Shale Debt Matters Most to Stock Investors as Oil PlungesOliver Renick and Isaac Arnsdorf
U.S. shale drillers may tout how much oil they have in the ground or how cheaply they can get it out. For stock investors, what matters most is debt.
The worst performers among U.S. oil producers in a Bloomberg index owe about 5.7 times more than they earn, before certain deductions, compared with 1.7 times for companies that have taken less of a hit. Operations, such as where the companies drill or how much oil versus gas they pump, matter less.
“With oil prices below $50 and approaching $40, we’re in survivor mode,” Steven Rees, who helps oversee about $1 trillion as global head of equity strategy at JPMorgan Private Bank, said via phone. “The companies with the higher degrees of leverage have underperformed, and you don’t want to own those because there’s a fair amount of uncertainty as to whether they can repay that debt.”
The biggest drop in oil prices since 2008 has spared few energy companies. The Bloomberg Intelligence North America Independent Exploration & Production Index, which includes 57 U.S. companies in the analysis as well as 17 Canadian ones, lost 55 percent since crude peaked in June, wiping out $343 billion in market value. The most-indebted producers suffered most, suggesting investors are concerned with their ability to pay back borrowers and fund future drilling.
Because shale wells deplete more quickly than conventional wells, producers need to keep drilling to maintain output. That takes debt. The companies in the index owe a combined $248.5 billion, an 86 percent increase from three years ago. Including some overseas assets, total production rose 59 percent to 13.3 million barrels a day in that time, data show.
West Texas Intermediate crude, the U.S. benchmark, fell as low as $45.90 a barrel on Monday, the lowest since April 2009 and down 57 percent from as much as $107.73 on June 20.
“These types of things wouldn’t be a problem if oil were $85, but now you really have to think about that,” said John Fox, director of research at Cobleskill, New York-based Fenimore Asset Management Inc., which oversees $2 billion.
Among the 57 U.S. companies in the index -- which excludes one that was acquired and one that’s part of a utility, as well as the Canadian companies -- the average ratio of net debt to earnings before interest, taxes depreciation and amortization was 3.7.
“Heavily indebted companies have the highest probability of either having to sell assets or raise equity if things don’t get any better, and that’s the one thing a company doesn’t want to have,” said Christopher Beck, senior vice president at Philadelphia-based Delaware Investments, which manages about $180 billion. “It gets to be a very tricky proposition for them.”
Among the worst-performing stocks are Energy XXI Ltd., down 89 percent since June 20, and Resolute Energy Corp., down 90 percent. Energy XXI has five times more net debt than Ebitda. Resolute has net debt of $735.8 million while posting a loss of $41.7 million before interest, taxes, depreciation and amortization in the last year.
“We get it,” H.B. Juengling, Resolute’s vice president of investor relations, said in an interview. “It’s debt. It’s obvious.”
Resolute borrowed $150 million last month to help withstand the downturn, Juengling said. The Denver-based company has old oilfields that are cheaper to maintain and don’t deplete as quickly as those of shale-focused rivals, he said.
A spokesman for Houston-based Energy XXI wasn’t immediately available to comment.
Cabot Oil & Gas Corp. and Occidental Petroleum Corp., both based in Houston, have fared relatively better. They earn more than they owe, data compiled by Bloomberg show. Cabot, down 15 percent since June 20, and Occidental, down 25 percent, are among the best performers among their peers.
“If you’re in the industry long enough you know there are cycles and you want to be able to manage through them,” said George Stark, a Cabot spokesman, in an interview.
Having more cash than debt “positions us well in this volatile price environment,” Melissa E. Schoeb, Occidental’s vice president for communications and public affairs, said in an e-mail.
Options traders, however, are positioning for a rebound. Contracts on energy companies in the S&P 500 are signaling more hope for a rally than in any other primary group in the index apart from materials stocks. On average, there are 0.9 bearish puts outstanding for every bullish call contract on energy companies, according to data compiled by Bloomberg.
Some companies have used derivatives to shield their income in coming months. Among 39 U.S.-based companies in the index whose hedging was analyzed by Wells Fargo Securities LLC, the worst-performing equities hedged 59 percent of their 2015 oil production, compared with 35 percent for the companies that fell less than the median.
“The worst-case scenario is being highly financially levered and unhedged,” said Stephen Clark, Boston-based senior vice president and portfolio manager at Standard Life Investments, which oversees $422 billion. “The more debt you have, the worse your stock has done.”