Skip to footer

Mounting debt for energy firms as oil prices plummet

Energy firms have been financing new oil production by taking on large amounts of debt. When oil prices averaged over $100, that strategy made sense. But with oil at $50, most indebted firms are suddenly in crisis.

|
Shannon Stapleton/Reuters/File
A man walks onto an oil drilling pump site in McKenzie County outside of Williston, North Dakota in this file photo from March 12, 2013. Several counties in North Dakota's Bakken formation and the Eagle Ford and Permian Basin of Texas have seen rig deployments or applications for new well permits drop in half, as energy companies are quickly steering drilling rigs away from marginal areas and focusing on sweet spots of U.S. shale oil fields. REUTERS//Files
  • By Nick Cunningham Oilprice.com

In recent years oil exploration companies have taken on more debt in order to finance their operations. The level of debt in the upstream sector – excluding integrated oil companies like ExxonMobil – hit $199 billion at the end of 2014, a 55 percent increase since 2010, according to the Wall Street Journal.

Loading up on debt made sense when oil prices were high. Fracking new shale wells can be an expensive process, but when oil was averaging over $100 per barrel, the debt load for many firms didn’t seem so burdensome. Now with oil prices falling by more than half in the past six months, the most indebted firms are suddenly in crisis. As Warren Buffet once said, “you only find out who is swimming naked when the tide goes out.”

With an ebbing oil tide, the huge financial problems with several oil firms are starting to become clear for all to see. The WSJ report finds that Quicksilver Resources has a net debt to EBITDA ratio of 12.6. This ratio measures debt to cash flows, with a resulting number that reflects the hypothetical number of years needed to pay back debt. Generally, anything above a 4 or 5 starts to raise red flags. (Related: The Next Decade Will Decide Peak Oil Outcome)

In other words, it is looking pretty unlikely that Quicksilver will be able to emerge from its mountain of debt given the value of the oil and gas it is producing. Other notable companies in trouble include Antero Resources, with a debt/EBITDA ratio of 6.2.

Without a swift rise in oil prices, a wave of write-downs and impairment charges could be about to wash over the industry. An estimated $1.6 trillion in production earnings could go up in smoke if oil prices hold at their current levels. Most of the write-downs will come from small and mid-sized companies who have taken on the most debt. Larger and more diversified companies – the Chevrons, Shells, and ExxonMobils of the world – could write off certain projects and see a dip in earnings, but they will likely weather the storm just fine.

But for smaller companies, today’s oil prices (around $50 per barrel) present an existential threat, even in the short-term. When access to finance gets cut off, the jig could be up. For example, the WSJ notes that one private exploration company, WBH Energy LP, just declared bankruptcy after a lender declined to lend more money. Drilling with debt only works so long as lenders allow you to roll over debt on the belief that they will eventually be paid back. But with oil prices less than half of what they were last summer that is looking less and less likely.

 

The problem is that oil prices won’t rise until there is a cutback in production. But with more debt to pay off, no company can afford to reduce production now. Indeed, drillers are even more desperate to maintain or boost production so that they can substitute lost value with more volume. (Related: Low Prices Lead To Layoffs In The Oil Patch)

“No one wants to disappoint their shareholders and say we’re cutting production. That’s death,” Judith Dwarkin, director of research at Calgary-based ITG Investment Research, told The Globe and Mail. “So it’s a bit of doing what they can to stay afloat during a difficult period and hoping somebody else shuts in.”

If oil prices don’t rebound soon, that’s exactly what will happen. The weakest won’t be able to keep up the charade, and the industry will experience a big shakeout. That will mean some more bankruptcies and lost oil production, which should begin to push prices back up.

For bigger companies, “capital discipline” is the name of the game, meaning a large cut in capital spending for exploration this year. While that may not affect production in the short-term – there is a backlog of oil wells that are nearing completion – by the end of 2015 production could begin to dip. The U.S. may finally see the shale boom begin to reverse.

By Nick Cunningham of Oilprice.com

More Top Reads From Oilprice.com:

Source: http://oilprice.com/Energy/Energy-General/Mounting-Debt-For-Oil-Drillers.html

You've read  of  free articles. Subscribe to continue.
Real news can be honest, hopeful, credible, constructive.
What is the Monitor difference? Tackling the tough headlines – with humanity. Listening to sources – with respect. Seeing the story that others are missing by reporting what so often gets overlooked: the values that connect us. That’s Monitor reporting – news that changes how you see the world.
editor@csmonitor.com
Subscribe
Mark Sappenfield
Editor

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to CSMonitor.com.

Subscribe to insightful journalism

QR Code to Mounting debt for energy firms as oil prices plummet
Read this article in
https://www.csmonitor.com/Environment/Energy-Voices/2015/0108/Mounting-debt-for-energy-firms-as-oil-prices-plummet
QR Code to Subscription page
Start your subscription today
https://www.csmonitor.com/subscribe