Don’t Try to Pick the Bottom for Oil – Yet

3d image of oil golden barrel background

US crude oil prices fell over 2% last night, dragging the overall market into the red. The Dow finished down 0.3%. The Aussie market will likely have a down day too.

The oil price just can’t gain any traction. The days of US$100 a barrel seem a long way off. While a lower oil price is good news for those consumers sticking a petrol nozzle in their car once a week, there is a flipside to consider.

That is, if the oil price stays around these levels for a prolonged period, say another 12 months or so, there is going to be a lot of pain for investors to absorb.

In the other essay today, Strategic Intelligence editor, Jim Rickards explains how the ticking debt bomb in the oil sector is actually larger than the sub-prime debt problem of 2007. A huge amount of debt issuance took place in the past few years based on the presumption of permanently high oil prices.

Now many operators are losing money, barely able to service their debts, let alone ever repay them. As Jim explains below, massive write-downs are on their way…and it won’t be pretty.

Australia has its own version of this energy debt debacle. Companies like Santos [ASX:STO] and Origin [ASX:ORG] took on huge amounts of debt in recent years to build massive LNG projects. The boards of these companies become lightheaded during the coal seam gas boom and approved projects that relied on high oil prices for their viability.

Those assumptions are now in tatters. The oil bust claimed another Aussie corporate scalp yesterday, when Origin Finance Chief Karen Moses resigned. Instead of going the same way, Chairman Gordon Cairns offered shareholders pathetic platitudes instead. From today’s Financial Review:

Mr Cairns admitted management had not foreseen the extent of the dive in crude oil prices, and had been mistaken in its original belief the company would be largely insulated from price weakness.

But he assured shareholders the company had learnt valuable lessons and had now reformed its investment planning to include a "worst possible case" scenario.

"It is appropriate here and now, to acknowledge your frustration, absorb the learning and move forward," Mr Cairns said.

I’m glad to see he’s learnt some lessons and is now ready to move forward. But at the cost of a 60% share price decline for a major (now former) blue chip company, those were very expensive lessons.

In fact, it’s a monumental stuff up. You only truly learn the value of good management and strategic direction in a crisis, and Origin’s management and board have failed shareholders spectacularly. King and Cairns both need to man up and walk.

Origin is yet to write off any of the debt associated with its new LNG project, so there is more pain to come.

This is the whole point of Jim’s essay today. He reckons there is about $1 trillion worth of energy related debt that will be written off in the years to come, and it will have profound implications for the financial system.

It’s a scary thought, but one you need to understand so you can avoid the fallout. In short, don’t try and pick the bottom for oil yet.


Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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