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Oil Slick for Silly Investors

Posted on January 13, 2015

By Wolf Richter

Wall Street spent years hyping, propagating, and funding the oil and gas drilling boom in the US. It handled the bonds and loans issued by often junk-rated companies. It instigated the waves of mergers & acquisitions, profiting every step along the way – advisory fees, bridge loans, syndication of loans, underwriting of bonds, etc. At the very tippy-top of the market, it pushed in the opposite direction and instigated spinoffs, creating independent publicly-traded companies that didn’t have a chance and cost unsuspecting investors in their shares and junk bonds a barrel of money. It orchestrated a series of similarly misbegotten energy IPOs.

Wall Street made money off the entire spectrum of companies associated directly or indirectly with oil and gas. It was one heck of a party.

The money had to keep flowing. Fracking is a capital intensive treadmill for companies that spend a lot more on drilling and completing wells than they get in cash from their production. Barclays estimated that larger drillers outspent their cash flows by 112% and smaller to midsize companies by a breathtaking 157%. The hole had to be filled with new money, or else the music would stop.

Wall Street hyped these junk bonds, leveraged loans, or new shares and pushed them into the hands of investors that had been bamboozled by the Fed into thinking that it had removed all risks from the equation. Investors closed their eyes and bought these nearly risk-free securities that are now decomposing before their very eyes.

But it didn’t matter to Wall Street because investment banking revenues were soaring, and because private equity firms where attracting a tsunami of money for their energy funds, and they all extracted their fees, and everyone got big bonuses, and to heck with the rest.

The money came from all directions, from TBTF banks, from local and regional banks, from PE firms, overseas investors, pension funds, hedge funds, mutual funds, and individual investors.

But here are the top 10 banks, according to DealBook, that in 2014 extracted the most investment-banking revenues from the oil and gas sector, or rather from its investors. Bailed-out and still troubled Citi was the king of the hill, obtaining $492 million in IB revenues from the oil and gas sector, representing 11.8% of its total IB revenues. Together, the ten skimmed off $3.52 billion last year.

And these $3.52 billion in investment-banking revenues were extracted all year even as West Texas Intermediate had been doing this since June:

WTI plunged 58% since June to $45.26 per barrel as I’m writing this. The bloodletting simply doesn’t want to stop.

Then the other shoe dropped. Natural gas had been in recovery mode, after having gotten demolished for years, as production keeps soaring despite a price that’s below the cost of production at most wells. By mid-November, going into the winter, it was trading at $4.65 per million Btu when this happened:

The price of natural gas plunged 40% in seven weeks to $2.82 per million Btu. . . .

The oil bust in the 1980s devastated the oil patch economy. It took down numerous local and regional banks as the losses were cascading through the system. The FDIC was busy auctioning off homes and office buildings. Business shut down. People left to find jobs somewhere else. This time around, Wall Street got involved in the boom up to its ears. And Wall Street is going to struggle with the aftermath. . . .

Despite Fed assurances that it had abolished all risks and that investors should no longer be rewarded with yield for taking risks it had abolished, investors find themselves suddenly confronted with terrible risks – for example, loans they considered nearly risk free because they were collateralized by oil. And losses are mounting.

(For the rest of the article, click the link.)

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