Two weeks ago, we used the term “crumbling” to describe what we saw happening in the oil business, but more importantly in the entire energy industry. The industry news since that time has only gotten worse as oil prices have once again fallen below $30 a barrel reinforcing fears about the prospect of oil reaching $20 a barrel before long.
The growing reality is that 2016 will not be the industry-recovery year that most industry executives assumed it would be as they were preparing their corporate budgets in late 2015.
As shown in the chart below, the price of oil was stable in the $45 a barrel range for most of September 2015 before rallying up to $50 a barrel at the start of October.
Falling Oil Prices Upset Budgeting
Source: EIA, PPHB
That price action provided ammunition for the industry optimists who were expecting an industry recovery beginning before year-end. Unfortunately, before they were able to open their champagne bottles, the oil price began dropping uninterruptedly, except for brief periodic short-covering rallies, until the middle of January, bottoming out in the mid-$20s a barrel.
Immediately afterward, the oil price bounced up to the low $30s a barrel before reversing and heading back to the mid-$20s a barrel once again. Throughout the first two months of 2016, industry headline after industry headline remarked how a new multi-year price low had been reached the day before, with the time period of these new lows extending backwards from just a few years up to 12 years. Whatever optimism existed among industry participants was flushed out by the oil price volatility and the growing reality that the “lower for longer” scenario was becoming the mainstream scenario.
Even one of the primary industry oil price bulls who had been calling for a V-shaped recovery for much of 2015 was forced to push the prospective timing of this oil price recovery into the second half of 2016. People are beginning to wonder whether an oil price recovery will even happen in 2016.
While January brought bad news from companies with respect to capital spending reductions, some of the worst news such, as dividend cuts and massive layoffs, only emerged in the past couple of weeks. The reality of the magnitude of damage being done to companies by the sharp reduction in their revenues and cash flows due to weak oil prices has finally forced managements and boards of directors to act, and act dramatically.
For example, the surprise decision by Southwestern Energy (SWN-NYSE) to lay off 40% of its staff, or more than 1,100 employees, and shut down all its drilling rigs after having recently moved into a massive new headquarters building shocked the industry.
Likewise, ConocoPhillips, after defending its dividend through the first year of this downturn even at the cost of laying off staff, finally caved and cut its quarterly dividend by two-thirds from 74-cents to 25-cents per share.
ExxonMobil, after reporting weak earnings results for its fourth quarter, followed up last Friday by announcing it had failed to replace its production last year for the first time in 22 years, announced a 25% cut in its 2016 capital spending plans and the suspension of its share repurchase program. These steps are designed to reduce the drain in the company’s cash balances.
Another optimist, Pioneer Natural Resources (PXD-NYSE), after signaling late last year that it might actually increase its 2016 capital spending by 20%-30% as a result of the multiple attractive exploration opportunities it has in its Permian Basin acreage, announced a 10% capex cut this year, which means it will be forced to cut in half the number of drilling rigs it operates, going from 24 at year-end 2015 to 12 by mid-year 2016.
The latest industry bombshell was Devon Energy’s (DVN-NYSE) announcement just last week that it was slashing its 2016 capital spending by 75% and laying off 1,000 employees, or about 20% of its staff. The shock from this announcement had barely been digested when Devon announced the sale of up to 69 million shares of stock and raising potentially $1.6 billion in cash to shore up its balance sheet. The cash infusion also helps the company by reducing the pressure to depend partially on selling assets to help fund capital spending.
The sale of stock by Devon is another example of the continuing ability of energy companies to tap capital markets, something a growing number of observers believe is prolonging the needed spending reduction that will cause oil output to fall off materially and set the stage for a recovery in prices.
According to Bloomberg, the energy industry has announced plans to raise $4.6 billion in new equity, accounting for nearly 30% of all new equity raised so far this year. The amount of equity being raised is almost evenly split among three deals – Pioneer Natural Resources, Hess Corporation (HES-NYSE) and Devon. Each of these deals was upsized from their original announcement reflecting high levels of demand from investors betting not only the individual companies surviving but that their share prices will soar when the oil price rises and energy industry fortunes improve.
