Financial stress is rising fast in the oil patch as money sits on the sidelines and credit rating agencies issue fresh warnings on the financial health of the industry.
Oil field service companies and upstream exploration and production (E&P) firms are getting the most scrutiny from ratings agencies. Midstream pipeline companies are also feeling the pinch, while refiners remain relatively healthy, even as one major downstream company recently posted a loss for the final quarter of 2015.
But debt distress is rising and credit outlooks are turning negative with each successive drop in the crude price. Last week’s brief rise didn’t alter the views of analysts, who see oil prices dipping under $30 a barrel again soon. Crude prices may even go lower still should bad news from emerging markets spark a financial panic.
Will we see a fire sale for distressed oil patch assets, or a more orderly consolidation as most are calling for? The ultimate outcome might be a bit of both, depending on where oil prices go.
Oil field service companies "are just absolutely dying," said Stephen Pouns of WoodRock & Co. "There’s no life out there. I’d expect either a bunch of these companies are going to merge, or they’re going to dump their assets."
For E&P companies, the market’s efforts to keep them alive have proved nothing short of heroic.
Pouns mentioned the debt-for-equity swaps that are becoming more common in lieu of traditional prepackaged bankruptcy filings. It’s one means by which companies have lightened their debt exposure and have managed to hold on for a bit longer.
"There must be 20 of these companies that are doing that today, and we haven’t seen that before. The last cycle, they would have done pre-packs," Pouns explained. "So a lot of the selling has already taken place."
Ratings firms Moody’s and Fitch Ratings Inc. have both soured on the short- and near-term prospects for the U.S. oil and gas industry, moving their views to negative for the sector, affecting mostly oil field service providers and E&P companies. Hedges allowing E&P firms to sell oil at prices higher than what the current market is offering are coming off this year and will dwindle to negligible levels of their crude output by next year.
Credit access has tightened considerably. Oil field service companies don’t have the luxury of hedges.
Fitch’s outlook has turned negative on some of the biggest names in the industry, including ConocoPhillips Co. and Hess Corp. Last week, Hess reported an adjusted net income loss of more than $1 billion for 2015. ConocoPhillips turns in its numbers this week.
"Low prices hit high yield oil & gas issuers hard last year, and they remain under considerable stress in this downturn," Fitch analysts said in a note.
PwC, formerly PricewaterhouseCoopers, has noted the tightening of high yield debt available to the industry last year, a trend seen continuing for 2016. Figures it reported last week showed 2014 high yield debt issuances of more than $52 billion. Last year, that value slid to about $31 billion as the number of issuances fell by half.
Much of this debt matures in 2017, but PwC expects a round of deleveraging this year mitigating some of the risk.
Moody’s has moved 130 oil field service and E&P companies to downgrade reviews, following a similar move in December. In total, 166 companies have been placed in review for credit downgrades by that ratings agency. The swift move and Moody’s downgrade in its expectations for oil prices — analysts there don’t see a return to the $50-per-barrel range until 2018 — should be cause for alarm, researchers there said in a note.
"The breadth of the rating actions we have just taken reflect the depth of our overall concerns for the oil and gas industry," Moody’s analysts wrote. "The industry has changed, and its ability to generate cash flow has fallen substantially. This condition now looks likely to persist for several years."
Distress at $20
Merger and acquisition (M&A) activity hasn’t been at levels many expected by this point in the downturn. Dealmaking registered a "precipitous decline in activity" during the fourth quarter of last year, said PwC’s U.S. energy transactions leader, Doug Meier.
PwC classifies half of all outstanding industry debt as "distressed." A recent analysis by the U.S. Energy Information Administration estimated that roughly 80 percent of the industry’s operating cash flow is being used to service debt. That estimate was issued before oil prices slid about 20 percent lower at the beginning of this year.
In an interview, Meier said the weakening M&A activity toward the end of last year factorerd into weaker oil prices, "coupled with credit markets deteriorating over the second half of the year." Nevertheless, he argued that 2015 was an overall healthy year for oil and gas M&As.
Still, it’s a worrying sign, he acknowledged, as "the fourth quarter is traditionally a strong quarter for doing deals." But Meier expects deals will eventually get done and discounted the possibility that a big chunk of the industry will go out to auction via distressed bankruptcies or forced sales from creditor pressure.
"Obviously, we’re going to have continued headwinds from the commodity environment and companies being in kind of a cash preservation mode," Meier said. "However … I do think that there will be opportunities for M&A in the oil and gas space for those who have dry powder and also for those who are willing to use their equity as a currency to make deals."
Well operators, service providers and their banks have proven far more resilient in this downturn than most observers earlier expected. Despite the sharp plunge in drilling activity, actual crude production from the United States has fallen relatively slightly. Output in Texas may have gone up in 2015 compared to the previous year. The industry has found ways to do more with less.
But all agree that time is running out for the most financially stressed firms.
Hedging strategies will largely come to an end this year with minimal benefits from hedges seen in 2017. IHS Inc., an industrial research firm gearing up to host the largest energy conference in Houston this month, recently reported that E&P companies have 14 percent of their total 2016 crude oil production hedged at values higher than the current range of $33 to $35 per barrel. Two percent of 2017’s oil production is hedged.
"2016 is going to be another very tough year, as plunging revenues lead to balance sheet deterioration, and financial pressures mount," said IHS principal analyst Paul O’Donnell in a note.
WoodRock sees dealmaking accelerating in the first and second quarters of this year, predicting a fairly orderly reorganization of the industry to begin in earnest. Analysts there estimate that some $150 billion to $250 billion in capital has been set aside by investors anxious to do energy deals.
Companies seeking relief through the Chapter 11 process will find interested buyers. "Anybody that files bankruptcy will attract that interest real quickly," Pouns said.
Many companies won’t have to wait for help from the bankruptcy courts for relief. Pouns cited as one example the agreement reached last week between a U.S. and a Canadian well services company. Keane Group announced Tuesday that it would purchase all of Trican Well Service Ltd.’s U.S. assets for $247 million.
Still, WoodRock principal John Dennis cautioned that the pace and form of the inevitable consolidation of North America’s oil and gas industry are heavily dependent on where oil prices go from here.
"It’s one thing if oil is $32 to $27," he explained. "There are still fields in the United States that produce and are profitable.
"When oil gets to $20, $15, there’s nothing in the United States that’s profitable, and that’s when there is no cutting to the bone to survive," Dennis said. "That’s when whole segments, fields, geographies just shut down."
