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On The Cusp Of A Staggering Default Wave


The Energy Intelligence news and analysis creator and aggregator is not one to haphazradly throw around hyperbolic claims and forecasts. So when it gets downright apocalyptic, as it did this week in a report titled “Is Debt Bomb About to Blow Up US Shale?”, people listen… and if they are still long energy junk bonds, they panic.

The summary:

“The US E&P sector could be on the cusp of massive defaults and bankruptcies so staggering they pose a serious threat to the US economy. Without higher oil and gas prices — which few experts foresee in the near future — an over-leveraged, under-hedged US E&P industry faces a truly grim 2016. How bad could things get?”

The full report by Paul Merolli, a senior editor and correspondent at Energy Intelligence:

Debt Bomb Ticking for US Shale

The US E&P sector could be on the cusp of massive defaults and bankruptcies so staggering they pose a serious threat to the US economy. Without higher oil and gas prices — which few experts foresee in the near future — an over-leveraged, under-hedged US E&P industry faces a truly grim 2016. How bad could things get and when? It increasingly looks like a number of the weakest companies will run out of financial stamina in the first half of next year, and with every dollar of income going to service debt at many heavily leveraged independents, there are waves of others that also face serious trouble if the lower-for-longer oil price scenario extends further.

“I could see a wave of defaults and bankruptcies on the scale of the telecoms, which triggered the 2001 recession,” Timothy Smith, president of consultancy Petro Lucrum, told a Platts energy conference in Houston last week. Much has been made about the resiliency of US oil production in the face of low prices, but the truth is that many producers are maximizing their output — even unprofitable volumes — because they need the cash flow to service their debt (related). “As an industry, we’re at the point where every dollar of free cash flow now goes to paying back debt,” Angle Capital’s Steve Ilkay told the same conference. Ilkay, who advises North American producers on asset management, said during the boom years of 2012-14 about 55% of the sector’s free cash flow, which is calculated by subtracting capital expenditures from operating cash flow, was allocated toward debt repayment.

With West Texas Intermediate (WTI) stuck below $50 per barrel since August — and closer to $40 recently — the industry has responded with deeper cuts to capex and a greater focus on efficiency (EIF Nov.4’15). However, experts say this won’t be enough to avoid a bloody reckoning with persistent low oil and gas prices, as the sector grapples with some $200 billion-plus in high-yield debt, which it absorbed to finance the shale oil boom. Credit quality has been steadily deteriorating since June 2014, when WTI peaked at $108/bbl. Standard and Poor’s says there have been 19 defaults so far in 2015 across the US oil and gas industry, while another 15 companies have filed for bankruptcy. Besides those that have missed interest or principal payments, the default category also includes companies that have entered into “distressed exchanges” with their creditors, including Halcon, SandRidge, Midstates, Goodrich, Warren, Exco, Venoco and Energy XXI (EIF Jul.8’15).

Of the 153 oil and gas companies that S&P applies credit ratings to, roughly two-thirds are E&P firms. Among these E&Ps, 77% now have high-yield or “junk” ratings of BB+ or lower. 63% are rated B+ or worse, and 31% — or 51 companies — are rated below B-. What does this all mean in layman’s terms? “Quite frankly it’s a lot of gloom and doom,” says Thomas Watters, managing director of S&P’s oil and gas ratings. “I lose sleep over what could unfold.” He says companies with ratings of B- or below are “on life support,” while those further down the ratings scale at C+ or lower are “maybe looking at a year, year-and-a-half before they default or file for bankruptcy.” While capital markets were still open to struggling E&P firms in the first half of the year, they are closing fast as investors accept a “lower-for-longer” oil price scenario. High-yield E&P firms raised $29 billion from 44 issuances of public debt in 2014. So far in 2015, $13 billion in junk-rated debt been raised from 23 issuances — but only two have come after June (EIF Jul.29’15).