2016 Energy Equity Raising SignificantSource: Bloomberg
The $4.6 billion equity raise so far this year compares with the $7.8 billion raised by exploration and production companies during the first two months of 2015, the fastest pace in raising new equity in over a decade. An interesting question is whether the capital raised in early 2015 has been wasted? If we consider what has been happening to companies within the E&P and oilfield service sectors, the oil price collapse is finally ending the corporate and investor strategy of “pretend and extend.”
That strategy means that company executives have been selling lenders and investors on the view that a turnaround is just around the corner, so if they will just give them a little more time (and money?) the companies will be fine. As this strategy evaporates, the battle lines are drawn between managements and their owners. A change in the past is that many of the owners of the companies are investors who specialize in distressed securities.
As a result, the struggle over how to redo the capital structure of energy companies becomes more intense as debt-owners, who have legal claims against the assets of the company, fight to gain the most ownership and thus stand to benefit the most whenever the share price recovers.
Many of these recapitalization struggles are being fought in the esoteric world of corporate bankruptcy law. The last great boom for the local bankruptcy industry occurred in the period of the 2008 financial crisis and the recession that followed.
For energy, the greatest bankruptcy boom was the demise of the industry in the 1980s bust. A recent article about the state of the bankruptcy business, in response to the collapse in oil prices, was in The Houston Chronicle. The article included a graphic showing the number of Chapter 11 (the section of the bankruptcy law that provides for restructuring of financially distressed companies rather than liquidations of companies that is conducted under Chapter 8 of the code) filed in the Southern District and the State of Texas.
In 2015, the number of bankruptcies filed in the Southern District approached close to those filed in 2008, the start of the financial crisis. The article cited a survey of 18 bankruptcy legal experts by The Texas Lawbook calling for a doubling of filings this year.
2015 Bankruptcies Near Financial Crisis Level
Source: The Houston Chronicle
The fallout from the low oil prices and the hefty cash outlays producers have been making to play the shale revolution and/or to continue to generate cash flows is showing up in the growing number of exploration and production companies filing for bankruptcy. The Houston energy practice of the law firm Haynes & Boone is tracking those filings for both E&P and oilfield service companies in the United States and Canada. As of the listings on their web site, as of early February, 48 E&P companies and 44 oilfield service companies have filed since the start of 2015. The total of secured and unsecured debt involved in these bankruptcy filings totals $25.1 billion, split $17.3 billion for E&P companies and $7.8 billion for oilfield service companies.
2015-2016 E&P Bankruptcy Debt LevelHaynes & Boone LLP
2015-2016 OFS Bankruptcy Debt LevelSource: Haynes & Boone LLP
The struggles for companies in bankruptcy proceedings can be monumental. Most times the companies that enter bankruptcy are not the same companies that exit. They are often forced to sell assets and possibly the entire company, besides dramatically altering the ownership of the company. Even strategies called “pre-packaged” bankruptcies, where supposedly all the creditors agree as to how to reorganize the company, can become contentious when a small number of debtholders challenge the plan. We have seen this situation develop following the recent filing for Paragon Offshore Plc.
Another interesting trend about the oilfield service bankruptcy universe is that there are three offshore drillers among the 44 companies, but they represent over 83% of the total debt involved. That speaks to the very capital intensive nature of offshore drilling, and the difficulty in reorganizing the companies other than restructuring the ownership. Another development that points to the continued difficulties energy companies are dealing with is the announcement by Hercules Offshore, Inc. (HERO-Nasdaq) shortly after exiting bankruptcy protection that it has created a special committee comprised of all its independent directors to consider strategic alternatives including selling, merging or restructuring the company.
The environment engulfing the energy industry will force it to change. How that change is undertaken is impossible to know but we are seeing various routes – limiting operations, downsizing, stopping cash returns to shareholders, diluting existing shareholders by issuing new equity, selling assets, merging and/or reorganizing either within or outside of bankruptcy protection. We will watch with great interest how this restructuring occurs as the future of the industry will be shaped by the various routes taken.
Published on Oilpro.com