Red flag: Oil company defaults are spiking

Worldwide oil players can't believe price, will keep pumping
Worldwide oil players can't believe price, will keep pumping

American oil companies are starting to scream "mayday."

Last year, 42 North American drillers filed for bankruptcy, according to law firm Haynes and Boone. It's only likely to get worse this year.

Experts say there are a lot of parallels between today's crisis and the last oil crash in 1986. Back then, 27% of exploration and production companies went bust.

Defaults are skyrocketing again. In December, exploration and production company defaults topped 11%, up from just 0.5% the previous year, according to Fitch Ratings. That's a 2,000%-plus jump.

It's just the beginning, says John La Forge, head of real assets strategy at Wells Fargo. If history repeats, people should prepare for the default rate to double in the next year or so.

No wonder America's biggest banks are setting aside a lot of money in anticipation that more energy companies will go belly up.

Related: Why you should worry about cheap oil

chart energy defaults are rising

Oil prices plunged 70%

Energy companies borrowed a lot of money when oil was worth over $100 a barrel. The returns seemed almost guaranteed if they could get the oil out of the ground. But now oil is barely trading just above $30 a barrel and a growing number of companies can't pay back their debts.

"The fact that a price below $100 seemed inconceivable to so many is kind of astonishing," says Mike Lynch, president of Strategic Energy and Economic Research. "A lot of people just threw money away thinking the price would never go down."

On the last day of 2015, Swift Energy, an "independent oil and gas company" headquartered in Houston, became the 42nd driller to file for bankruptcy in this commodity crunch. The company is trying to sort out over $1 billion in debt at a time when the firm's earnings have declined over 70% in the past year. Trimming costs and laying off workers can't close that kind of gap.

"In the 1980s, there was a bumper sticker that people in Texas had that said, 'God give me one more boom and I promise not to screw it up,'" says Lynch. "People should have those bumper stickers ready again."

Related: Big banks brace for oil loans to implode

A lot like 1986

The last really big oil bust was in the late 1980s. The Saudis really controlled the price then, says La Forge. Now the Saudis (and other members of OPEC) are in a battle with the United States, which has become a major player again in energy production.

No one wants to cut back on production and risk losing market share.

"It will be the U.S. companies that go out of business," predicts La Forge. OPEC countries don't have a lot of smaller players like the United States does. It's usually the government that controls oil drilling and production in OPEC nations. La Forge predicts the governments can hold their position longer.

As the smaller players run out of cash, they will get swallowed up by bigger ones.

"The big boys and girls will snap up a lot of cheap assets," predicts Lynch.

Related: Saudi Arabia says it can handle low oil prices 'for a long, long time'

Are oil prices set to rebound?

There's a lot of debate about whether oil prices have bottomed out. Crude oil hit its lowest price since 2003 this week. But even if prices have stabilized, the worst isn't over for oil companies.

"Some companies went under in 1986-'87 even when prices rebounded," says La Forge.

This week, Blackstone (BGB) CEO Stephen Schwarzman said his firm is finally taking a close look at bargains in the energy sector.

One of the largest bankruptcies so far is Samson Resources of Oklahoma. In 2011, private equity firm KKR (KKR) bought it for over $7 billion. Now it's struggling to deal with over $1 billion in debt that's due this year alone.

Companies are using bankruptcy to restructure -- a code word for eliminating debt or not paying creditors back in full. Hercules Offshore, another Houston-based company, filed for bankruptcy over the summer. It has already emerged from it.

Concerns of what's ahead have sent jitters through the junk bond market. The energy sector makes up about a fifth of the high-yield bond index. A panic in the junk bond market in December dragged stocks down temporarily too.

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