When money was growing on trees even for junk-rated companies, and when Wall Street still performed miracles for a fee, thanks to the greatest credit bubble in US history, oil and gas drillers grabbed this money channeled to them from investors and refilled the ever deeper holes fracking was drilling into their balance sheets.
But the prices for crude oil, US natural gas, and natural gas liquids have all plunged. Revenues from unhedged production are down 40% or 50%, or more from just seven months ago. And when the hedges expire, the problem will get worse. The industry has been through this before. It knows what to do.
Layoffs are cascading through the oil and gas sector. On Tuesday, the Dallas Fed projected that in Texas alone, 140,000 jobs could be eliminated. Halliburton said that it was axing an undisclosed number of people in Houston. Suncor Energy, Canada’s largest oil producer, will dump 1,000 workers in its tar-sands projects. Helmerich & Payne is idling rigs and cutting jobs. Smaller companies are slashing projects and jobs at an even faster pace. And now Slumberger, the world’s biggest oilfield-services company, will cut 9,000 jobs.
It had had an earnings debacle. It announced that Q4 EPS grew by 11% year-over-year to $1.50, “excluding charges and credits.” In reality, its net income plunged 81% to $302 million, after $1.8 billion in write-offs that included its production assets in Texas.
To prop up its shares, it announced that it would increase its dividend by 25%. And yes, it blew $1.1 billion in the quarter and $4.7 billion in the year, on share buybacks, a program that would continue, it said. Financial engineering works. On Thursday, its shares were down 35% since June. But on Friday, after the announcement, they jumped 6%.
All these companies had gone on hiring binges over the last few years. Those binges are now being unwound. “We want to live within our means,” is how Suncor CFO Alister Cowan explained the phenomenon.
Because now, they have to.
Larger drillers outspent their cash flows from production by 112% and smaller to midsize drillers by a breathtaking 157%, Barclays estimated. But no problem. Wall Street was eager to supply the remaining juice, and the piles of debt on these companies’ balance sheets ballooned. Oil-field services companies, suppliers, steel companies, accommodation providers… they all benefited.
Now the music has stopped. Suddenly, many of these companies are essentially locked out of the capital markets. They have to live within their means or go under.
California Resources, for example. This oil-and-gas production company operating exclusively in oil-state California, was spun off from Occidental Petroleum November 2014 to inflate Oxy’s share price. As part of the financial engineering that went into the spinoff, California Resources was loaded up with debt to pay Oxy $6 billion. Shares started trading on December 1. Bank of America explained at the time that the company was undervalued and rated it a buy with a $14-a-share outlook. Those hapless souls who believed the Wall Street hype and bought these misbegotten shares have watched them drop to $4.33 by today, losing 57% of their investment in seven weeks.
Its junk bonds – 6% notes due 2024 – were trading at 79 cents on the dollar today, down another 3 points from last week, according to S&P Capital IQ LCD.
Others weren’t so lucky.
Samson Resources is barely hanging on. It was acquired for $7.2 billion in 2011 by a group of private-equity firms led by KKR. They loaded it up with $3.6 billion in new debt and saddled it with “management fees.” Since its acquisition, it lost over $3 billion, the Wall Street Journal reported. This is the inevitable result of fracking for natural gas whose price has been below the cost of production for years – though the industry has vigorously denied this at every twist and turn to attract the new money it needed to fill the holes fracking for gas was leaving behind.
Having burned through most of its available credit, Samson is getting rid of workers and selling off a big part of its oil-and-gas fields. According to S&P Capital IQ LCD, its junk bonds – 9.75% notes due 2020 – traded at 26.5 cents on the dollar today, down about 10 points this week alone.
Halcón Resources, which cut its 2015 budget by 55% to 60% just to survive somehow, saw its shares plunge 10% today to $1.20, down 85% since June, and down 25% since January 12 when I wrote about it last. Its junk bonds slid six points this week to 72 cents on the dollar.
Hercules Offshore, when I last wrote about it on October 15, was trading for $1.47 a share, down 81% since July. This rock-bottom price might have induced some folks to jump in and follow the Wall-Street hype-advice to “buy the most hated stocks.” Today, it’s trading for $0.82 a share, down another 44%. In mid-October, its 8.75% notes due 2022 traded at 66 cent on the dollar. Yesterday they traded at 45.
