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The latest fall in oil prices is once again putting pressure on indebted shale companies.
After falling from over $100 per barrel down to $43 per barrel at its lowest point in March of this year, WTI prices rebounded with a 40 percent rise, trading for more or less $60 per barrel for May and June.
The rebound appeared to spell the end to the worst of the glut, with production plateauing, if not falling, and demand starting to rise. Although estimates were all over the map, many saw a strong bounce coming in the oil markets, with some even predicting supply shortages before the end of the year.
A few companies donned a renewed sense of confidence, suggesting that they would start drilling again with oil prices in the $60-per-barrel range.
Still, mountains of debt had accumulated across the U.S. shale sector. That didn't go away but was sort of on hold as drillers, and their financial backers, hoped that further price increases would allow them to pay down debt. To stay afloat, drillers issued new debt and equity.
But the renewed plunge in oil prices is kicking off a fresh round of debt concerns. Bloomberg reported that energy-related junk bonds have lost 3 percent of their value in the last two weeks, after WTI crashed to nearly $51 per barrel and Brent fell below $57. Bond traders are avoiding high-yield, high-risk debt, and yields have jumped to nearly 10 percent, a level normally associated with default risk.
"The energy sector of the high-yield market continues to be a silo of misery," Margie Patel with Wells Capital Management, told Bloomberg telephone interview. "If we stay near these levels, marginal high-cost producers won't be able to survive."
Bonds due in 2020 for Energy XXI, a driller in Louisiana, are now trading at 84.5 cents on the dollar, and Oklahoma-based SandRidge has seen its debt fall to 87 cents on the dollar.
The markets will get a clearer picture as second quarter earnings season arrives, as indebted shale companies provide some clues into their ongoing struggles.
However, the outlook moving forward may be gloomier than whatever they report in the second quarter.
The swift drop in oil prices over the past year was driven by tepid demand and surging supplies. But the renewed drop has occurred because of broader market turmoil, which comes on top of the ongoing glut. Greece has defaulted on its debt and the stage is set for its exit from the euro, with unknown ramifications for the EU. That could weaken oil prices through a stronger dollar, falling EU demand, and a higher perception of risk.
More concerning is the meltdown in the Chinese financial system. The Shanghai Composite and has lost more than 30 percent of its value since June and the Shenzhen Composite has seen 40 percent of its value vanish into thin air. While the precipitous decline raised worries at first and saw modest action from the government, the turmoil is quickly turning into a meltdown, sparking panic in China and around the world.
Now Chinese regulators, in a desperate attempt to stem the outflows, have banned large shareholders selling their stakes for at least five months. Companies representing roughly 45 percent of the two exchanges (or $2.4 trillion) are suspending trading, trying to avoid more sell offs.
"We are seeing a panic in China. It goes back to 2008, when it always seemed the Chinese were really in control of their economy. They were the first ones out there with a stimulus, and now it looks like they don't know what to do," oil historian and vice chairman of IHS said on CNBC on July 8.
Of course, as the largest oil importer in the world, China has massive influence over prices. A sharp downturn could crush oil prices.
That would ensure larger default rates in the shale industry.
By Nick Cunningham of Oilprice.com. Oilprice has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.