Oil glut risks lighting fuse of next recession or fresh financial crisis

Sagging oil prices have sent shock waves through the financial markets in the past several months, and now news that Iran is about to start pumping crude back into the global system has upped the ante on those fears.

The lifting of international sanctions against Tehran over the weekend means that oil prices which already were trading near a 12-year low of $28 a barrel Monday could have much further to fall, the International Energy Agency has warned.

While the pace of stock-building eases in the second half of the year as supply from non-OPEC producers falls, unless something changes, the oil market could drown in oversupply, said the IEA. Prices could go lower.

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Why is the falling price of oil important? Because in addition to higher prices being synonymous with positive world growth, plummeting energy prices mean that numerous drilling and refining companies, particularly those in North Americas shale patches, are going bankrupt. That means the loss of thousands of well-paying engineering and processing jobs.

Bonds signal 44% recession odds: The stress is already manifesting itself in the struggling high-yield, or junk-bond market, which is indicating a 44% chance of a recession in the U.S. within one year, largely because of the nose-diving oil sector, Bloomberg reported.

Furthermore, an analysis published at Zero Hedge estimated that 80 U.S. energy firms have a combined debt of $325 billion. And, since 2015, 42 North American oil companies have sought bankruptcy protection.

Recall that the mortgage meltdown helped spur the crisis of 2008-09. Now some analysts are concerned that dropping oil prices could light the spark for a new Lehman Bros.-style catastrophe. Big banks brace for oil loans to implode, a CNN story reported.

Three of Americas biggest banks warned last week that oil prices will continue to create headaches on Wall Street especially if doomsday scenarios of $20 or even $10 oil play out, the story said.

Banks burdened with massive exposure: According to CNN, Wells Fargo has loaned more than $17 billion to the energy sector and is setting aside $1.2 billion to cover any potential losses. Meanwhile, JPMorgan is setting aside anywhere from $124 million to $750 million to cover losses. And Citigroup has built up $300 million in loan-loss reserves, with the danger of that rising as high as $1.2 billion if oil prices keep stagnating.

Right now the banking industry to downplaying the issue. Were not worried about the big oil companies. These are mostly the smaller ones that youre talking, JPMorgan chief Jamie Dimon said.

However, remember when then-Federal Reserve Chairman Ben Bernanke insisted that the subprime mortgage crisis was contained? Now we seem to be hearing the same sort of razzle-dazzle.

For the moment, these big banks are telling the public that the damage can be contained, commented Michel Snyder of The Economic Collapse blog. But didnt they tell us the same thing about subprime mortgages in 2008? We are already seeing bank stocks start to slide precipitously.People are beginning to realize that these banks are dangerously exposed to a lot of really bad deals.

Imagine 1 billion refugees: Moreover, if oil continues to fester or tank even further, the risks of geopolitical tensions and unrest could grow. Look how many countries in Africa, for example, depend on the income from oil exports,said the World Economic Forums executive chairman, Klaus Schwab, ahead of the groups 2016 meeting in Davos, Switzerland. Now imagine 1 billion inhabitants, imagine they all move north, he added, warning of unexpected consequences and a substantial social breakdown.

Falling oil prices and cheap gasoline are often touted as a blessing in our automobile-centric society. But todays energy crisis is showing us that the issue is much more complex, with serious implications for all of our portfolios. While this situation plays out, the most prudent course of action is to stay defensive with a healthy allocation of precious metals and rare coins.

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