Despite what Wall-Street hype mongers want us to believe: bottom-fishing in the early stages of an oil bust can be one of the most expensive things to do.
Paragon Offshore is another perfect example of Wall Street engineering in the oil and gas sector. The offshore driller was spun off from Noble in early August 2014 with the goal of goosing Noble’s stock price. They loaded up the new company with debt. As part of the spinoff, it sold $580 million in junk bonds at 100 cents on the dollar. When its shares started trading, they immediately plunged. By the time I wrote about the company on October 15, they’d dropped 68% to $5.60. And the 6.75% notes due 2022 were trading at 77 cents on the dollar. Then in November, Paragon had the temerity to take on more debt to acquire Prospector Drilling Offshore.
Two days ago, Moody’s downgraded the outfit to Ba3, with negative outlook, citing the “rapid and significant deterioration in offshore rig-market fundamentals,” “the high likelihood” its older rigs might “not find new contracts,” and the “mostly debt-funded acquisition” of Prospector Drilling. The downgrade affects about $1.64 billion in debt.
Today, Paragon’s shares trade for $2.18, down another 61% since October 15. Its junk bonds are down to 58 cents on the dollar.
Swift Energy – whose stock, now at $2.37, has been declining for years and is down 84% from a year ago – saw its junk bonds shrivel another eight points over the week to 36 cents on the dollar.
“Such movement demonstrates the challenging market conditions for oil-spill credits, with spotty trades and often large price gaps lower,” S&P Capital IQ LCD reported.
It boils down to this: these companies are locked out of the capital markets for all practical purposes: at these share prices, they can’t raise equity capital without wiping out existing stockholders; and they can’t issue new debt at affordable rates. For them, the junk-bond music has stopped. And their banks are getting nervous too.
Their hope rests on cutting operating costs and capital expenditures, and coddling every dollar they get, while pushing production to maximize cash flow, which ironically will contribute to the oil glut and pressure prices further. They’re hoping to hang on until the next miracle arrives.
“We are not panicking,” is how a bank CEO responded to the fact that loans to energy companies made up 20% of the bank’s loan portfolio. Read… How Wall Street Drove the Oil & Gas Drilling Boom That’s Turning into a Disaster
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“(Slumberger) had an earnings debacle. . . . its net income plunged 81% to $302 million, after $1.8 billion in write-offs that included its production assets in Texas.
To prop up its shares, it announced that it would increase its dividend by 25%. And yes, it blew $1.1 billion in the quarter and $4.7 billion in the year, on share buybacks, a program that would continue, it said. Financial engineering works. On Thursday, its shares were down 35% since June. But on Friday, after the announcement, they jumped 6%.”
When investors see blood in the streets it’s the signal to buy. They are betting on a quick rebound of the price of oil. But that’s probably a sign that there isn’t nearly enough blood in the streets yet.
These buyers are looking at the price of oil during the 2008-2009 financial crisis, when it dropped by 75% in half a year, but made a quick v-shaped recovery accompanied by stocks and every other asset after the Fed started its QE program.
The bet is that this will happen again and the Fed will start QE4 to further inflate asset prices and transfer wealth rather than allow the oil patch to go bust. But that is not a bet I would make just yet. Even if the Fed did start QE4, the chances are that new money right now would avoid oil and gas assets and be deployed elsewhere. !
Exactly, well said
Unless the fed starts buying barrels of oil and burning them. That’s the only solution that would work.
I’m a new reader who is enjoying your bracing cynicism. Although, like the lefty economic sites I’ve visited, it doesn’t really help with investment decisions. Maybe I should be buying diamonds and hiding them in the toilet tank? I certainly won’t be following my broker’s advice to buy the dips.
I did get a personal twinge from your description of cataclysmic job losses in the oil and gas industry. My niece and her husband live in Houston. He was pink slipped from a consulting firm that services fracking operations right before Christmas (natch). With a new baby they have to decide whether to stay or go from a city that may soon resemble the Rust Belt.
“Thrift is a form of class warfare against the wealthy … who borrow their fortunes and thereby require circulating money to flow to them so that their stupendous debts might be serviced: the non-wealthy are the support for the tycoons. By saving, the non-wealthy deny the tycoons funds, the tycoons are ruined by their own creditors, the creditors are likewise ruined.”
