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Oil: The Wildfire Spreads

Business

Summary

The fires continue to burn in the oil sector.

The longer that oil prices persist near cycle lows, the more likely it is that a wave of defaults from the sector will eventually follow.

What was once a problem that was largely confined to the commodities space is now spreading to other sectors of the market.

The fires continue to burn in the oil sector. The operational environment in the energy space has become increasingly challenged since the summer of 2014 when oil prices began their descent from over $100 a barrel to just over $40 today. Many of the more leveraged oil companies have been staking their survival on the hopes that oil prices would recover sooner rather than later. The longer that oil prices persist near cycle lows, the more likely it is that a wave of defaults from the sector will eventually follow. But what is perhaps more notable is the following: what was once a problem that was largely confined to the commodities space is now spreading to other sectors of the market.

Oil: Still Trending Lower

Not only are oil prices not showing any signs of rallying, they are still trapped in a sharp downtrend. The oil price (NYSEARCA:OIL) decline began picking up speed to the downside back in early October 2014. Since that time, we have seen some impressive rallies in the oil price. This includes a near +50% rally from March to May and a +35% bounce from August to early October. But any such rallies have come from deeply oversold levels. And what has been notable about the price declines and the periodic rallies is that the oil price remains in a sequence of lower highs and lower lows, which is bearish for the oil price going forward. Moreover, oil prices as measured by West Texas Intermediate Crude have barely tested resistance at its downward sloping 200-day moving average throughout the price decline. Through Wednesday, oil prices remain well off the pace at -14% below this 200-day moving average trendline. Of course, one does not have to work hard to explain this sharp price decline over the past year from a fundamental perspective, as supply continues to outstrip demand. In a market that is priced on the margins, such an imbalance is generally not supportive of sustainably higher prices any time soon.

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This persistent oil price weakness continues to take its toll on the energy sector (NYSEARCA:XLE). For while stocks in the space have shown some recent signs of life, the sector too remains trapped in sustained downtrend marked by lower highs and lower lows.

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Other than the oil refiners that benefit from a sharp decline in oil prices, none in the energy sector have been spared the carnage. This includes the energy giants such as ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX), Schlumberger (NYSE:SLB), EOG Resources (NYSE:EOG), and ConocoPhillips (NYSE:COP). ExxonMobil has perhaps held up marginally better than the rest, but it is still down double-digits from the oil price peak in the summer of 2014. As for the rest, they are all down effectively in lockstep with the overall sector.

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Of course, it is not among mega cap names where the real challenges lie. Instead, it is among the more speculative fare in the energy sector, a growing number of which are increasingly fighting for their very survival as an ongoing concern. The effects of this mounting threat can be seen in the price performance of the high yield corporate bond market (NYSEARCA:HYG), where commodity related names including energy market up roughly 18%, or more than one-sixth, of the entire asset class. For while the U.S. stock market as measured by the S&P 500 Index (NYSEARCA:SPY) has rebounded to threaten new all-time highs, high yield bonds are pushing back toward recent lows.

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When digging even further under the surface into the individual credits within the high yield corporate bond space, we can see the growing magnitude of the current challenge facing not only the energy space but also broader capital markets in general.

Since the start of 2015, I have been monitoring a number of energy and commodities names in the high yield corporate bond space as an early warning system for potential broader market stress. During much of the first half of 2015, the most at risk energy related credits were trading at discounts anywhere between 25% to 50% below par. At the time, I referred to this group as being on “The Front Lines” or most at risk in the energy space. Behind this group was “The Second Wave” that was trading at a discount anywhere between 10% to 25% below par. Today in November 2015, these parameters for being “at risk” now look quaint, as the problem has become much worse in the months since.

Returning To The Front Lines

The following is the group of companies that were listed as being on the front lines of the energy battle with bonds trading at discounts between 25% to 50% or more below par.

Breitburn Energy Partners (NASDAQ:BBEP)

Comstock Resources (NYSE:CRK)

Energy XXI (NASDAQ:EXXI)

Exco Resources (NYSE:XCO)

Halcon Resources (NYSE:HK)

Hercules Offshore (NASDAQ:HERO)

Linn Energy (NASDAQ:LINE)

Midstates Petroleum (NYSE:MPO)

Pacific Drilling (NYSE:PACD)

Paragon Offshore (NYSE:PGN)

Peabody Energy (NYSE:BTU)

Sandridge Energy (NYSE:SD)

Seventy Seven Energy (NYSE:SSE)

Vantage Energy Services (NYSEMKT:VTG)

So where are these companies and their bonds today? Let’s begin with the positive. Three companies on the list above have managed to hold their ground on what was once the front lines, as Exco Resources, Midstates Petroleum and Pacific Drilling still have bonds that are trading with a discount between 25% to 50% below par. While these firms are certainly not out of the woods, they have at least been able to hold their ground to date. And this is the good news.

