How Oil is Hurting Finance

According to a recent report issued by Goldman Sachs, about 40 percent of the loans that have been issued to oil and gas companies are to firms that have been rated as “junk.” A junk loan is one that has been classified as a high risk one, or, in other words, to a company that may not be able to pay back their obligation before declaring bankruptcy. These loans—many of which have been promised and not yet paid—were mostly given out when oil was still somewhat steady. Now that oil has declined so dramatically, it is becoming much more likely that these loans will be defaulted on. Goldman Sachs has over $10 billion of their funds tied up in this right now, leading to a very touchy situation for them.

This is not good news for the long term when it comes to what these companies will do, and it’s certainly not going to help the oil industry to recover. Yes, there has been a need to issue loans to help these companies recover thanks to the crashing price of crude oil, but this sentiment reeks of what happened in 2008, when there was far too many “junk” loans that had been given out in the housing industry. This lead to the housing market crash, which in turn led to the financial crisis that the country has apparently not fully recovered from. It also seems that some financial institutions have not quite learned their lesson from this, either.

Over the past year, the price of crude oil has fallen by over 40 percent, bringing the price per barrel down to dangerously low levels. It’s also hurt lenders, like Goldman Sachs, simply because the confidence that the public has in these companies is beginning to wane, especially as the situation is prolonged. The longer it takes oil and other energy companies to start making money, the longer it will take for lenders to be paid back, and the closer the economy creeps to another financial crisis. Goldman Sachs is not alone here. Both Citigroup and Wells Fargo have much more in outstanding loans when it comes to working with energy companies.

As traders, it’s important that we look at the fundamentals of the companies we focus on, especially when it comes to financial companies. Looking at a balance sheet doesn’t illuminate in the same way that looking at technical indicators on a line chart does, but this data is just as important when we are putting together a long term strategy. For example, seeing that Citigroup has over $50 billion in outstanding loans to energy companies, many of which are in danger of default, would be an encouragement to stay away from long positions with this company for the time being, regardless of what type of trading you are doing. Even binary options traders, who have an ability to trade up or down with seamless ease, should be looking at this info just because you so seldom want to trade against a dominant trend. For all of the recovery that has gone on since 2008’s financial crisis, the trend for Citi now appears to be a downward one, and thus even 60 second call options take on an added element of danger.

What the outcome of all of this hinges on is the price of oil. Oil did drop below $30 a barrel recently, and it now seems to be able to hold its own slightly above that mark. At the time of this writing, oil was trading at over $33 per barrel. This is progress, but much more is still needed.