Oil prices traded yesterday near $30 per barrel, the lowest level since 2003.
The slump in oil prices is a result of China’s slowdown and the fact that drillers don’t stop pumping despite the oil glut. Also, a strong US dollar is not helping matters. Falling oil prices are a bearish driver for metal prices since it’s an asset closely followed by commodity investors. In addition, oil is the main benchmark for energy prices. Lower oil prices mean lower production costs, which improves the margins of metal producers, delaying the very much needed production cuts to help support metal prices.
Together, US oil producers are losing around $8 billion per month at current prices. Energy companies took on huge debts to finance their work and now all they can do is keep pumping oil to generate cash to pay interest on their debts while hoping for demand to come back and lift prices.
At these levels, it is estimated that a third of US oil and gas producers could go bankrupt within the next year or two. Many are going to have huge problems and the longer it takes producers to throw in the towel, the longer oversupply stays and the more companies will need to eventually shut down.
That’s raising concerns among US investors – not only energy investors, all investors in stocks. The energy sector is an important part of the US economy and the bankruptcy of drillers would create economic pain domestically. This includes pain not only in the energy sector but in the metal sector in which we’ll see significant shutdowns and job losses eventually.
Chinese Stock Sell-Off
Over the past two weeks, a sell-off in Chinese stock markets is only throwing a further pall over the market’s mood. This is not something new. We already pointed out last year that both, stocks and commodities markets were linked as all eyes were on China.
Current market conditions are suggesting the same theme. When will oil prices find a floor? Most likely when companies start declaring bankruptcy. That’s the kind of news that makes stock markets hit a bottom. When the worst news is already on the table it leaves nothing left to be priced in.
So that’s still our guess. The current fall in global stock markets will stop when commodity markets find a floor, which will happen when enough bankruptcies are on the table. That might happen as the US dollar loses strength and, in that way, all the individual pieces of this puzzle will fall into place, proving again how important it is to look at different markets to understand the big picture.