As for the remaining names on the list above, conditions have become markedly worse. Hercules Offshore has since entered bankruptcy, and Paragon Offshore is all but there at this point. As for the remaining nine names on the list, all are trading at a discount of more than 50% below par. This includes five companies – Comstock Resources, Energy XXI, Linn Energy, Peabody Energy and Seventy Seven Energy – that are all trading with a discount between 80% to 90% below par. Put simply, bankruptcy is a very meaningful probability for these firms at this point.

Perhaps just as notable are those companies that were not even originally on the front lines that have also fallen into alarming discounted territory. Included among these are former second wave listed firms including Penn Virginia (NYSE:PVA) and Ultra Petroleum (NYSE:UPL) as well as arguably the most notable name now on the list in Chesapeake Energy (NYSE:CHK). All of these companies also have bonds that are now trading at a discount of 60% or more below par, suggesting that the default risks are also very real with these companies today as well.

All of this leads us to a “new front line” that includes bonds that are trading at a discount of 50% to 90% below par.

Breitburn Energy Partners

Chesapeake Energy

Comstock Resources

Energy XXI

Halcon Resources

Linn Energy

Peabody Energy

Penn Virginia

Sandridge Energy

Seventy Seven Energy

Ultra Petroleum

Vantage Energy Services

What is also notable is the names not included in the energy sector that are also now trading at a discount well south of 50% below par. This includes Avaya (AVYA), iHeart Media (OTCPK:IHRT) (the former Clear Channel Communications), Claire Stores (CLE), Genworth Financial (NYSE:GNW) and U.S. Steel (NYSE:X). This suggests a problem that was once confined to the energy sector is potentially starting to overflow into other areas of the market.

The New Second Wave, Which Was The Old Front Line

So who other than Exco Resources, Midstates Petroleum and Pacific Drilling now populate at a 25% to 50% discount to par? These are included in the list below, some of which like CONSOL and Transocean are highly notable in their own right.

California Resources (NYSE:CRC)

CONSOL Energy (NYSE:CNX)

Denbury Resources (NYSE:DNR)

Exco Resources

Memorial Production Partners (NASDAQ:MEMP)

Midstates Petroleum

Pacific Drilling

Sanchez Energy (NYSE:SN)

Terraform Power (NASDAQ:TERP)

Transocean (NYSE:RIG)

Moreover, a number of non-energy companies have also descended into this 25% to 50% discount to par grouping. This includes many high profile and well-known names such as Advanced Micro Devices (NASDAQ:AMD), Avon Products (NYSE:AVP), Bombardier, Chemours (NYSE:CC), Intelsat Global (NYSE:I), Navistar International (NYSE:NAV), Sprint (NYSE:S), Tronox (NYSE:TROX) and Windstream (NASDAQ:WIN).

Lastly, the list above should also include those firms that are still investment grade rated, at least for now, but are also seeing discounts of more than 25% below par. Included among these most notably is Freeport McMoRan (NYSE:FCX), which has been struggling notably it is own right over the last few years.

In short, all of these companies, energy-related or otherwise, have meaningful solvency risk in their own right and have seen conditions deteriorate in recent months, but not to the magnitude that those on the front lines are currently struggling.

Bottom Line

The problems plaguing the energy sector continue to get worse. An increasing number of firms are spiraling their way toward insolvency, and a parade of names that were formerly off the at risk radar, some of which are well known, are also now finding themselves tumbling toward the abyss. Not only has this taken a severe toll on the stock and bond prices of these firms, but is also does not bode well for the high yield bond market in general and the broader stock market going forward, particularly given that the stresses that were once confined to the energy sector are now being seen in a variety of other sectors including some very well-known names. Thus, these are ongoing risks that warrant much closer attention as we move forward, as a sudden and sharp shift lower in this specific area of the market could end up foreshadowing something far worse for the broader market.

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8 Comments on "Oil: The Wildfire Spreads"

  1. twocats on Fri, 27th Nov 2015 7:05 pm 

    best summary i’ve seen yet of ACTUAL pain in the oil patch as opposed to the usual “if prices keep up like this for another 6 months companies are going to be hurting.”

  2. penury on Fri, 27th Nov 2015 8:42 pm 

    Fairly good summary showing the wheels will be coming off for the entire economy is the oil patch dies.

  3. Davy on Fri, 27th Nov 2015 9:05 pm 

    You have oil in the states and metals in China http://www.zerohedge.com/news/2015-11-27/why-china-hit-panic-button-metals-traders-1-simple-copper-chart. The pressures of these two commodity bubbles popping appears to be a death rattle for the status quo. The question is how long will extend and pretend keep the shit out of the fan. These days it is hard to say because nothing is as it was. Normal fundamentals are over. Moral hazard is in. Eventually things don’t work. Eventually a system breaks under its own weight. Your guess is as good as mine.

