A FEW weeks ago, a big hedge fund manager in New York asked a major Wall Street bank what was happening to energy sector loans. The answer was sobering.

“They said that the covenants on 72 out of the 74 loans to the oil and gas sector had recently been modified,” this investor reports. Or to put this into plain English, this bank now realises that most of its energy sector borrowers are struggling — so it is quietly relaxing the borrowing conditions, to avoid the embarrassment of seeing loans it has made go into default.

It is impossible to tell precisely how typical this is; bankers are pathologically secretive about loan modifications. But judging from the tone of US quarterly bank earning calls this week, I suspect the pattern is widespread — and points to an issue that investors need to watch closely this coming winter.

Over the past year, the oil price has slid by more than 40pc, to trade below $50/barrel. At that level many energy companies are almost unviable — particularly those small and midsized US explorers and producers that have ridden the shale boom.

Yet this slump has caused remarkably few ripples in the wider financial world. True, the price of most energy sector bonds has tumbled, with many junk bonds now trading below par. But there have been few outright bond defaults and banks themselves have not been calling loans in; instead, it seems most have been ‘modifying’ those covenants — and praying for an oil price rebound.

American regulators recently summoned the large banks to a special, secretive summit in Houston, where they urged the banks to get more ‘realistic’ (that is, less forgiving) with their energy sector loans and make provisions, if not call in loans

But this could soon change. One reason is that bankers are starting to accept that oil prices below $50/barrel might be the new norm.

Earlier this month, for example, the International Energy Agency warned that the current pattern of excess supply and weak demand will continue throughout 2016. And banks such as Goldman Sachs are now telling clients to brace for a world where prices could even touch $20/barrel.

A second factor is the stance of the authorities. Until quite recently, regulators in the US and Europe seemed willing to let banks engage in forbearance. But now they are keen to show they have learnt the right lessons from last decade’s crisis — by getting ahead of the curve and forcing banks to be tough.

Thus the Bank of England recently warned that it plans to scrutinise bank exposures to the commodities and energy world. And American regulators recently summoned the large banks to a special, secretive summit in Houston, where they urged the banks to get more ‘realistic’ (that is, less forgiving) with their energy sector loans and make provisions, if not call in loans.

This tactic has sparked irritation among some bankers, who say they are reluctant to run from clients. And behind the scenes there are some bitter tussles under way between bankers and regulators. One particularly thorny question is how financiers should evaluate their clients’ so-called ‘reserve bases’ — the untapped reserves of fossil fuels against which banks extend loans.

Last week most of the large American banks admitted in their latest quarterly earning calls that they are setting money aside to cover more losses on their fossil fuel loans — while also insisting that they can cope.

For example Jamie Dimon, chief executive of JPMorgan, revealed that his bank is now conducting stress tests to see how its loan book would fare if oil fell to $30/barrel. But he argued that even that scenario would only require another “$500m or $750m in reserves, which is just not something we worry a lot about”.

Perhaps he is right. Certainly the bigger banks seem well cushioned. But even if the largest of them such as JPMorgan can swallow the hit, there could still be some pockets of localised pain; after all, total global energy sector debt now tops $2.5tn, according to the Bank for International Settlements.

And what is also crystal clear is that banks are unlikely to provide much more credit to the energy sector again soon.

That does not mean that the Wall Street funding spigot will close all the way: large non-bank lenders are now quietly preparing to jump into this void, to provide funds to cash-starved energy groups instead.

But any new non-bank funding will be costly for borrowers. Indeed, some private equity players expect this to be their fattest profit source this winter. Call it, if you like, the genius of capitalism; or a sign of Wall Street’s predatory instincts.

Either way, the funding weather is changing for the energy world; unless there is another big — unexpected — oil price swing.

gillian.tett@ft.com

Published in Dawn, Business & Finance weekly, October 19th , 2015

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