Key to Surviving the Oil Bust: Beware Bankers Bearing Cheap Debt

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Why Markets Care About Oil’s Sliding Fortune
  • Just saying `No' to easy money made Diamondback a winner
  • Diamondback one of just four producers that gained in 2015

During the go-go days of $100 oil, bankers swarmed into Travis Stice’s office in downtown Midland, Texas, trying to sell him on the wonders of easy credit.

QuickTake Oil Prices

He didn’t bite, not even when equity analysts groused that Diamondback Energy Inc. would grow a lot faster if he’d just spend more of other people’s money.

“We had bankers with wheelbarrows of cash that were coming up the elevator saying, ‘Hey, here’s debt, take it on,’" said Stice, chief executive officer of Diamondback.

Today he heads one of the best-performing oil producers in the country. Diamondback rose 12 percent last year while crude fell 30 percent. Moody’s Investors Service raised the company’s credit rating in 2015, one of only 10 oil and gas firms to earn that distinction. It’s vindication for a company that resisted the junk-bond binge that fueled many competitors.

“In hindsight, it really looks like a good decision," Stice said. "Had we not done that, we would be parked with a lot of debt on the balance sheet right now, and quite honestly, we might not be able to survive.”

Of the 61 members of the Bloomberg Intelligence North America Independent explorers and producers index, Diamondback is among just four that gained last year. The others were PDC Energy Inc., Newfield Exploration Co. and Parsley Energy Inc. They all avoided loading up on cheap debt.

During the boom, investors poured money into shale. While the high-yield bond market doubled in size from 2004 to 2014, the amount issued to exploration and production companies grew 11-fold to $112.5 billion, according to Barclays Plc.

“The high-yield debt markets were pretty benign and people weren’t expecting prices to fall the way they did,” said Arvinder Saluja, a senior analyst with Moody’s.

High crude prices made the traditional methods of measuring an oil company’s debt burden misleading, Saluja said. Earnings swelled as crude prices rose, making drillers appear healthy even as ballooning debt left them increasingly vulnerable to a downturn. Saluja looked instead at retained cash flow compared with how much companies had borrowed.

By that metric, a handful of producers stand out. Along with Diamondback, there’s Pioneer Natural Resources Co., EOG Resources Inc., Matador Resources Co. and Cimarex Energy Co., according to data compiled by Bloomberg from third-quarter 2015 financial statements.

“The best-performing E&P stocks have the rare combination of production growth and low net debt with little to no outspending,” said David Beard, managing principal of Coker & Palmer, a Jackson, Mississippi-based company offering securities brokerage and financial planning services.

West Texas Intermediate oil for March delivery rose $1.11 on Tuesday to close at $31.45 a barrel on the New York Mercantile Exchange.

Selling Oil

PDC Energy, a company focused on developing the Wattenberg field in northern Colorado, ticked all those boxes. It was one of only 16 companies in the Bloomberg Intelligence index to earn more selling oil and gas than it spent on drilling in the third quarter, according to data compiled by Bloomberg. The company was the top performer last year, gaining 29 percent.

Newfield, which gained 20 percent, owed its success to its shale acreage in southern Oklahoma, said CEO Lee Boothby. The company raised money by selling equity instead of debt, and its total debt at the end of the third quarter was 17 percent lower than the year before.

“Our focus on the debt side has been pay down debt,” said Boothby. “It was just a smart financial move and it sets us up well for weathering the storm.”

PDC didn’t respond to several calls and e-mails seeking comment.

Parsley CEO Bryan Sheffield said the company’s Wolfcamp well performance helped the company see 40 percent production growth in 2015.

Saying ‘No’

Saying no to debt is a lesson Stice learned at the start of his career during the bust of the 1980s. He still keeps a stack of 30-year-old job rejection letters. He figures there are about 40. Finding a job wasn’t easy for a newly minted petroleum engineer in 1985. Oil was plummeting and wildcatters all over town were selling their planes and boats, even pulling their children out of expensive private schools.

If that downturn is a guide, only the companies that avoided debt during the boom will survive as oil dips below $30 a barrel, he said.

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“When you have an experience like that as a young man in your 20s, it makes you debt-averse,” says Stice. “When oil was $100 a barrel, everyone looked like a genius.”

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