Originally written for and published in The State Bar of Texas, Bankruptcy Section Newsletter, May 2015
The oil & gas industry forecasters, experts and prognosticators are all wrong.
To find the clues to the future of oil & gas and the overall effect on the general economy you don’t look back to 2008, you need to go all the way back … to the 80’s. 2008 was an anomaly for the entire economy, not just oil & gas. To look back only seven years obfuscates the reality of what has occurred without providing clear historical perspective. The 80’s oil & gas bust and its aftermath provide the necessary historical, contextual, operational and economic framework to begin to understand what’s happening today, and what will likely happen tomorrow. As a veteran of both the O&G and restructuring industries, I can’t forget the 80’s bust; it’s where I made my bones – and I still have the scars to prove it.
Many forecasters and experts in the early 80’s made statements like this one in forecasting future oil prices for 1985: “Conservative estimates project a price of $80 a barrel, even if peace is restored to the Persian Gulf…” National Geographic, 1981. Oil then promptly dropped from roughly $40 BBL to lows in the teens, seemingly overnight. In the heat of the chase, almost everyone forgot the principals of cyclical business segments…what goes up must (and will) come down.
Here’s how it works: Prices wobble and drop like a rock. Rigs and equipment, of all types, get stacked. Asset values decline precipitously and sometimes go to zero. Customers balk at prices. They demand, and get significant price reductions eliminating profitability as businesses “churn cash” to stay afloat. Revenue drops and cash flow dries up. Jobs, many jobs, simply evaporate. Bankers don’t lend anymore. They want more collateral, lines reduced, loans paid off…but with what? Delinquencies on everything from trucks to boats to homes and credit cards all rise. The word “default” enters into every day conversations. The business roller-coaster that was so much fun to ride up is now a terrifying free falling elevator. No one knows what’s going to happen next. Everyone has an opinion. Oil traders daily froth the markets. From the petroleum clubs to the coffee shops to the oil fields, everyone hangs on each new analysis and opinion about when oil prices will calm and rise; all seeking consolation where there is none.
In the 80’s a little known Oklahoma shopping center bank called Penn Square folds, and it is in retrospect, credited with being partly responsible for the collapse of Continental Illinois National Bank and Trust Company of Chicago which had to write-off some $500 million in loans purchased from Penn Square (mostly oil & gas). Major losses eventually occurred at other banks like Seattle First National Bank, Michigan National Bank, and Chase Manhattan Bank. The MBank system goes bankrupt along with Global Marine and scores of other businesses and “formerly wealthy” individuals. Significant industry consolidations occur. Ripples are felt throughout housing, retail and other business segments. The bust from the oil & gas industry creates a boom for bankruptcy lawyers and related professionals.
Some theorize that this cycle will be different (e.g. shorter or less severe) because there is non-bank money available from private equity, hedge funds or non-traditional lenders, allegedly all awash in cash, who will swoop in with free flowing billions to save companies and their stakeholders. But, private equity and related firms are the predatory sharks in the business sea. They are all built specifically to find targets, assess and acquire (or lend to) them at the most advantageous moment on the most advantageous terms. The consensus that someone, anyone will step-in and save the O&G industry from future trauma at this early stage of the cycle, seems to me indicative of those exhibiting the early symptoms of the seven stages of loss and grief, beginning with shock and denial heading with a bullet towards bargaining.
Free flowing money created the problems for banks in the 80’s and today is no different. Contrary to popular myth, no one has ever “drilled their way out of trouble” and no one has ever solved endemic industry issues by throwing cash at the problem. An industry bailout, by anyone, at this juncture seems at best, premature and at worst, unrealistic. The recent oil boom was longer. The capital flowing in was greater and ironically the industry was remarkably more successful in producing hydrocarbons, albeit at greater drilling and production costs, than in decades. This oil & gas down cycle is only six months old and most, if not many, are already trying to find light at the end of the tunnel.
Unfortunately, this tunnel is still being dug…