Sorry to hear about your niece and her husband. I’m starting to hear those stories quite a bit now.
The good thing is, oil busts don’t last forever. Well…. Houston has always recovered from them. But Tulsa – once called the “oil capital of the world” – got hit very hard in the bust of the 1980s and never really recovered.
I think you’re right. Oil busts don’t last forever, and H-town is not going to start losing companies. They will just tighten belts until the price recovers (how long that will be is anyones guess). I think real estate will come down making it harder for people out of work to relocate, but Houston is one of the most overpriced markets in the US right now (on an affordability scale) so that probably needs to happen anyway.
These boom and bust cycles in the job market will keep home ownership low for the foreseeable future. No one has a secure job or knows where their next job will be. Texas was the place to go for a good job, until it wasn’t.
How is the price going to recover?
– If the nominal price per barrel increases so will nominal costs to drillers – they all use the same dollars! This currency multiplier effect is amplified by forex volatility, the ‘New Bully’ on the block. Overseas’ drillers’ costs in some ‘Brand X’ currency will likely be even higher than the US costs in dollars … so watch oilcos overseas try to get their hands on dollars!
– If the real price per barrel increases it would be on account of purchasing power accruing toward retail customers away from drillers. The flow is always toward drillers because they are large businesses and can gain cheap credit by using themselves as (ahem) ‘collateral’. Customers cannot do this (they have no collateral, only stupid, suicidal willingness to waste capital without a care in the world).
If purchasing power flows toward customers the drillers don’t get the funds they need to drill => no more marginal oil => shortage => creeping insolvency and less demand b/c shortages affect customers more than they affect drillers => lower price in a vicious cycle. This is called ‘energy deflation’ once it takes hold there is no escape from it.
Keep in mind, ALL money is nothing more than an (empty) claim on purchasing power. The oil price in the oil market speaks like a God: the folks who must buy gasoline and other oil company products have much less purchasing power. People don’t do without gasoline because they don’t want to (unless they are like me, I like Italian hill towns I hate cars).
Read ‘Wolf Street’ about Japan and forex losses there due to Abenomics and the clueless Bank of Japan. This guy Richter really knows his stuff (he clearly knows that the loss of purchasing power in Japan is why the oil price has crashed, leading to ripple effects around the globe). Marginal fuel customer is Japanese …
BTW, any shortages caused by unaffordability are permanent.
I have a different take on this oil bust. It’s unlike the others, for a number of reasons, and this is why I don’t think the conventional wisdom of cycles applies here.
Saudi Arabia has explicitly stated they are doing this to remove marginal players, so they won’t be satisfied until that’s done. Some would say they’re bluffing. I don’t think so, because with demand falling and expected to fall for a long time, it’s not in their best interests to prop up the price by cutting production. They would be sacrificing their revenues so higher cost producers could survive. I don’t blame them for their stance, why should they subsidize marginal players?
Then you have the irony of all producers making that same logical decision, and even being forced to increase production due to being cash strapped, thereby putting further oil on the market and more pressure on the price.
Toss in the massive debt of shale, their short life spans, and the inability to get the product to a larger market(keystone), and you’ve got a situation like no time in US history.
Nope, this ain’t no boom bust cycle, this is a different animal altogether.
The destruction of capital is permanent. The upswing in each business driven cycle does not erase those losses. It is simply compounding the future problem by creating more malinvestment. Eventually this system will lead to a total collapse and those who pay the price, those who suffer from the ensuing violence, will not be those who made the debt. This is how civilizations and empires end.
I think this is the end of the oil and gas boom, or at least for now. The weaker players with wind up and the cycle will start again.
Mary I think we’re all in the same boat. This globally connected fiat currency mess is in uncharted territory, the place on the map that says “here there be dragons”. My wife has several wealthy friends we keep in touch with, and they are battening down hatches for a big blow, and are in the PMs and cash, as are we. Far be it from me to give financial advice. The fact is there are very few places TO invest these days. The banks are preparing for something shady to the point you can’t pull more than $3000 dollars of your own money out of the bank without signing a statement as to what you plan to do with it. Good luck with your quest. My wife and I are commited to the path we’ve chosen, but no one can summon the future. Grandich commented a couple of weeks ago that Bulls and Bears each have their day, but Pigs get slaughtered.