Debt Burdens Straining US Shale Industry

Posted on 2-29-16 by

US shale drillers are under increasing pressure from unsustainable levels of debt, with two companies having recently missed debt repayments, writes Kevin Godier

What: US shale players must find US$1.2 billion in interest payments by the end of March

Why: The low oil price is making debt repayment increasingly difficult.

What next: More bankruptcies are likely among the weaker, more debt-laden players.

Two missed debt repayments in the US shale industry have illustrated the impact of the US$30 per barrel oil price, with drillers under more financial pressure than ever. The smaller players, which snapped up acreage at the height of the shale boom using billions of dollars in borrowed money, are now being hit the hardest.

According to data compiled by Bloomberg on 61 companies in the Bloomberg Intelligence index of North American independent producers, the US shale industry must come up with US$1.2 billion in interest payments by the end of March, with nearly half of this owed by companies with junk-rated credit.

Energy XXI said in a filing on February 16 that it had missed a US$8.8 million interest payment, with SandRidge Energy announcing the next day that it had failed to make a US$21.7 million interest payment. As more such payments fall due, and are missed, expectations of more impending bankruptcies have grown.

One of the US’ largest shale gas producers, Chesapeake Energy, recently issued a statement denying it was planning to file for Chapter 11 bankruptcy protection, after its stock fell 50% in a day. Chesapeake has hired lawyers to help restructure over US$10 billion in debt.

Data compiled by the Wall Street Journal have indicated that the total debt of US oil and gas companies, excluding Chevron and ExxonMobil, is anticipated to grow to over US$200 billion when all the 2015 financials come out, marking a 55% increase since 2010. The toll that this has taken as crude prices have fallen is illustrated by law firm Haynes & Boone, which has said that 48 North American oil and gas producers have declared bankruptcy since the start of 2015. Combined, these companies owed over US$17 billion. SandRidge said in a statement that it “has sufficient liquidity to make these interest payments, but has elected to use the 30-day grace period in connection with its ongoing discussions with stakeholders”. SandRidge’s president and CEO, James Bennett, said in the statement that the company’s actions “will preserve liquidity and flexibility” as these discussions continue.

Even the bigger players are not immune to the slump, as profits dwindle and credit rating firms downgrade their debt. Dividend payments have suffered as a result. Anadarko Petroleum is among those most recently affected, having cut its quarterly dividend by over 81% on February 16 in an effort to conserve cash.

Disappearing cushions

The lowest oil and gas prices in around 14 years are making it increasingly difficult for companies to find the cash needed to stay current on their debts. In 2009, crude prices rose sharply and stayed at around US$100 per barrel until 2014, since when they have fallen by around 70%. While prices were high, many drillers spent more than they earned, bridging the gap with debt. That debt has become a deadweight with the price collapse.

Fort Worth-based Energy & Exploration Partners, for example, borrowed from at least 24 hedge funds to help acquire thousands of acres in Texas while oil prices topped US$100 per barrel. In December 2015, the company filed for bankruptcy, with lenders unable to agree on how to save it.

Until recently, companies were able to ride out the slump using hedges to sell their output at a higher price. Now, though, only 15% of US oil and gas production is hedged, compared with 28% of output in the fourth quarter of 2015, according to IHS. And the remaining hedges are coming up for expiry. Without the cushioning from hedges, oil prices are in many cases no longer covering the costs of production – and a recovery seems unlikely until 2017.

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What next?

The US oil and gas industry is facing US$9.8 billion in interest payments up to the end of this year, according to Bloomberg. Some companies will suffer more than others as they attempt to make their payments.

Energy XXI may be unable to meet its commitments in the next 12 months, triggering “substantial doubt” about its ability to survive, according to a company filing with the US Securities and Exchange Commission. SandRidge has another payment of about US$28 million due on March 15, but had used its US$500 million credit line by January 22. Meanwhile Chaparral Energy, which has also drawn down its entire credit line, has a US$17 million payment looming next month, according to Bloomberg’s data. Both SandRidge and Chaparral are reported to have hired legal and financial advisers. Deloitte said in a report this month that nearly 35% of US production and exploration companies were at high risk of going bankrupt in 2016. This year “will be the year of hard decisions”, Deloitte vice chairman and US oil and gas sector leader John England said. “Access to capital markets, bankers’ support and derivatives protection, which helped smooth an otherwise rocky road for the industry in 2015, are fast waning.”

According to Deloitte Center for Energy Solutions’ executive director, Andrew Slaughter, staying solvent is now the main challenge for hundreds of companies that piled on debt to grow from tiny start-ups into significant players in the US shale boom. It “will require the same level of perseverance, innovative thinking and creativity as the technology breakthroughs that led to the boom in supply we have seen over recent years”, he said.

Those that fall by the wayside may be acquired, with majors that still have the ability to scoop up assets standing to benefit.

Nobody expects oil prices to remain low forever, but even the average US$40 per barrel price recently forecast for the year by the US Energy Information Administration (EIA) will not offer much relief.

NewsBase anticipates the availability of credit lines for US shale producers being a major issue in the months ahead. In April, banks will carry out their semi-annual review of borrowing bases and credit lines for oil and gas producers. They will need to decide whether to cut back some lending, risking borrower defaults, or whether to maintain borrowing bases at a level sufficient to facilitate continued operations, including the drilling of new shale wells to replace depleting production. The risk for lenders is that any new loans can quickly turn into bad debt, especially if oil prices decline further. However, it is in their interest to allow producers enough breathing space to keep drilling, as new production would enable companies to make repayments. As a result, the review of borrowing bases may yet be more lenient than some expect.

Eventually, the global supply glut will be reduced and the market will rebalance. In the meantime, shale producers – particularly the smaller and more debt-laden players – are set to suffer more than ever.