As oil prices remain low, the benefit for US consumers is obvious. But for oil companies? In the short run, prices running at about the cost of production mean no profits for the year, but in the longer run there is a terrible problem ahead.
That’s because the start-up of so many fracking operations across the US came at a cost, and that cost was financed primarily through junk bonds – high yield securities that demand a hefty interest payment to keep the operation going.
Zero profit means more than hard times – it means default and, in all likelihood, a shut down of many wells. That might not only spike up the price of oil, it is big enough to trigger a huge financial problem.
Is the stock market nothing but a bubble waiting to burst? There are many reasons to believe that there is one last downturn at the exit of this Managed Depression, which may indeed be slowly forming. The risk comes in the nature of how the economy is so carefully managed through monetary policy directed by the Federal Reserve. Years of zero interest and $3.7T in quantitative easing have produced a situation that’s hard to pull out of without a lot of collateral damage.
The problem is that a lot of money is chasing an awful lot of risk these days. Junk Bonds (aka “speculative grade investments”) are making a strong run, selling a record $265B through May 2014. The reason? Interest rates stuck near zero mean no return for investors, and as things turn around they have an appetite for risk. A rise in interest rates would slaughter this market and cause losses that will reverberate through equity markets before things really have a chance to turn around.
When is junk a good thing? When you can’t afford a new car, a rusty old one might do just as well, at least for a little while (even if it is purple, like mine). And if bond rates are so low that you might as well put your money in the mattress, you might also develop a taste for junk – junk bonds, that is, or more politely known as “high yield bonds”. It’s been the latest trend in the bond market and, strangely, it might be proof that things are getting better. It’s not the quality of the debt that really counts, it’s what they do with it.