After posting negative free cash flow of $24 billion in 2015, capex cuts and efficiency measures should help the industry post positive free cash flow of $8 billion in 2016, S&P reckons. However, the high-yield E&Ps are expected to see negative free cash flow of $10 billion, so the group that can least afford a cash crunch will get just that. Better hedging could have helped, but data from IHS Energy shows a woefully under-hedged E&P sector in 2016. Small producers have 27% of their oil production hedged at an average price of $77/bbl; midsized firms have 26% hedged at $69; and large producers have just 4% hedged at $63. That is much less protection than E&P firms had in place for 2015 (EIF Aug.19’15).

Small and midsized producers, which rely heavily on revolving lines of credit with banks, have not yet seen these liquidity lifelines cut off. Some analysts were shocked after banks reduced lines to credit to E&Ps by just 10% on average during October redetermination negotiations (EIF Oct.14’15). Banks appear to be putting off the inevitable in hopes of a price rebound. Many have been using price forecasts above the average 12-month forward strip — suggesting the pain could extend to energy lenders if markets don’t recover as they expect. Heading into October redeterminations, Macquerie Tristone’s energy lending survey showed banks using an average 2016 WTI price outlook of $54. That has since dropped to around $47 this quarter — closer to the $46 indicated by the Nymex strip.

Yet another source of concern for E&Ps and their lenders are price-related impairments and asset write-downs (EIF Nov.11’15). Year-to-date, there has been $70.1 billion in asset write-downs in 2015, approaching the $94.3 billion total for the previous 10-year period of 2005-14, according to Stuart Glickman, head of S&P Capital’s oil equities research. And he expects even more write-downs and impairments to emerge at year-end. “Companies are putting this off for a long as they can. You don’t want to be negotiating in capital markets with a weakened hand,” says Glickman. This will be a problem up and down the E&P sector, not just for the little guys. Chesapeake Energy, one of the largest US independent producers, shocked earlier this month by indicating a $13 billion reduction in the so-called PV-10, or “present value,” of its oil and gas reserves to $7 billion. Had Chesapeake used 12-month futures strip prices — instead of Securities and Exchange Commission-mandated trailing 12-month prices for PV values — the value would’ve fallen to $4 billion. “That’s staggering, just alarming to me,” said Watters, noting that E&P firms’ borrowing capacity is contingent on such measures (EIF Jul.22’15).

Many believe all of these issues will come to a head in first-half 2016, as the effect of fewer hedges is felt and banks once again reassess credit lines in April. Pitifully low natural gas prices could also play a big factor, especially if the US experiences a mild winter. The confluence of these factors could be the catalyst that finally spurs a long-awaited tidal wave of mergers and acquisitions throughout the sector (EIF Oct.28’15). News of rampant defaults, bankruptcies and write-downs, combined with closed capital markets, might be enough to lower upstream asset valuations to the point where buyers and sellers can more easily agree to deals. Watters describes an “M&A playland” for strong companies with investment-grade credit ratings, noting that the six largest integrated majors together hold a war chest of some $500 billion. Smith says it could be a great opportunity for majors to improve their positions in US shale, where they were famously late in the game. “Some of the best shale acreage is held by companies with poor balance sheets. It seems like a natural fit,” he says.

But there’s also some $100 billion in private equity sitting on the sidelines, meaning majors and large independents may face stiff competition (EIF Oct.28’15). Anadarko has openly complained about being outbid for assets by management teams backed by private equity. “Does that mean we’re overpaying? No,” insists one private equity executive. “It means we’re willing to pay a bit more because we think our guys can run the assets better than some larger outfits, who can struggle with cost structures.”


16 Comments on "On The Cusp Of A Staggering Default Wave"

  1. Dredd on Sat, 28th Nov 2015 4:54 pm 

    It is default of oil-qaeda that the sea is falling and rising at the same time.

    Know why (New Type of SLC Detection Model – 10) ?

