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The Oil Short Squeeze Explained: Why Banks Are Aggressively Propping Up Energy Stocks
The Oil Short Squeeze Explained: Why Banks Are Aggressively Propping Up Energy Stocks
Last week, during the peak of the commodity short squeeze, we pointed out how this default cycle is shaping up to be vastly different from previous one: recovery rates for both secured and unsecured debts are at record low levels. More importantly, we noted how this notable variance is impacting lender behavior, explaining that banks – aware that the next leg lower in commodities is imminent – are not only forcing the squeeze in the most trashed stocks (by pulling borrow) but are doing everything in their power to “assist” energy companies to sell equity, and use the proceeds to take out as much of the banks’ balance sheet exposure as possible, so that when the default tsunami finally arrives, banks will be as far away as possible from the carnage. All of this was predicated on prior lender conversations with the Dallas Fed and the OCC, discussions which the Dallas Fed vocally deniedaccusing us of lying, yet which the WSJ confirmed, confirming the Dallas Fed was openly lying.
This was the punchline:
[Record low] recovery rate explain what we discussed earlier, namely the desire of banks to force an equity short squeeze in energy stocks, so these distressed names are able to issue equity with which to repay secured loans to banks who are scrambling to get out of the capital structure of distressed E&P names. Or as MatlinPatterson’s Michael Lipsky put it: “we always assume that secured lenders would roll into the bankruptcy become the DIP lenders, emerge from bankruptcy as the new secured debt of the company. But they don’t want to be there, so you are buying the debt behind them and you could find yourself in a situation where you could lose 100% of your money.“
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What Just Happened With OIL?
What Just Happened With OIL?
Yesterday, we reported exclusively how the Dallas Fed is pulling strings behind the scenes to conceal the fallout from the oil market crash. As Dark-Bid.com’s Daniel Drew notes, by suspending mark-to-market on energy loans and distorting the accounting, they are postponing the inevitable as long as possible. The current situation is eerily reminiscent to the heyday of the mortgage market in 2007, when mortgage defaults started to pick up, and yet the credit default swaps that tracked them continued to decline, bringing losses to those brave enough to trade against the crowd.
Amidst the market chaos on Friday, a trader brought something strange to my attention. He asked me exactly what the hell was going on with this ETN he was watching. I took a closer look and was baffled. It took me awhile to put the pieces together. Then when I saw the story about mark-to-market being suspended, it all made sense.
Here is the daily premium for the last 6 months on the Barclays iPath ETN that tracks oil:
Initially, Dark-Bid.com’s Daniel Drew thought this was merely a sign of retail desperation. As they faced devastating losses on their oil stocks, small investors turned to products like oil ETNs as they tried to grasp the elusive oil profits their financial adviser promised them a year ago. Oblivious to the cruel mechanics of ETNs, they piled in head first, in spite of the soaring premium to fair value. After all, Larry Fink is making the rounds to convince the small investor that ETFs are indeed safer than mutual funds. Because nothing says “safe” like buying an ETN that is 36% above its fair value.
Sure, there are differences between ETFs and ETNs, particularly regarding their solvency in the event of an issuer default, but the premium/discount problem plagues ETFs and ETNs alike. Nonetheless, widely trusted retail sources of investment information perpetuate the myth that ETNs do not have tracking errors.
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2 days of gains push oil up 17%, TSX up 3.6%
Global stocks calmer after a week of volatility set off by doubts about China’s growth
After a week with wild swings in the values of stocks and commodities, oil futures ended up gaining 17 per cent in two days and the TSX was up 3.6 per cent in the same period.
That didn’t wipe out the damage done to the Toronto market in the last 10 days after China’s devaluation of its currency triggered global market turmoil. The TSX is down 5.2 per cent on the year and 2,7 per cent from its level before the Chinese currency crisis began last week.
Investors were cheered by oil’s rapid recovery and bought up Canadian energy stocks, pushing the TSX up 98 points to 13,865 on Friday.
The Dow was down 11 points today at 16,643, but it has recovered its week-ago level after a sharp rise yesterday.
The Dow has lost 6.6 per cent since the beginning of the year and is trading at the same level it was at last October.
The volatility triggered by China’s currency devaluation Aug. 18 lasted more than a week. But North American markets shook off the gloom by Wednesday, with a sharp recovery in the last two days.
TD economist Ksenia Bushmeneva attributed the relative calm in markets later in the week to a statement by New York Fed president William Dudley that prospects of a U.S. rate increase next month have dimmed amid rising concerns about the rest of the world.
