capped wells in the USA. Unfortunately this long-term strategy could be to their detriment when their obstruction of Hydrogen lose ground as solar cell cost fall. Its an undeniable that decentralizing power sources is to national security interest and hydrogen energy would make such possible.

  2. W. Howard Pritchartt III

    I agree 100% with everything Mr. Lewitt stated not as a prediction but factual as being a professional in the field. I began my career as a landman in 1980 and currently reside in Houston, Texas. I am getting requests for my resume’ from solvent companies/investors to perform the due diligence in the production they will be acquiring from sales due to bankruptcy and foreclosure knowing what goes down must go back up.

  3. OK, I’m a bit confused by this: You say “The result is likely to push [oil or energy] companies…into bankruptcy…, which will put further downward pressure on oil prices.” Huh? How does a reduction of supply (or suppliers) cause prices to DROP?

  4. The “strong dollar” paradox will be just the impetus the Fed needs to justify QE4 in spring 2016-sooner if the DOW continues its decline, which I believe it will. The Fed DOES NOT WANT A STRONG DOLLAR and it, too will join the QE derby soon. Any investor who thinks we can just set fires in everybody else’s currencies and somehow U.S. markets will not get burned is a moron. The consensus last week was a rate increase! How’d that work out?

    The Fed WILL NOT raise rates in December, liquidity will continue to dry up, markets will continue to fall, and EM currencies cheap dollar carry trade will continue to crumble. Draghi is buying 60 billion in euro bonds every month and yet the dollar is weakening against the euro! We exported QE to Japan and Europe, and China has exported deflation to the rest of the world. It is over. Who cares about the price of crude. There is only cost-push and asset bubble inflation now. There is a 0% of the demand-pull inflation to drive the crude price higher. But never question the criminality of the money handlers and their government co-conspirators! I guess the Chinese could build some more empty cities.LOL!!!!

    As I see it, the 150 year old economic paradigm based on Rockefeller oil is dead. I truly believe that a revolutionary energy breakthrough coming seemingly out of nowhere will render the current oil based system obsolete. Trade in these rigged markets at your own peril.

    The petrodollar racket, commencing in 1973, died in 2008; the Keynesian fiat freaks just don’t know it yet. Weak or strong dollar, it does not matter. Gordon T. Long’s “crisis of trust” will soon illuminate the fact that the world has been in a global depression since 2008 and all the usury free paper cannot stop the free market from crushing the speculators and their overvalued crap based on CB money printing. ZIRP is proof of it.

    God help us all!

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