Silver as an investment

What Comes After The Commodities Bust?

zerohedge.com / by Leonard Brecken via OilPrice.com, on 01/05/2016 10:57

The days of E&P companies using external debt financing to fuel growth have most likely come to a close.

The one thing executives should have learned in 2015 is that Wall Street can for long periods of time remain disconnected from fundamentals and can swing to extremes. Another lesson from 2015 is that OPEC can no longer be relied upon to set prices.

Thus, the debt fueled financing boom in the shale space will most likely never return.

As a result, the industry will likely move to self-funding capital expenditures through free cash flow generation in an attempt to significantly reduce its reliance on leverage. Debt levels will initially have to be reduced, significantly fueling a cycle of dramatically lower capital expenditures and consolidation. This process is already underway, but still has a long way to go.

When the internet bubble burst in 2001, only the business models that generated cash vs subscriber growth and cash burn survived and continued to get funded. Furthermore, larger companies survived and thrived as the smaller ones got starved for cash, died or dramatically scaled back subscriber acquisition to achieve a positive cash flow. We are about to experience the same consequences of misguided investments from a Federal Reserve-inspired bubble.

The toxic combination of lower capital expenditures and constrained output will result in another spike in prices, one that few will anticipate. The current Federal Reserve policy, which isn’t conducive to higher commodity prices, will also make the price spike more difficult to see ahead of time. However, in the interim, until policy changes at the Fed or OPEC are enacted, prices will remain below the marginal cost to maintain production.

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