Is There An Oil Crisis On The Way?

November has just ended and oil prices appear to have reached rock bottom. West Texas Intermediate crude futures are below $65 for the first time since May 2010, and the decline is turning out to be the worst since the collapse of the financial system in 2008. Some analysts are saying that the oil collapse could possibly trigger the next credit crisis.

Oil mavens paint a pretty dim picture of what could happen if crude continues its current free fall. The collapse could initiate a wave of defaults through the high-yield debt market. Stocks would be hit next. In fact, prices of high-yield bonds have already fallen and according to analysts at Charles Schwab & Co. (SCHW), they will continue to do so.

Oil price drop hurts everyone

Lower oil prices tend to hurt energy companies, which may exert a strain on the total high-yield market because of their sizable share of the market. Despite the recent drop in high-yield bond prices—and accompanying higher yields—analysts at Schwab are still cautious on high-yield bonds. They believe that any further declines in oil prices could continue to put pressure on the high-yield market.

Energy companies make up a rising share of the high-yield bond market and the energy sector, which was only the seventh largest weigh in the index at the end of 2005. Energy is now the second-largest weight in the high-yield bond index, trailing only the communications sector, which accounts for more than 18% of the index.

According to the U.S. Energy Information Administration (EIA), total crude oil production is expected to average 9.5 million barrels per day in 2015, the highest amount since 1970, up from an average of 7.4 million barrels per day in 2013. In anticipation of the increase happening, energy corporations have been borrowing money to expand their facilities and boost their output.

Worst Performer

In truth, the energy sector has been the worst-performing sector of the high-yield bond market over the past few weeks. From August 31 through October 20, the Barclays U.S. Corporate High-Yield Bond Index (JNK) generated a total return of -1.8%. The energy sector of the index performed even worse over the same period, falling 4.6%.