New York: Wall Street supercharged America’s energy boom of the past decade by making it easy for oil companies to finance growth with cheap, borrowed money. Now, that partnership is in tatters as the coronavirus pandemic has driven the fastest collapse of oil prices in more than a generation.
The energy sector has buckled in recent weeks as the global demand for oil suddenly shriveled and oil prices plunged, setting off a price war between Saudi Arabia and Russia. Oil prices are now one-third their most recent high, trading as low as $24 a barrel, and could fall further.
The crisis has been a body blow to the U.S. oil and gas industry. Already heavily indebted, many companies are now struggling to make interest payments on the debt they carry and are finding it challenging to raise new financing, which has gotten more expensive as traditional buyers of debt have vanished and risks to the oil industry have grown. Companies are increasingly turning to restructuring advisers to work through their finances, and the weaker businesses could end up filing for bankruptcy.
Collectively, the energy companies in the S&P 500 stock index are down roughly 60% this year. Prices of bonds issued by U.S. energy companies - both the safer investment-grade kind and riskier junk bonds - have plummeted, while their yields have skyrocketed.
Even once-unassailable energy giants appear fragile. On Monday, S&P Global Ratings cut the oil behemoth Exxon Mobil’s credit rating, citing the impact of lower oil prices on cash flows, and some analysts are questioning whether it will be able to keep paying its current dividend. A week after Occidental Petroleum slashed its dividend, Moody’s Investors Service downgraded its rating of the company. Occidental is stretched by its acquisition of Anadarko last year, which required it to take on $40 billion in debt, and is now expected to make severe payroll cuts.
“The shale players were already stretched to their limits, and the virus has just broken every thread they were holding on by,” said Ed Hirs, an energy economics lecturer at the University of Houston.
The American shale revolution began around 2008 as oil prices flirted with $150 a barrel and when the U.S. faced chronic shortages of energy and dependence on Saudi Arabia and unstable producers like Venezuela and Nigeria. In the decade that followed, investors - and the Wall Street bankers who catered to them - were more than happy to provide financing for upstarts like Oklahoma-based Chesapeake Energy and Devon Energy.
Interest rates were low, and investors embraced the riskier debt that energy companies typically issued with the promise of higher returns. In the last 18 years, energy companies were among the largest issuers of junk bonds on Wall Street, according to analysis from JPMorgan Chase. In 10 of the last 11 years, energy companies were the single largest junk bond borrowers.
That borrowing binge meant that by 2014, almost all investors in junk bonds were heavily exposed to the fate of these companies. Since 2016, when oil prices began to drop, 208 North American producers have filed for bankruptcy involving $121.7 billion in aggregate debt, according to the Haynes and Boone’s Oil Patch Bankruptcy Monitor report released in late January. That means many investors in those bonds lost their principal. But debt offered by the companies that did survive the bust still accounts for more than 10% of the junk bond market.
“The main technology innovation there was financial innovation,” said Roman Rjanikov, a portfolio manager at DDJ Capital Management in Waltham, Massachusetts. “Somehow they were able to convince investors that never generating cash was cool.”
The problem with that model, he said, is that “when you lose access to that capital, things break down.”
Oil companies were already under pressure from lower oil and natural gas prices because of a warm winter even before the coronavirus outbreak and the price war between Saudi Arabia and Russia. Also, margins for refining and chemical production have been shrinking. And with analysts at Citi projecting that the global Brent oil benchmark price will go as low as $17 a barrel, things could get much worse.
In recent days, oil companies have cut their capital spending sharply. In Texas, the epicenter of the shale drilling boom, companies have axed at least $8 billion in the last few days from their 2020 capital budgets, pulling drilling rigs and canceling hydraulic fracturing crews. The job losses that follow will likely be significant, worsening what’s expected to be a deep recession in the United States.
At the same time, major bills are coming due. North American oil exploration and production companies have $86 billion in debt that will mature between 2020 and 2024, and pipeline companies have an additional $123 billion in debt coming due over the same period, according to Moody’s.
Chesapeake Energy has $192 million of bonds coming due in August. With debt of $9 billion, the company is almost out of cash and has hired restructuring advisers, Reuters reported. Another company at risk is Whiting Petroleum, focused on the North Dakota Bakken shale, which has roughly $1 billion of debt coming due over the next year.
Among those hit hardest from the latest oil price plunge and pullback in exploration and production activity will be oil service and drilling companies such as Halliburton, Schlumberger and General Electric’s Baker Hughes, along with hundreds of smaller companies. The oil field services sector in North America faces high financing risk with $32 billion of debt maturing between 2020 and 2024 - roughly two-thirds of which was issued by smaller, more speculative companies - according to Moody’s Investor Service.
But the entire energy industry is adjusting. Parsley Energy, a leading West Texas oil and gas producer, has devised its 2020 capital budget assuming that oil prices will be in the range of $30 to $35 for the remainder of the year. It is reducing its capital budget by more than 40% to under $1 billion and reducing salaries of its executive officers by at least 50% compared with last year. It has already reduced drilling and fracking crews and it plans to cut some more.
Parsley refinanced its debt in February and won’t face a crunch for at least five years. Matt Gallagher, Parsley’s chief executive, said his company would survive, but he expects multiple bankruptcies in the industry. “There’s not a rosy long-term picture for the debt out there,” he said.