A few short months ago, we warned our readers that a wave of defaults would be emerging from the oil fracking industry.
You see, fracking projects make economic sense when the price of oil stays above $60 to $65. But anything below $60 a barrel for oil and the projects become significantly less economically feasible.
In our initial report, we stated the opinion that it would take upwards of a year for our thesis of greater defaults in the fracking industry to play out. In the meantime, we expected many frackers to expand production successfully while at the same time making deep cuts in spending.
It turns out we were spot on with our analysis. But we went on to say that production gains would be nothing more than a delay of the inevitable without a quick reversal in oil prices.
Now that oil prices remain near $35/barrel, even the most cost efficient firms are having significant trouble staying afloat. Growing numbers of bankruptcies are starting to emerge and many more are on the way in 2016.
In fact, we estimate that total losses could exceed $1 trillion this year alone.
Unfortunately, the pain is just beginning and it will not be contained to the energy sector. About $99 billion in face value of high-yield energy bonds are trading at distressed prices, according to Bloomberg Intelligence analyst Spencer Cutter.
The Bank of America-Merrill Lynch U.S. High Yield Energy Index has given up almost all of its gains since 2001. And with yields reaching their highest levels relative to the broader market in more than a decade, it’s easy to see further deterioration in liquidity, which will put some banks in significant distress before all is said and done.
Prudent investors can avoid some of the upheaval by avoiding high-yield bonds and financial stocks with exposure to frackers.