West Texas Intermediate (WTI), the most important North American futures contract, finished Friday at $45.43 US a barrel, an increase of 6.7 per cent on the day or $2.87 and reverses the seven-week decline that had taken it below $38.
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Brent oil was up $2.62 or 5.5 per cent to $50.18.
WTI at $60 US would improve the outlook for North American oil producers, but it hasn’t been that price since the end of June.
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This Week In Energy: Why Anything Can Happen in 2015
This Week In Energy: Why Anything Can Happen in 2015.
The New Year is upon us but oil prices are carrying on the trend from the second half of 2014 and continuing to drop, with the thirteenth negative week from the last 14 and lows not seen since 2009. With early morning volatility seeing rises of 3.5% and subsequent falls of 2.3%, trader concerns over the continuing supply glut are outweighing any early positioning opportunities in the New Year. Energy stocks overall on Wall Street were the worst performing of 2014 with a drop of over 9%, but utilities had been performing surprisingly well through December before a 4% drop at year’s close to finish 2014 up by 28%. With approximately 40% of U.S. power generation now coming from natural gas, an increase of 28% over recent years, gas-based utilities look poised to be early over-achievers this year.
If current energy and currency market trends continue, 2015 could prove to be a huge year for the United States as a combination of weaker commodity prices, a strong dollar, and steady economic growth, especially in a global context, create huge foreign flows coming into the U.S. market which could all potentially lead to the fastest pace growth in a decade. The U.S. Dollar has continued its strong performance at the end of 2014, and this week has hit its highest level since March 2006. Problems for competitor economies in Asia and Europe have resulted in the dollar index, which measures dollar strength against several other major currencies, reporting 9 year highs of 90.90 as of this morning.
Today’s Market Contagion: Energy High-Yield Credit Spreads Blow Above 1000bps For First Time Ever | Zero Hedge
For the first time on record, HY Energy OAS has broken above 1000bps – signifying dramatic systemic business risk in that sector (despite a modest rebound today in crude prices). The energy sector is entirely frozen out of the credit markets at this point with desk chatter that there is no bid for this distressed debt at all and air-pockets appear everywhere as each new trade reprices the entire sector. The broad high-yield ‘yield’ and ‘spread’ markets are now under significant pressure – both pushing to the cycle’s worst levels.
HY Energy weakness is propagating rapidly into the broad HY markets:
This suggests significant weakness to come for Energy stocks:
This cannot end well (unless the Fed decides monetizing crude in addition to TSYs and E-Minis is part of its wealth preservation, pardon “maximum employment, stable prices, and moderate long-term interest rates” mandate…)
Jobs, Shale, Debt and Minsky – The Automatic Earth
Jobs, Shale, Debt and Minsky – The Automatic Earth.
OK, I don’t see a whole lot of comprehension out there, so let’s try and link the obvious: employment to shale to plummeting oil prices to the debt the shale industry was built on (and which is vanishing). I know, people look at the US jobs report today, and at the stock exchanges (Europe up some 2% across the board), and think salvation has landed on their doorstep, but the true story really is very different.
The EU markets are up because of US job numbers + the expectation that Draghi will launch a broad QE in January. But US jobs are far less sunny than meets the eye at first glance, and the Bundesbank will not all of a sudden do a 180º on ECB stimulus options. Ergo: a lot of European investors are set to lose a lot of money.
Anyone notice how quiet Angela Merkel has become about the QE debate? That’s because she doesn’t want to be caught stuck in a losing corner. Even if the Bundesbank would give in to Draghi, and chances are close to zero, there would be multiple court cases in Deutschland against that decision, and chances are slim the spend spend side would win them all. That’s the sort of quicksand an incumbent leader like Merkel wants to avoid at all cost.
But let’s leave Europe to cook itself, and its own goose too. What’s happening stateside is more important today. First, Marc Chandler has a good way of putting what I have said for as long as oil prices started testing ever deeper seas: the danger to the industry is not even so much falling prices, it’s financing both existing and future endeavors. Shale is a leveraged Ponzi, that’s its most urgent problem. Even if shale could break even at low prices, financiers and investors would still leave the building.
Both shale oil and gas have two big problems: 1) projects are based on highly optimistic returns, and 2) they are financed with very large and leveraged debt loads. With WTI prices now at $66 a barrel, and the first Bakken prices below $50 a barrel having been signaled, the entire industry starts resembling a house of cards, a game of dominoes and/or a pyramid shell (pick your favorite) more by the day. Chandler:
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