  2. penury on Sat, 28th Nov 2015 5:06 pm 

    Many people believe lots of thing which are not factual. The death of the oil patch has been forecast for the last thirty years as far as I know. As long as the Central Banks and the world governments consider fossil fuel to be a strategic necessity the money will be provided to stave off bankruptcy. It is almost impossible to even imagine the true state of affairs is the oil patch goes bankrupt. I do not wish to think of the consequences.

  3. makati1 on Sat, 28th Nov 2015 8:25 pm 

    penury, I do not think the banks will be able to rescue the ‘oil patch’ this time, or ever again. Maybe that is a good thing. A reset sooner would be better than a crash later. Maybe it would force the Empire to shrink it’s foreign bases and slow or stop it’s meddling and plundering in other countries. Worth a try anyway, I think.

  4. SugarSeam on Sun, 29th Nov 2015 12:38 am 

    ” A reset sooner would be better than a crash later.”

    didn’t we say that in September 2008 also?

  5. Rodster on Sun, 29th Nov 2015 6:45 am 

    “I do not think the banks will be able to rescue the ‘oil patch’ this time, or ever again. Maybe that is a good thing. A reset sooner would be better than a crash later. Maybe it would force the Empire to shrink it’s foreign bases and slow or stop it’s meddling and plundering in other countries. Worth a try anyway, I think.”

    You fail to realize that EVERYONE is in on the same game including the East. How so? The IMF now wants to accept China into the IMF-SDR breadbasket of Fiat currencies. If that doesn’t tell you both the East and West are playing everyone for fools and the only losers are the serfs, then nothing will. Cheerleading for one side over the other is like being an iSheep for Apple gadgets. In the end you will get taken to the bank both literally and figuratively.

  6. Davy on Sun, 29th Nov 2015 7:06 am 

    Like I said in an earlier feed its oil in America and metals in China in regards to dangerously destabilizing forces from the end of the commodity super cycle. What is sad is the problems with the commodity super cycle bubble bursting is just the tip of the iceberg. The problems are much greater across the board because multiple wide ranging problems are surfacing. The global powers that are can only extend and pretend.

    There is nothing being done to combat these problems because any real and significant solutions will likely destroy the status quo. If you destroy the status quo millions starve relatively quickly. If anything there are dangerous policies that are being promoted for a variety of reasons at a various levels. These dangerous policies represent an out of control system with no direction drifting in a sea of entropic decay. This is the financial end game that ultimately is dictated by confidence found in human nature. Who here can predict human nature?

  7. makati1 on Sun, 29th Nov 2015 7:09 am 

    Rodster, ‘East’ is NOT the US. The oil patch they are talking about in the article is the US oil patch, not the foreign suppliers. The US banks and investors will take the hit big time, or the US taxpayers, of which I am no longer in that club.

    That the US can take the rest of the world down because US oil imports will have to increase to make up for the end of the shale bubble, is a misconception of arrogant Americans.

    It will cause some disruption but mostly be confined to the investors that will lose their shirts and most likely the skin off their back. If it takes down a few TBTF banks, so be it. They should have gone away in 2008.

    So, let the oil patch fail. It will anyway, so make it in 2016 and get it over with. The US cannot do without imports from the ‘East’. Most of what you own comes from there. Read the labels. LOL

  8. Davy on Sun, 29th Nov 2015 7:30 am 

    It appear to be increasingly likely it will be your Asia Mak that brings down the world economy. The US is proving to be much more resilient than any of you anti-Americans care to admit. I mean your whole agenda has been drug through the dirt. It is true many arrogant Americans like to think what happens in China stays in China but this is no longer true. China will bring down the US economy and with a China and the US economic collapse, the world.

  9. Aire on Sun, 29th Nov 2015 8:19 am 

    At this stage of time in globalization, it appears rather weak no matter where you are living. It almost seems like any event can be the starting of the domino-effect. Sure a major collapse in the US or China would surely affect the entire world drastically. I would have to say each country would react and handle a collapse differently and similarly. One example would be that if there were famine in both the US and China – surely one would agree, the US government may have an easier time feeding its people. On the other hand, Chinese government would most likely have an easier time keeping order due to the lack of public arms floating around like in the US.

