It’s Happening: Debt Is Tearing up the Fracking Revolution

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The shares of Chesapeake Energy, second largest natural-gas driller in the US, crashed nearly 10% today, to $9.29, the lowest price since August 2003, down nearly 70% since oil began to plunge a year ago. The company’s $1.1 billion of 5.75% notes fell to an all-time low of 84.88 cents on the dollar. And its 4.875% notes dropped to 81.25 cents on the dollar, from 86 last week, according to S&P Capital IQ LCD.

All this in the wake of its announcement that it would suspend its dividend for the first time in 14 years. It’s trying to conserve cash, and that dividend costs $240 million a year. It’s dumping assets as fast as it can, including some Oklahoma fields that will save it another $75 million a year in preferred dividends. It’s cutting operating costs and capital expenditures. It’s trying to stay alive.

It has been cash-flow negative in 22 of the past 24 years, according to Bloomberg.

The only thing surprising is that it took so long, that Wall Street kept funding its cash-flow negative operations and dividends for all these years.

Chesapeake used to be mostly a natural gas producer. But the price of natural gas plunged over five years ago and has remained below the cost of production for most wells for much of that time. The only saving grace was that these wells also produced natural-gas liquids and oil, which sold for much higher prices. As its natural-gas business model collapsed, Chesapeake began chasing after oil-rich plays. But a year ago, the price of oil collapsed.

Among natural gas drillers, Chesapeake isn’t in the worst shape. Much smaller Quicksilver Resources filed for Chapter 11 bankruptcy in March. It listed $2.35 billion in debts and $1.21 billion in assets. The difference has been forever drilled into the ground. Stockholders got wiped out. Creditors are fighting over the scraps.

Then there’s natural gas driller Samson Resources. It was acquired by a group of private equity firms, led by KKR, in 2011 for $7.2 billion. Since then, Samson has lost over $3 billion. When Moody’s downgraded Samson to Caa3 in March, it pointed at, among other things, “chronically low natural gas prices” and invoked “a high risk of default.” Samson warned it might have to resort to bankruptcy to restructure its debt.

At the time, a JPMorgan-led group, which holds a $1 billion revolving line of credit, granted Samson a waiver for an expected covenant breach to avert default. But the group reduced the size of the revolver. Last year, the same group had already reduced the credit line from $1.8 billion to $1 billion and had also waived a covenant breach.

“Liquidity death spiral,” is what S&P Capital IQ called this principle by lenders to whittle down the size of the loan as the company runs deeper into trouble, as I wrote at the time. It eventually ends in bankruptcy.

On August 15, Samson has to make an interest payment of $110 million on a $2.25 billion junk-bond issue. That date is coming up in a hurry. And its debt “continued to wallow around record lows today after press reports circulated about restructuring negotiations along two different paths,” S&P Capital IQ LCD’s reported today.

The loan investor group want to find new money to get the company through a Chapter 11 bankruptcy. The bondholder group wants to find new money to fund an out-of-court restructuring via a debt swap.

Samson’s covenant-lite second-lien term loan due 2018 was quoted at 31.5/33.5 cents on the dollar. Its 9.75% notes due 2020 were “essentially worthless.”

And more bloodletting among energy credits today: California Resources’ 6% notes fell to 77 cents on the dollar, a record low, according to S&P Capital IQ, “amid a repricing of the energy sector and more broadly a sell-off in commodities credits this week as oil and precious metals probe lower levels.”

Time and again, despite the collapsed prices of oil and gas, the players in the shale revolution have gotten more funding from Wall Street, whose ZIRP-blinded clients kept gobbling up the newly issued junk bonds, leveraged loans, and shares, taking on huge risks and hoping to make a little extra money in a Fed-laid minefield where all decent assets are way overpriced.

During the first half of 2015, according to Bloomberg, deeply troubled shale drillers were able to sell $32 billion in new debt and $12 billion in equity, in total $44 billion, more than during any half-year period since the go-go days of 2007.

Exhibit A: Halcon Resources. Though it has been drilling cash into the ground at a breath-taking rate, it went on a money binge in April, including a debt-for-equity swap and junk-bond sale that left some prior investors seething. The company has become ruinous for investors. Yet it keeps getting new money.

