From the Midwestern plains, through the valleys of Switzerland, to the red dust of the Australian desert, a giant sucking sound is reaching a deafening roar.
In crude terms, oil and gas producers and miners make their living by sucking stuff out of the ground. But they can’t do that if capital is being sucked out of the industry -- as it is now.
Exhibit A is Glencore, the commodity marketer-cum-miner whose stock has morphed from a play on trading smarts into a pinata for sell-side analysts. With its stock down 70 percent this year and default insurance premiums on its debt having soared past those of even Brazilian miner Vale, there is now talk of Glencore potentially taking itself private again.
Glencore is not alone in scrambling for capital. Alcoa announced a split this week that clearly favors the downstream manufactured products division, taking the chief executive and targeting a higher credit rating -- they even called it “Value-Add Co.,” in case investors missed the point. In contrast, legacy Alcoa will take the clearly less-loved upstream operations that actually mine bauxite, refine alumina and smelt aluminum.
On the same day, Royal Dutch Shell gave up on its Arctic exploration effort after sinking $7 billion into it. The oil major blamed a dry hole. But the need to conserve cash with oil below $50 a barrel and its dividend yield above 8 percent is the essential context here.
These war stories illustrate a broader crisis as investors and lenders back away. Even relatively stronger companies have tasted rejection. After Glencore’s stock plummeted on Monday, diversified giant BHP Billiton saw its Australian shares drop 6.7 percent, despite being an objectively stronger credit. Exxon Mobil, with a credit rating many sovereign issuers would envy, is trading at close to its highest dividend yield since the merger that formed the modern company.
New equity issuance from the oil, metals and mining sectors has dried up. On a trailing four-quarter basis, these sectors accounted for 10.1 percent of all new share sales in the current quarter, the lowest since mid-2004, data compiled by Bloomberg show.
That revulsion is mirrored in the credit markets. “The commodities crunch is what will define summer and fall 2015, if not the whole year” for the high-yield market, says Matt Fuller of S&P Capital IQ, who adds that primary issuance for the sector “is completely shut in.”
U.S. energy sector high-yield bonds now yield almost six percentage points more than the broader market, compared with just one percentage point a year ago. And there are real signs of contagion. In a report published on Tuesday, analysts at CreditSights noted that investment-grade utility bonds had become correlated with broader energy bonds, despite most utilities having minimal exposure to oil prices.
Even the merger market looks subdued given the fire-sale prices out there. On a trailing four-quarter basis, energy, metals and mining targets are running at about 10 percent of global M&A volume, data compiled by Bloomberg show. Deal activity has been stuck at around that level since late 2013 and compares with a range of 15 percent to 20 percent between 2009 and 2013.
There is a silver lining for some. With apologies to Warren Buffett, when the tide of liquidity goes out, anyone selling swimming trunks can command a premium. Those with capital available should be able to capitalize.
An obvious candidate is Exxon, whose stock is down by a relatively mild 20 percent over the past year, compared with the broader exploration and production sector’s 43 percent. With its triple-A credit rating, the oil major should be scooping up assets while they’re cheap. Stymied long-term growth plans in Russia provide the motivation.
And while Exxon isn’t immune to investors’ concern -- as that dividend yield indicates -- it has critical advantages over its peers. First, it has historically relied more on buybacks than other oil majors, so it can rein in shareholder payouts more easily while preserving sacrosanct dividends. Fortuitous timing on project start-ups means Exxon also has more flexibility on its capital spending budget, in marked contrast to rival Chevron. The latter is forecast to have negative free cash flow this year, to the tune of $9.3 billion. Exxon, meanwhile, is forecast to generate $5.7 billion, more than Shell and BP combined.
The dark horse could be private equity, which ought to be feeling like a payday lender for suffering commodity producers now. Buyouts in the oil, metals and mining sectors are running at about $7.8 billion so far this year, data compiled by Bloomberg show. That suggests 2015 will be the biggest year since 2012, but still less than half of 2011’s $23.6 billion. If private equity is cautious, it likely reflects that earlier spree and the beating volatile commodities prices can dish out to even storied investors (see KKR).
Like nature, though, markets abhor a vacuum, and capital will step forward eventually to fill it. The bounce-back may take longer than after the financial crisis, given the centrality of China, the world’s commodity consumer-in-chief, to the current bout of anxiety. But, as was ever the case, the current phase of miners and drillers downing tools for want of cash will be the precursor to tomorrow’s tighter commodity markets -- and the next up cycle.