  10. Aire on Sun, 29th Nov 2015 8:26 am 

    Back to the article subject tho. Yes, I believe this shale bubble can certainly be the first of many bubbles to pop. Once some of these smaller bubbles pop like shale oil industry and the housing bubble, it can definitely make the big US economy and other world economies’ bubbles pop too

  11. Rodster on Sun, 29th Nov 2015 8:55 am 

    “So, let the oil patch fail. It will anyway, so make it in 2016 and get it over with. The US cannot do without imports from the ‘East’. Most of what you own comes from there. Read the labels. LOL”

    And what happens when no one is buying any goods? China’s economy has already flatlined and has gone negative. You appear to be a person willing to throw the baby out with the bath water.

    No one will win this time which is something you seem to overlook.

  12. makati1 on Sun, 29th Nov 2015 6:50 pm 

    Rodster, China exports to the rest of the world. The Us is a small percentage(<17%)of it's exports. The US will still have to import much of what it does now and you will still have to buy it as those products are what you need to live and are not made in the US any more.

    So, drastic it may be, but only for the unprepared. A depression in the US is not the end of the world. Most people will still have jobs and income, just less overall. Read about the Great Depression sometime. The high point was ~25% unemployment. That meant that ~75% were still employed. 75% still had paychecks.

    That is also true of the rest of the world. Difficult times ahead, but mostly for the unprepared and the pampered 'exceptional' country. The neighborhood our farm is located in in the Ps will hardly notice the change. Bring it on now and get it over with.

  13. makati1 on Sun, 29th Nov 2015 7:00 pm 

    Rodster, “No one will win this time which is something you seem to overlook.”

    False. Barring a nuclear exchange, many will win. There are always winners. Usually those who start the problem/war are also the ones to profit from it because they have something to gain. Billions of $$$ will be made when the SHTF. Millions will suffer, but many will not notice or be much affected by the collapse.

    You seem to view the world thru rose colored glasses if you see it as an extension of the West. This is especially true if you are an untraveled American. Outside of the biggest cities in the 3rd world, it is totally different. Self reliance is the norm in the outside world. Dependence is a trait of the West and especially America.

    Perhaps the 3rd world will only notice the change when the West can no longer meddle in their country and the 1,000 overseas US military bases close due to lack of funds and problems at home. We shall see.

  14. Davy on Sun, 29th Nov 2015 7:38 pm 

    Mak’s Asia

    “Chinese Debt Snowball Gaining Momentum”

    “It’s a safe bet that China, following the developed world’s lead, will soon toss a big chunk of its foreign exchange reserves at the problem. When this fails, the next steps include QE and negative interest rates, which take money from savers and retirees and give it to banks, again with the hope of moving the inevitable crash to some later date. The result? An even more highly-leveraged world and Potemkin markets that look real but no longer are.”

  15. Kenz300 on Mon, 30th Nov 2015 12:38 pm 

    Banks have stopped lending…………..


  16. Kenz300 on Mon, 30th Nov 2015 12:40 pm 

    The oil companies and the auto companies need to get their collective heads out of the sand and realize that the world is changing with or without them.

    Climate Change is real….. it will impact all of us…

    It is time to move away from fossil fuels and embrace alternative energy sources like wind, solar, wave energy, geothermal and second generation biofuels made from algae, cellulose and waste. They need to change their business models and move from being OIL companies to ENERGY companies.

    The auto industry needs to move from just building compliance vehicles to embracing electric vehicles and start putting development and advertising behind them..

    The world is moving to embrace alternative energy sources…….. the fossil fuel companies can transform themselves into “energy” companies or they can die a slow death. As Climate Change impacts more people there will be a bigger backlash against fossil fuels.

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