The domestic energy industry has been on a roller coaster ride for the past year. As America has put an emphasis on increasing domestic production in an effort to offset and lower costs for always-booming domestic demand, states like North Dakota and Texas have started to literally overflow with oil and natural gas. This, of course, has led to some huge revenues for energy companies and a dramatic decline in gasoline prices for consumers.
Those declining prices have inevitably led to those booming revenues dropping, as producers are getting less in exchange for their labor. One plan to deal with the situation has been to stymie production, but OPEC and other oil-producing regions have decided not to play ball — in an effort to effectively wait until American oil companies exhaust all of their resources, and go out of business.
And that strategy has proved correct, at least in some respects. The production slow-down has resulted in huge layoffs for oil workers, and revenues have been drying up for many domestic companies. But there was some foresight into the coming crisis from many companies, which is the big reason that they are still around. In other words, domestic energy companies saw this coming, and bought themselves a little insurance — to the tune of $26 billion.
According to Bloomberg, that’s how much of a safety net domestic energy companies could end up seeing if prices stay as low as they have been. These companies purchased risk insurance from big Wall Street banks, although that itself could have been chopped up and sold off to third parties. The question, then, is who will actually end up having to pay out those billions if market conditions stay the same.
What has played out between these large financial institutions delves into the rather complicated world of hedging and risk management, a far-flung world from the oil fields of North Dakota and west Texas. These banks, and no one else, for that matter, don’t want to be responsible to cough up the money when things go south. In an effort to minimize their exposure, they engage in defensive tactics to put themselves in the best position if the markets turn south.
Even with that in mind, there are some hefty sums of money at stake. “At the end of 2014, JPMorgan had about $671.5 million worth of derivatives exposure to five energy companies, including Pioneer Natural Resources Co., Concho Resources Inc., PDC Energy Inc. and Antero Resources Corp., according to company records,” write Bloomberg’s Asjylyn Loder and Dakin Campbell.
“It’s a similar story for Wells Fargo, which was on the hook for $460.9 million worth of oil and natural gas derivatives for companies including Carrizo Oil & Gas Inc., Pioneer, Antero, Concho and PDC, according to regulatory filings,” the article says.
Wall Street has acted as a facilitator of both funding and risk for those bankrolling domestic oil production, but they are obviously not excited at the prospect of being caught holding the ‘hot potato.’ It does look like the $26 billion insurance policy that oil companies worked out is one of the main things keeping the industry afloat, though. Without it, how many of these companies would be willing to keep going? The threat of a prolonged production slowdown may be enough to convince some companies to close up shop and keep what money they do have.
Now, the question is when, or if, prices will start rising again. While it doesn’t look like that’s bound to happen any time soon, it is inevitable at some point. Knowing that, it does prove to be another chance to make big bucks on the markets. But in the meantime, the name of the game for financiers is finding a way to deal with the new face of the market.
Follow Sam on Twitter @Sliceofginger