North America’s small and mid-sized energy companies are searching for creative ways to stay afloat as investors smell blood in the water from the almost 60 percent fall in the price of oil since June.
Oil and natural gas companies are straining for solutions before cuts in credit lines and increases in lending rates hit home in April, when banks re-price the collateral used to secure revolving credit lines. Some are turning to more creative forms of financing as familiar sources of money dry up.
That financing is coming from hedge funds, private equity shops and mega-wealthy investors like billionaire Carl Icahn who have the cash to weather a prolonged downturn and are on the hunt for deals among the wounded, bankers and analysts say. Oil operators, meanwhile, are laying off staff, freezing salaries and deferring investments to conserve cash.
“Companies have lived in a state of outspending cash flow, and the markets have facilitated that,” said Gregory Sommer, who runs energy investment banking at Deutsche Bank AG in New York. “But if prices persist at this level, you’re going to see some companies pulling back significantly” more than they already have.
Eclipse Resources Corp. turned to private equity investors in December after the cost to issue unsecured debt to fund capital spending became prohibitively expensive, according to Matthew DeNezza, the company’s chief financial officer.
“Traditional, high-yield debt markets were not available” at reasonable prices, DeNezza said in a telephone interview. “The debt markets were closed to us.”
Shares of the State College, Pennsylvania-based driller have fallen by 77 percent since it raised $818 million in its initial public offering on June 20, when U.S. oil prices were $107 a barrel. In a deal announced three days before the new year, Eclipse sold $325 million in additional equity to its largest investor, EnCap Investments, and brought in extra money from private-equity firm KKR & Co. to help fund drilling operations in 2015, DeNezza said.
Private equity investors, he said, can look past the market turmoil and “take a longer term view of what these assets are really worth.”
The firms have already raised $15 billion for general energy investing in recent years. Carlyle Group LP, Apollo Global Management LLC, Blackstone Group LP and KKR are raising billions more for new funds created in the past few months to invest in distressed oil producers.
Blackstone, in addition to closing a $4.5 billion energy fund this month, is asking its clients for more than $1 billion for two new energy funds to buy bonds of troubled oil producers and to provide rescue financing, a person with knowledge of the plans said last week.
“It will take companies 1 1/2 years to really get into a lot of trouble, but for some of the service companies it’s just going to happen very, very quickly,” Steve Schwarzman, Blackstone’s chief executive officer, said on a Jan. 29 investor call. “You’re going to see all kinds of shakeouts over the period of a year to three years.”
Traditional bond investors, meanwhile, are demanding increasingly higher yields as sentiments swing wildly away from the easy capital flow of recent years. Energy companies tapped into $550 billion in new debt and loans between 2010 and late 2014, according to Deutsche Bank data, money not easily rolled over after the oil price rout.
At least three mid-sized energy-related borrowers, including C&J Energy Services Inc., postponed financings late last year as the market turned against them.
Small energy producers “are effectively shut out of the debt markets. They’re priced out. You can’t raise money at any reasonable terms,” Sean Sexton, who oversees oil and gas research at Fitch Ratings Ltd. in Chicago, said in an interview.
Research firm CreditSights Inc. projects the default rate for energy junk bonds will double to 8 percent this year. The costs to insure energy company debt against default has also soared -- even for some of the biggest and healthiest conglomerates like Exxon Mobil Corp. and Chevron Corp., whose credit default prices have already doubled since September.
Energy XXI Ltd.’s bankers agreed in August to waive a potential violation of the Houston-based oil company’s revolving lending agreement after its earnings tumbled and leverage rose. The prices of bonds due for repayment in 2017 have plummeted to 56 cents on the dollar on Jan. 29 from about 108 cents in June. At the same time, the yields paid to investors have surged to almost 35 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Analysts and bankers say the oil price collapse marks more than just a technical market correction. It signifies a fundamental shift in the industry that will result in a new normal featuring fewer operators and smaller profit margins as revenues shrink and financing costs rise.
