US shale and oil producers shocked OPEC with their tenacity, ingenuity and toughness through all of 2015. Everyone, myself included, thought a lot of these guys would fold in the first half of 2015. That wasn’t the case. Lower production costs, and effective hedges kept them above water. But no longer. Their hedges are rolling over at the worst possible time. Credit spreads are widening to heights not seen since the depths of the crisis. Oil has fallen way below 2015 levels which were once thought intolerable to these high cost producers. BP and Exxonmobil reported profit reductions of 90% and 50% respectively. If the majors are hurting, the small fish must be frying in a pan of bacon grease.
Make no mistake, this will only get worse before it gets better. As I have stated many times over, US shale companies have to die, for oil to actually bottom. With no more hedges to save them from the blistering low oil price, US shale companies will drop like flies. This will weigh HEAVILY on the corporate bond sector whose yields have been rising like it’s 2008.
Since the crisis, corporations have added record amounts of debt onto their balance sheets, and I fully expect the widening spreads to crush future growth expectations. Once again, ignoring the probability of a US recession or any global macro factors, widening US corporate spreads + record high debt loads at the very least spell a bear market in US equities. I am not touching these stocks with a barge pole.
However, there is a silver lining here. US shale wells are notorious for their depletion rates. Combined with a drastic reduction in capex, I fully expect a sharp drop off in shale oil and gas production over the next 6month-1year. In particular, US natural gas looks like a very interesting play as it has peaked quite significantly last year.
Demand for natural gas in the US has steadily risen over the past decade as we have tried to move away from higher polluting fossil fuels such as coal. As such we are looking at quite an epic short squeeze over the next few months as shale gas producers die off and their existing wells run dry.
The warm winter isn’t doing shale gas producers any favor, which is suppressing seasonal demand and weighing down on the price of nat gas. Also I think tying down my capital in a commodity before China further devalues the Yuan is a risky proposition. In my mind, it’s better to wait a bit until March or even April before I think about initiating a position in US natural gas.