  4. makati1 on Fri, 27th Nov 2015 10:04 pm 

    All bad news for the Empire…

    “US Steel To Lay Off Thousands Of Workers”
    “White House: States can’t say no to Syrian refugees”
    “Oil prices have moved into ‘super contango'”
    “Average american has energy equivalent of 450 human slaves working 8 hours shifts every day” (Wait until they are gone and see the pain.)
    “As costs, mishaps mount, U.S. nuke industry weighs extending aging reactor lives up to 80 years” (More Three Mile Islands in America’s future.)
    “Oklahoma Leads The World In Seismic Activity As 2015 Quake Count Tops 5,000”
    “The TPP: A Time Bomb That Could Blow Up a Free Internet”
    “Why Even a Modest Disruption Will Shatter the Status Quo”
    “Why The Obamacare Exchanges Are Failing”
    “Drone Pilots have Bank Accounts and Credit Cards Frozen by Feds for Exposing US Murder”
    “Dirty Connecticut Mayor (Sentenced To Prison For Corruption) Reelected In Landslide”
    “2015: The Year Of The American Identity Crisis” (The government will easily rally a bloodthirsty and directionless public into supporting changes to the law that practically eliminate free speech, privacy, trial by jury and the few other protections the Constitution still provides.)

    And the beat goes on…

  5. Kenz300 on Sat, 28th Nov 2015 9:52 am 

    The oil industry needs to take their collective heads out of the sand and move to safer, cleaner and cheaper energy sources like wind and solar. Climate Change will impact all of us…….we need to deal with the cause (fossil fuels)

    4 Ways Exxon Stopped Action on Climate Change

    http://ecowatch.com/2015/11/27/exxon-stopped-climate-action/?utm_source=EcoWatch+List&utm_campaign=1d016dacb9-Top_News_11_28_2015&utm_medium=email&utm_term=0_49c7d43dc9-1d016dacb9-86023917

  6. rockman on Sat, 28th Nov 2015 10:19 am 

    They don’t mention the status of the privcos like the Rockman’s company. Unfortunately, unlike the numerous pubcos, collectively the privcos don’t spend a lot of capex. But we are still here in the game: Rockman has zero $debt and $250 million cash he can spend tomorrow. The bad news: there are fewer viable projects then before the oil price drop. And even at $100/bbl it was difficult to find enough places to poke holes.

    Thus the difference in drilling wells to simply make a profit then drilling with borrowed capex with the primary goal of increasing stock prices by booking as much questionable reserves as fast as possible.

    And “fast” was very important: despite what many believe the collapse of the pubcos didn’t come as a surprise to their managements. It was just a question of how soon. Which was exactly why their business plan was to borrow as much capex (that they knew could never be fully repaid) as possible and drill as many wells as fast as possible.

    And the greedy bought the BS hook, line and sinker. LOL. After all there were guaranteed profits at $100/bbl, right? LOL. It would have been more interesting if they had also posted a list of companies that floundered when oil prices were high. Even from the first well drilled by Col. Drake over 100 years ago our profitability has never been determined by the price of oil/NG. It has always been the ratio between what it cost to bring the production online to what it’s sold for. The best return on a NG play the Rockman has made in his entire 40 year career was in the mid 80’s when he was selling NG for 1/3 of the CURRENT low price. And yet that was done for a pubco that eventually went bankrupt because they were crooks that stole from the company till.

    The pubcos have always depended on the MSM hype and the greed of investors/bankers for their success. The Rockman has no reason to believe that won’t continue into the future.

  7. shortonoil on Sat, 28th Nov 2015 10:37 am 

    This article from Seeking Alpha may have been taken from one recently published by Energy Intelligence: http://www.energyintel.com/pages/non-subscriber.aspx and reproduced by Zero Hedge

    We commented on the particular danger of just using a cash flow analysis for determining the health of the industry in Oil prices have moved into ‘super contango

    Crude prices have moved down faster than our energy Model indicated that they would. That does not imply that they will continue down at the same rate that has been witnessed over the last 22 months:

    http://www.thehillsgroup.org/depletion2_022.htm

    “As an industry, we’re at the point where every dollar of free cash flow now goes to paying back debt,”

    http://www.zerohedge.com/news/2015-11-27/cusp-staggering-default-wave-energy-intelligence-issues-apocalyptic-warning-energy-s

    To cover cash requirements producers have been maximizing production to increase their cash flow. This has been driving prices down even further. Prices can, however, only decline until producers can no longer cover lifting costs; at that point their cash flow goes from positive to negative if they continue to produce. It becomes, from the cash flow perspective, more important to reduce production, rather than to increase it.

    Lifting costs, for the average 4,000 foot well with a 50% water cut, will average between $20 and $25 dollars per barrel. For wells with 90%+ water cuts costs will approach $40. The average well now being pumped in the US, according to EPA figures, has a water cut of about 90%. The price point where it becomes more cost effective to reduce production than increase it will begin when the price no longer covers the lifting cost of the average well.

    Taking into consideration the full production life cycle of petroleum, most producers are now losing money on every barrel that they produce. They are failing to replace reserves that they are now extracting, and the difference between the two must be considered an expense. When fields now being produced have become fully depleted without replacement the operations will cease. Merely taking cash flow into consideration in no way gives an accurate projection of the overall condition of the industry.

    http://www.thehillsgroup.org/

  8. theedrich on Sat, 28th Nov 2015 6:34 pm 

    ¿Is contango the new normal?

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