Fitch, JPMorgan Chase & Co. and others on Wall Street predict oil prices, when they rebound, will probably settle at somewhere around $75 a barrel. Goldman Sachs Group Inc. President Gary Cohn, a former oil trader, predicted Jan. 26 that prices could first fall to $30 a barrel.
The United Steelworkers union, which represents employees at 200 refiners, pipelines and chemical plants, stopped working Sunday after failing to agree on a new labor contract -- sending oil prices above $50 a barrel earlier today. West Texas Intermediate oil prices, the benchmark used in U.S. trading, rose 2.8 percent Monday to $49.57 a barrel on the New York Mercantile Exchange.
For prices to stabilize, companies and countries will have to pump less oil, but few want to be the first to reduce output and risk losing the international game of chicken.
Saudi Arabia, which traditionally reduces production when supply outstrips demand, has refused to take the hit, as have other members and non-members of the Organization of Petroleum Exporting Countries. U.S. oil output rose to 9.21 million barrels a day as of Jan. 23, the most since 1983, according to preliminary data from the U.S. Energy Information Administration.
Need for Revenues
“People are a little surprised at the production that was positive out of Libya and Iran and Iraq and some other places,” JPMorgan CEO Jamie Dimon said on a Jan. 14 conference call. “A lot of people need oil revenues.”
While U.S. consumers stand to see a short-term gain from lower energy costs, smaller oil producers and their suppliers know the blood in the water is theirs. They are divesting assets, cutting spending and seeking backup financing to stay in operation.
Midstates Petroleum Co., for instance, spends about $1.15 drilling for every $1 it earns. The Houston-based oil operator, with $1.67 billion of total debt outstanding, is at risk of violating its lending agreements with prices below $50 a barrel, according to Spencer Cutter, a Bloomberg Intelligence analyst. Moody’s Investors Service lowered the company’s credit rating Jan. 26 on $1.3 billion in bonds and warned that the risk of defaulting on those payments has risen.
The price of Midstates’ bonds that mature in 2021 has plunged from 110.5 cents on the dollar in early July to 53 cents last week while investors demand yields of about 24 percent, making it impossible for the company to issue new unsecured debt, Cutter said.
Midstates has used about 70 percent of a $525 million credit line with a consortium of lenders, including Goldman Sachs, Capital One Financial Corp. and the Bank of Nova Scotia, and may need to raise extra capital come April when the lenders reprice its collateral, Cutter said. Calls to Midstates Chief Financial Officer Nelson Haight were not returned.
Linn Energy LLC is also among those seeking new survival strategies.
Linn cut its payout to investors, sold two properties to raise a combined $2.3 billion in cash and took out an additional $500 million in credit last month from GSO Capital Partners, the lending unit of private-equity firm Blackstone.
Based in Houston, the oil and gas partnership has seen its market value plunge from $10.7 billion in June to $3.4 billion on Jan. 30. It has already drawn $2.5 billion on a $4 billion credit line from a consortium of banks led by Wells Fargo & Co. Chief Financial Officer Kolja Rockov didn’t return a call seeking comment.
Like Linn, a lot of energy producers actually owe investors more than the company is worth. When Eclipse Resources decided to forgo issuing new and costly debt to conserve cash, it also cut capital spending for 2015 by 20 percent, CFO DeNezza said. “People across the board are slowing down their operations,” he said.
It’s a vicious cycle. The drop in oil prices will reduce cash flow for producers, prompting them to spend less money exploring and drilling new wells. That will, in turn, exacerbate the drop in revenues, profits, market value and liquidity, analysts and bankers say.
It’s a “double-whammy,” said John T. Young, who manages the Houston, Dallas and Los Angeles offices for corporate restructuring firm Conway MacKenzie Inc.
Oil companies, which are demanding steep price reductions, are also paying their bills late and lengthening cash-flow gaps for drilling and equipment firms, according to Young. “The second quarter is going to be devastating for the service companies,” he said. “There are certainly companies that are going to die.”