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Why the Timing of the Oil Price Collapse Couldn’t Be Any Worse

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The oil price situation now

The US energy sector hoped for a rebound in April 2015, when oil prices rose to $60. Given the recent drop to $40, the mood in the industry seems somber. Specifically, funding for energy firms is likely to tighten and more projects are likely to be kept on hold with greater cuts to capital expenditure.

Drillers Helmerich & Payne (HP) and Diamond Offshore Drilling (DO) have posted gains during the past week. However, oil and gas exploration and production firms such as Marathon Oil (MRO) and Noble Energy (NBL) could see more difficult times, as we’ll explain in this article. Together, these four firms represent 3.62% of the Energy Select Sector SPDR Fund (XLE).

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Tightening of funding

Funding is the propelling force behind the US energy industry since it provides energy firms with the cash flows necessary for funding projects to generate revenue. Less funding translates to lower drilling activity, which—while increasing oil prices—proves harmful for energy firms trying to stay profitable.

Bank lenders conduct an annual review of loans offered to E&P (exploration and production) firms in October. Owing to the weak outlook for oil with the sharp drop in oil prices, credit lines will very likely be removed. Industry experts expect the next review from banks in April 2016 to be more significant in affecting oil production. Oil majors such as ExxonMobil (XOM) and Chevron (CVX) are cutting down their capital expenditure, given the backdrop of low oil prices.

Rise in high-yield defaults

Due to the large amount of distressed debt taken on by E&P firms, defaults will be a key issue if oil prices remain low or continue to fall.

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