Each new wave of investors hopes it won’t suffer the same fate prior investors suffered. Bloomberg put it this way:

Halcon Resources Corp. almost ran into trouble with its banks in June 2013. And again in March 2014. And in February 2015.

Each time, the shale driller came close to violating debt limits set by its lenders, endangering a credit line that provided as much as $1.05 billion in much-needed cash. Each time, Halcon’s banks, led by JPMorgan Chase & Co. and Wells Fargo & Co., loosened their restrictions, allowing Halcon to keep borrowing.

If there is a bankruptcy, Halcon’s unsecured bondholders might get, at most, 10% of the nearly $2.6 billion they’re owed, Standard & Poor’s estimates. Secured creditors such as banks will fare better. Many other investors, including stockholders, will be just about wiped out.

The Office of the Comptroller of the Currency has been warning the banks it regulates about these oil & gas loans. Their collateral has plunged with the price of oil and gas. And as banks begin to fret while investors lick their wounds, after all these years, a strange phenomenon in the world of ZIRP is showing up on the horizon: a cash crunch.

Devastating for the permanently cash-flow negative shale revolution.

Most drillers survived the last redetermination by their banks of their oil & gas credit lines. That was in April. These loans are backed by the value of the drillers’ reserves. But low oil and gas prices have knocked down that value, and drillers had to pay down their credit lines with money extracted from other investors. That’s where some of the new money went that drillers have raised.

The next redetermination cycle is in October. And hedges are now expiring which have partially protected drillers’ revenues from the oil price plunge. So it’s going to be tough. But turning off the money spigot will push these companies off the cliff. And banks would end up with the oilfields and have to get their hands dirty. So they’re not eager to pull the ripcord. But they can’t afford to play this “extend-and-pretend” charade for too long either, or else they’ll get sucked down too.

Oil gets blamed for Canada’s troubles, and not just oil but also China, Greece, and “global instability.”  Read…. Epic Glut of Office Space Crushes Hope in Canadian Oil Patch

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  14 comments for “It’s Happening: Debt Is Tearing up the Fracking Revolution

  1. NotSoSure
    July 21, 2015 at 10:03 pm

    And Apple missed its projected iPhone sales. It’s just 1 million plus off, but I am shorting the market tomorrow.

  2. lG
    July 21, 2015 at 10:25 pm

    Maybe they can issue few thousend C shares like Zillow? LOL!

  3. PL
    July 21, 2015 at 10:59 pm

    HOW HIGH OIL PRICES WILL PERMANENTLY CAP ECONOMIC GROWTH For most of the last century, cheap oil powered global economic growth. But in the last decade, the price of oil production has quadrupled, and that shift will permanently shackle the growth potential of the world’s economies.

    BUT WE NEED HIGH OIL PRICES: Marginal oil production costs are heading towards $100/barrel

    HIGH PRICED OIL DESTROYS GROWTH According to the OECD Economics Department and the International Monetary Fund Research Department, a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second years of higher prices.

    Rock and hard place… no way out

    • Ben
      July 22, 2015 at 6:55 am

      It would be valuable if anybody had to give us a row analysis of oil production cost in US. Percent of labor cost, taxes, finance, rents etc?

  4. Sam
    July 21, 2015 at 11:54 pm

    Wolf: Could you comment on the following Forbes article by Michael Lynch? (The author has had close association with the oil/gas industry.)
    Shale Gas: Making Money On Every Well, Losing It At The Company Level

    • night-train
      July 22, 2015 at 4:04 am

      Not Wolf, but have some O&G experience. Mr. Lynch is talking about natural gas in his commentary, which has been pricing below $3.00 MCF. Conventional natural gas wells might make a little money at that price in shallow plays, but the much higher costs of tight sand and shale wells means most operators are probably producing gas at best at break even and most likely at a loss.

