UBS: Things could get messy if oil drops below $40
That's according to new research from UBS, which notes that the "health of the energy sector remains critical for corporate credit," and that sustained weakness in oil prices poses a broader risk to corporate profits.
Debt in the energy sector accounts for about 15% of the high-yield credit market in the US and 10% of the investment grade market, according to UBS. Weak oil prices could cause more energy companies to default and would heighten risks for corporate lenders. It would also dampen earnings for US companies with commodities exposure.
Crude oil has struggled in recent months, with the West Texas Intermediate dropping about 17% since mid-April, when it was trading above $53 a barrel. The WTI was at $44 a barrel Tuesday.
There's a significant risk of oil trading at or below $40 through 2018, and if the WTI dips into the $30s, it would "pose serious problems" and likely signal "broader global demand issues," UBS analysts said in a research note.
Here's UBS (emphasis ours):
"If oil prices fall to $40 or below, the negative impact on rest of world profits (via commodity-related foreign subsidiaries of US companies) could be a material headwind for aggregate corporate profits, and a prolonged $40 oil price would trigger more stress and defaults in lower-quality HY issuers heading into 2018 (and could prompt banks to tighten lending standards on C&I loans at the margin)."
In plain English, if oil prices fall below $40, corporate profits would take a hit, there would be more stress in the high-yield market, and bank lending might tighten.
Oil has suffered in recent weeks, with the Energy Information Administration unexpectedly announcing a glut of inventory in early June and OPEC cutting production by less than investors had hoped. Prices also took a hit after President Donald Trump announced America would withdraw from the Paris Climate Accord.