OPEC’s contentious decision to keep its production target, leaving the market with a supply glut, could trigger a wave of debt defaults by U.S. shale oil producers, warn analysts.
The 12-member oil cartel on Thursday said it would stick to its output target of 30 million barrels a day, triggering a sharp decline in oil prices, with U.S. crude futures tumbling nearly $6 to $67.75 on Friday – the lowest since May 2010.
Neil Beveridge, senior oil analyst at Sanford C. Bernstein, told CNBC the plunge in oil prices raises the risk of bankruptcy for U.S. shale players.
“While production growth is very strong [in North America], remember if you look at the debt situation for a lot of these companies, there is a lot of distressed debt,” said Beveridge.
“$68 a barrel is not economical for a lot of these shale oil wells. CDS [credit default swap] spreads and yields on some of the debt are rising very quickly, because at these kinds of oil prices you are going to see producers go bankrupt,” he added.
Since 2011, U.S. energy firms have ploughed some $1.5 trillion into ramping up their operations, taking on a large share of debt to do so, according to AllianceBernstein. Debt issued by energy companies now accounts for more than 15 percent of the U.S. junk bond market, compared with less than 5 percent a decade ago.
Small companies that have levered up to fund exploration and production will see their margins squeezed with bankruptcy “a distinct possibility,” Ivan Rudolph-Shabinsky, portfolio manager of credit at AllianceBernstein, wrote in a blog post this week.
“Companies involved in exploration and production—known as ‘upstream operations’—are vulnerable simply because they’ve earmarked too much capital for production. While fracking has helped increase capacity, the cost of developing production capabilities isn’t likely to be fully recovered,” Rudolph-Shabinsky said.
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“The lower the price of oil goes, the more likely it is that companies will struggle to recover their costs,” he said.
Following the OPEC’s production policy decision, Russian oil tycoon Leonid Fedun, vice president and board member at the country’s second-largest oil company OAO Lukoil, warned of a similar risk.
“In 2016, when OPEC completes this objective of cleaning up the American marginal market, the oil price will start growing again,” Fedun said, as quoted by Bloomberg. “The shale boom is on a par with the dot-com boom. The strong players will remain, the weak ones will vanish,” he said.
John Kilduff, partner at Again Capital, a commodity investment firm that sees prices diving into the low-$50 area early next year, agreed highly leveraged shale producing companies are a risk to watch for.
However, he doesn’t subscribe to the doomsday theory floating around that a wave of debt defaults by U.S. oil producing companies could cause another financial crisis a la 2008.
“I don’t subscribe to that, but it is worth noting, and I am on the lookout for signs of real trouble.”