      Another point made by the author was in regard to land, or leasing costs. His analysis sounded like an accounting manipulation. As a small independent, we always included the leasing costs in the Authorization For Expenditure (AFE) for every well proposed. I am not sure what the practice is for larger operators. But leasing costs are real cash outlays and for these shale plays, the leasing costs were astronomical, in my opinion, for the likely production expected, much less actually realized.

      Perhaps the companies lease out of one pocket, drill out of a second, and operate out of a third. Not an accountant. But someone somewhere ultimately has to account for the leasing costs. Some of the early players leased huge acreage blocks with the intent of selling their undeveloped leases to larger operators at a nice profit and maybe a retained over-ride to boot.

      O&G accounting is a discipline unto itself and it would be very enlightening to hear from one on this issue. But my overall impression of the article is that it is a rah-rah piece for the shale gas industry. If we could talk oil and gas out of the rock, it wouldn’t be worth a dime, and not a silver one at that.

      • CrazyCooter
        July 22, 2015 at 9:47 am

        Thank you for posting NT. I don’t work in oil/gas, but my father and grandfather both did, so I have enough background (and have read enough) to tell when articles/information are just investor marketing hype, which is pretty much the norm these days. I feel like most information in the major outlets greatly glosses over all sorts of details to draw unrealistic conclusions.

        It is too bad TheOilDrum shut down, they were the best for that sort of stuff (and had a great comments section/community).



      • Sam
        July 22, 2015 at 11:52 am

        Thanks, NT. Forbes has another article today. Would like to see your or Wolf’s comments.
        U.S. Winning Oil War Against Saudi Arabia

        • night-train
          July 23, 2015 at 3:02 am

          Sam, I read the article posted and as Cooter put it regarding the previous one, I call marketing hype. It appeared to me to be wishful thinking ostensibly supported by semi-truths and omissions. Now, I don’t really consider myself to be a big picture guy. One of the reasons I enjoy this site is that Wolf and some other posters and commenters are. I am a humble geologist and my career involved exploration and exploitation. How and where it was marketed was not my bailiwick, although, it was impossible to completely avoid such matters.

          It appears that the author has pitted the Saudis against the US shale industry, which is somewhat like saying WWII was between the US and Germany. While that is true, so far as it goes, it leaves out a lot of important stuff. For example, Iran’s reserves and at some point more from Iraq. Another point overlooked is that conventional wells can be and are drilled with horizontal drilling technology and can benefit from same with increased production and increased primary recovery. Also, conventional oil wells benefit from secondary and tertiary recovery technology, while shale producers have yet to determine whether the formations will even respond to the enhanced recovery techniques such as water flood and gas injection.

          I am also suspect of the highly and widely vaunted increased efficiencies brought about by consolidation in the shale industry. While I would assume there is some truth to the assertion, it fails to address the “Red Queen” syndrome that Wolf has addressed in previous postings. It would take a whole lot of efficiency to account for 3 to 4 very expensive wells to produce the same amount of oil from 1 less expensive well.

          These are my main observations from the article. I am sure other readers have observations that I missed or didn’t address. But on the whole, I do find this article to be marketing to retain and bring new investors to shale producers. Always remember the First Rule of the oil industry: Never use your own money!

          Hope you find this helpful.


  5. Debtserf
    July 22, 2015 at 5:27 am

    The fracking boom really does typify our stupidity as a species.

    The sooner it ceases the better, but in vast swathes of the US it is probably too late to reverse the ecological (and geological) damage already done.

    One positive putcome of all this might be that other regions of the world will not be subjected to such damage once it is clear that the financials just dont add up.

  6. Christopher Martin
    July 22, 2015 at 10:18 am

    I keep seeing this mantra that the oil companies have so far been protected to large extent by hedges (although some were under hedged). That begs the question ‘who is paying out under these hedges and how deep must their pockets be?’ No doubt there is circle jerk of derivatives involved but there are sure to be players that get stuck with the exposure.

  7. Todd
    July 22, 2015 at 3:59 pm


    Try as a replacement for The Oil Drum.

    Rockman and a few others post on

  8. Sam
    July 23, 2015 at 10:11 am

    NT: Thanks for your insights. I agree this is a great site for information not found elsewhere – particularly about the oil/gas industry.

Comments are closed.