Are you worried about oil prices? If you’re a consumer, the answer is probably, “No”.
If you’re an investor, chances are you’re seeing things differently—and you’re not alone.
Investors have been feeling the pain caused by the dip in oil. While we’re seeing green shoots of progress, there’s trouble ahead if it doesn’t stick.
Don’t High Oil Prices Spark Recessions?
If you’re scratching your head and thinking that oil price spikes usually precede a recession, you’re absolutely right.
In fact, nearly every major recession since the memorable “oil crisis” in the early 1970s included an oil-price hike as one of its precursors.
That was then; this is now.
It’s no secret that plunging oil prices have roiled the U.S. stock market, but worldwide, as well. It’s also no secret that stock market crashes have featured large in past recessions.
The anguish being felt by the oil industry is spreading outward, as plunging profits fuel fears of massive defaults on the high-yield debt the sector has been using to finance oil exploration.
The idea that plummeting oil prices could trigger a U.S. recession isn’t new. An analysis published in January 2015 noted that the 1987 stock market crash occurred on the heels of a drop in oil prices, and likens an energy-loan default scenario to the subprime mortgage crisis.
The same month, the Convergex Oil Impact Survey for 2015 found that more than one-quarter of the investors canvassed viewed $30 per barrel as the price point at which a global recession would be unavoidable.
Experts Weigh In
Others have joined in sounding the alarm…
Citigroup analysts foresee a global recession based less upon conventional measures—such as diminishing growth of a country’s gross domestic product—and more upon the words and actions of its own moneyed clients.
These clients, it seems, are engaging in behavior meant to reduce their investment risk in the event of an economic downturn.
Financial Times pegs the chances of a U.S. recession at 20%, based upon a poll of more than 50 economists. Morgan Stanley concurs with this assessment, while noting that markets are currently pricing in a recession risk of 50%. Bank of America Merrill Lynch analysts also believe that investors give the economy a 50% chance of succumbing to recession within a year’s time, and raise their own expectations of recession to 25%.
To what do these financial experts attribute their dire predictions? In a word—oil. Or, rather, the downward spiral in the per-barrel price that has turned world markets upside-down.
The BAML investors’ note acknowledges that market fears are high, and the Morgan Stanley report dedicates a hefty amount of text to the issue of oil prices.
In their analysis, Morgan Stanley experts parse just how the oil problem is battering the economy—and why the sector’s ills are affecting the economy differently now than during past price slumps. They identify the spectacular drop in oil prices as being an instrumental player in the volatility affecting markets over the past few months, as West Texas Intermediate crude prices fell almost 70% in less than two years’ time.
Without a slowdown in production, prices have continued to drop. The report notes that, while significant oil price dips occurred in the mid-1980s and late 1990s, this recent scenario is different because of a new funding model. Rather than secure oil exploration loans from conventional banks, as it had in the past, the energy sector has been relying more heavily on financing from capital markets.
Unlike banks, who would swoop in to protect their interests when the good times ceased to roll, capital market lenders continued to throw good money after bad, in hopes of salvaging their investments. Production stayed high, and oil prices sank lower—until these investors closed the money spigot.
Desperate to keep cash flowing, failing oil producers are turning to private equity firms to stay afloat, and the frantic cycle continues. Meantime, these firms watch and wait, poised to snap up the detritus of the oil boom at rock-bottom prices.
Are You Ready for a Downturn?
Though the Morgan Stanley analysts say they don’t buy into the notion of a recession triggered by plunging oil prices, they acknowledge that the world is currently “in uncharted territory in which (oil) oversupply could conceivably cause a recession,” and find it worrisome that oil’s downward spiral seems to have no end in sight.
But hard evidence exists that the downturn has begun. Several U.S. states are currently in the throes of recession: Alaska, North Dakota, West Virginia and Wyoming.
It’s no coincidence that these four states are also associated with oil, and that the slide in that commodity’s price has been the primary reason for their economic misery. Production cuts have resulted in crushing job losses, and good-paying jobs, at that—the average pay for Wyoming energy workers is $1,777 per week.
If the recent oil price surge doesn’t stick, malaise affecting oil states is bound to spread to the rest of the country…
According to research from the Manhattan Institute, tens of thousands of jobs in at least 16 U.S. states are tied to the oil sector, and the industry has contributed approximately $350 billion each year to the national economy.
If prices don’t pull out of the plunge, the economies of other oil-producing states such as Texas, Oklahoma, and New Mexico will likely stumble, as well.
While the surge is encouraging, it has to prove itself before investors can truly exhale for a while.