OPEC's Real Challenge Is Far Bigger Than Shale

Investors keep funding its rivals, and the cartel just encouraged more.

Shale? OPEC is competing with something far bigger and harder to tame: U.S. capital markets.

The morning after the night before in Algiers, Chesapeake Energy announced a private placement of $850 million in 10-year convertible notes. Chesapeake, which pioneered the shale-gas land-grab strategy before 2008, is better known these days for its creative efforts to chip away at its debts. The placement's timing may be an accident, of course. But I'm going to go out on a limb and suggest maybe not.

Why? Here are Wednesday's top 10 performers in the SPDR S&P Oil and Gas Exploration and Production ETF:

Jump Day

Top 10 performers in the E&P ETF on what was a big Wednesday for the sector

Source: Bloomberg

Note: Performance on September 28th, 2016.

Apart from the obvious, these 10 have another thing in common: less-than-pristine balance sheets. The highest-rated company, Murphy Oil, is rated BBB- by Standard & Poor's and has a high-yield rating from Moody's. The others are all firmly in junk territory. Chesapeake's stock, incidentally, was only the ETF's 15th-biggest gainer on Wednesday, rising just 8.7 percent. And it gave all of that back on Thursday morning on news of the convertible.

OPEC's market-share strategy of the past 2 years, led by Saudi Arabia, was supposed to work like this: Maximize the amount of lower-cost OPEC barrels on the market and displace the higher-cost oil being produced by the likes of some U.S. shale drillers. And it was working, though not as quickly as had been expected. In part, that's because E&P firms did all they could to stretch their resources: squeezing suppliers, targeting their best rocks, firing workers, selling assets and tweaking their drilling methods to boost production.

All those efforts would have been for nothing, though, if they hadn't been underwritten by U.S. bond buyers and shareholders. From the start of 2015 through spring of this year, U.S. E&P companies raised around $50 billion of new debt, according to Sanford C. Bernstein.

Meanwhile, they've sold just over $40 billion of new shares since the start of 2015, according to Bloomberg data; that's more in the past 21 months than in the prior three years (when oil averaged $95 a barrel).

If you really wanted to make money off the sector this year, it paid to pick up the trash:

Junk Rockers

Stocks and bonds of junk-rated E&P companies have outperformed this year

Source: Bloomberg, Bloomberg Gadfly analysis, CreditSights

Note: Performance indexed to 100. High Yield E&P Stocks Index is a custom, market-cap weighted index of Antero Resources, Chesapeake Energy, Continental Resources, Concho Resources, Denbury Resources, EP Energy, Murphy Oil, Newfield Exploration, Oasis Petroleum, Range Resources, Whiting Petroleum.

In finally blinking, by deciding in Algiers to cut production -- and until we see tangible cuts at OPEC's next meeting in November, it is just a blink -- OPEC has revived the prospects for the weakest of its competitors to tap capital markets for more money to drill for more oil that, as of now, isn't really needed.

Apart from boosting the prices of stocks and bonds of rivals, OPEC's move has already had a tangible effect in the oil market. Energy economist Phil Verleger points out that open interest in the the three main crude contracts rose by the equivalent of 111 million barrels between Wednesday and Thursday. If they stay, putting those barrels into storage, then that is the equivalent of raising global oil consumption by 0.1 percent this year -- which sounds small but, done in less than 24 hours, amounts to "one heck of a buying spree," as Verleger puts it.

We may never know what havoc a different result from Algiers may have wreaked on an E&P sector straining to cope with low prices and potentially facing a loss of faith on the part of its benefactors. As it stands, OPEC has just helped to keep that relationship alive.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Liam Denning in New York at ldenning1@bloomberg.net

    To contact the editor responsible for this story:
    Mark Gongloff at mgongloff1@bloomberg.net

    Before it's here, it's on the Bloomberg Terminal.