For some E&P companies, 2015 will be the year of bankruptcy

Jun 08, 2015 12:00 AM

IF YOU WERE TO GO BACK IN TIME 15 or even 10 years and say that in 2015 the United States would be on the cusp of overpowering the new OPEC, you might be dubbed a dreamer. Now that we're here, it's not so hard to believe even if it isn't the happiest of stories.

On the way to the top spot, fueled by cheap debt and high oil prices, producers overshot demand that led to the current price slide of about 50% since July of 2014. What made matters worse is that OPEC had little choice but to grapple for market share and keep production steady. Exploration and production players, primarily those on the fringe of this business, suffered the most. It's a sea change and it already has come to bear.

Most E&P companies are heavily leveraged and must keep drilling, even at the current oil price, to survive and meet debt service obligations. This is the reason consolidation has not happened more rapidly. Company valuations are still too high due to expectations that the oil prices will recover by the fourth quarter to the $70 to $80 range. The Shell-BG deal doesn't count because it was a natural gas deal.

Workers test a well on a BPZ Energy platform off the coast of Peru.
Houston-based BPZ voluntarily filed for Chapter 11 bankruptcy protection earlier this year.

 

Oil production in the US is expected to slow in the next three-to-six months. In fact, there is a good chance that production will peak in June or July. It may start to stabilize and then decline in the middle of the third quarter, when we should see stabilization in crude stock inventory.

HOW IT STARTED

It started as overzealousness in 2011, when crude oil prices began their climb in the first quarter on the back of improving demands and concerns about possible international supply disruptions, which pushed up petroleum prices. Prices then fell during the second and third quarters before turning upward at the start of the fourth quarter, according to the US Energy Information Administration (EIA).

EIA data shows that Brent and US West Texas Intermediate crude oil started 2012 above $100 per barrel. Prices peaked in early March 2012 at $125 per barrel for Brent and almost $110 per barrel for WTI. At the time, economists forecasted strong domestic and international growth due to potential supply disruptions tied to Iran's nuclear program, which contributed to higher prices. Sound familiar? Ultimately, that situation turned an inopportune corner.

Crude oil prices fell in the second quarter of 2012 due, in part, to concerns about lower oil demand with a slowdown of the global economy. China and other emerging markets disappointed soothsayers for posting weak GDP figures. By the end of June that year, oil prices were down about 30% to about $78 per barrel for WTI and $91 per barrel for Brent, according to the EIA.

In the headlines we read that production disruptions in Syria, Sudan, and Yemen took about 1 million barrels of oil per day off the world market, raising oil prices. Then there was Iran - a different story today - where we spoke of sanctions in a pre-nuclear deal world. Ongoing US and European sanctions on imports of Iranian oil, which were intended to pressure Iran to give up its nuclear program, helped reduce Iran's oil exports and incited fear that Iran would retaliate by disrupting oil shipments.

US oil producers ramped up exploration, and by early 2012 US oil production had topped six million barrels per day, the highest level since 1998, EIA data shows. With cheap debt and Wall Street more than willing to accommodate the industry, shale E&P companies borrowed and "overproduced" without any discipline to rein in output. This contributed to building US crude oil inventories that put downward pressure on oil prices in the second half of 2014. Late last year when OPEC decided that maintaining market share was crucial and refused to cut production volume, the oil price sank.

WHAT WE SEE TODAY

Even with a more than 50% drop in rig count, US oil production today remains close to 40-year highs. The industry exceeded nine million barrels in November, and production has been about 9.3 million barrels a day recently. While US production remains high, Saudi Arabia's output has increased to 10.3 million barrels, and Russian output reportedly has remained steady, a bearish formula for prices.

When oil was in the $100 to $110 per barrel range ($105 in July 2014), these companies borrowed heavily against that valuation to fund their capital expenditures. That was three years ago. The oil, which is the collateral, gets reevaluated at half its market value from 2012, and many E&P companies now don't have the additional money to borrow because the borrowing base has been used (and won't renew).

There are approximately 85 publicly-traded E&P companies with revenue of more than $100 million. The future of these companies hangs in the balance.

The bloodletting started in January with WBH Energy, a Texas-based company that drew headlines for filing bankruptcy. Reuters reported WBH "may be the first US oil company to do so since crude prices started tumbling six months ago."

Matters worsened in March with four more bankruptcies. Houston-based BPZ Energy, an independent oil and gas E&P company, announced it was voluntarily filing for Chapter 11 bankruptcy protection. So did its Houston neighbor Dune Energy. According to reports, Dune had requested approval of $10 million debtor-in-possession financing from its pre-bankruptcy lenders, and would continue to operate its oil and gas production facilities as debtor-in-possession.

Dune was followed by Cal Dive International, also based in Houston. Cal Dive contracts out marine work to the offshore oil and gas industry and provides services such as manned diving, oil platform installation, and pipeline burial. While it's an ancillary business, it's quite relevant.

Finally, Sabine Oil & Gas Corp., the exploration and production company that merged with Forest Oil Corp. in 2014, said its banks may cut its fully drawn $1 billion credit line after oil prices plunged. As of April 21, the company received an extension on a major interest payment.

In 2010, US E&P companies focused on producing oil and gas had $128 billion in combined total debt, according to financial data collected by S&P Capital IQ. As of the third quarter of 2014, such companies had $200 billion of combined total debt.

Most companies were hedging into this year, but in 2016 they no longer will have the benefit of hedging at a much higher oil price. Even though oil is trading at $51 per barrel, likely won't go below $40, and should see the $60 to $70 range in the second half of the year, we expect to see more E&P companies filing bankruptcy and seeking formal reorganization as they start to run out of options.

While US producers have cut capital expenditures drastically, as much as 20% to 50% from prior year, resulting in a reduction in rig count (as of Mar. 20, 2015, the US drilling rig count totaled 825, compared with 1,473 a year ago, a decline of 648), production hasn't slowed from existing wells.

It's about time this gets on a course to stabilization on rig count, but many headwinds still remain. I'm less optimistic that oil prices will recover to the $70 to $80 range by the end of the year, though I wouldn't be surprised if it gets back up in the $60 to $70 range by then. Yet, for many E&P companies, it won't be enough.

Kim Brady is a senior managing director at SOLIC. He has nearly 20 years of professional experience, including 15 years of managing distressed situations, executing complex in-court and out-of-court capital restructuring solutions, negotiating and integrating acquisitions, and developing operating rehabilitation plans for underperforming companies and driving performance improvements.

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