The Creditors are Coming

(Also on as “Shale Oil Companies Beware, Your Day Of Reckoning May Be Here“)

The day of reckoning for America’s shale oil producers finally may be just around the corner. After surviving for nearly a year on crude oil prices too low to cover operational costs, the Wall Street financiers that have kept firms alive with lines of credit, generous financing, and deferred interest payments are getting ready to call in the loans.

Federal regulations dictate that creditors must re-evaluate the worth of the companies they actively loan money to twice a year – in June and October. Last June, oil was trading for around $60/barrel. October is coming and oil prices are just pushing $45/barrel. This is bad news for oil companies, many of whom have unflattering balance sheets and could find their loans labeled “troubled.” Once a loan is marked “troubled” by the Office of the Comptroller of the Currency (OCC), a bank must set aside additional capital to cover the credit risk. This is basically the kiss of death for an energy firm, because it destroys the likelihood of securing any further financing from national banks.

How are energy companies responding?

  • Raising as much cash as they can by selling assets. W&T Offshore Inc. is putting a Texas shale-oil field up for sale for only $376.1 million. This is half of what it was valued at last year. Still, this cash would only benefit the company marginally, as its $600 million line of credit has already been cut twice this year. In July, Comstock Resources sold assets in Burleson County, Texas, and Austin Exploration is on the hunt for buyers for a 5,000-acre oil and gas property in the same region. Look for other assets like pipelines, natural gas fields, and even idling oil rigs to go on sale at cut-rate prices.   Private equity firms will be the first to snatch them up.
  • Selling shares to raise cash. The Wall Street Journal reports that publicly trading firms in the U.S. and Canada have raised $21 billion by issuing shares this past year. RSP Permian Inc. raised $232 million this way over the summer, and Encana Corp., and Noble Energy Inc. got a jump on reducing their debt early in 2015 by issuing shares in February and March and raising $1 billion each. But this avenue seems to be drying up as offerings slowed to a trickle in August. Investors should be cautious with firms that are currently looking to raise capital in this way. The healthier firms already took advantage of this strategy earlier in the year.
  • Negotiating with creditors ahead of the October review. Halcon Resources Corp., which has already lost 90% of its market value since 2014, renegotiated its agreement with creditors over the summer, but it had to relinquish a stake in its oil and gas assets and accept 13% interest rates in exchange for some debt forgiveness. Yes, 13%! SandRidge Energy has refinanced $525 million in debt, but has approximately $4 billion of outstanding loans. Magnum Hunter Resources Corp, after defaulting briefly this summer, arranged for a fifth extension with its lenders. These companies are in bad shape. A successful renegotiation with a creditor might give them a positive headline, but these moves are just bandages designed to stave off default a little longer in hopes of a sale or other fortuitous events.

All of this sounds like doom and gloom for the energy sector, but it really is not. Investors and lenders can learn a lot right now about which companies will thrive. How and when shale-oil companies deal with their debt is key to predicting which companies will survive in an era of low oil prices, and which companies will not. Firms that ignored many of the experts last winter and anticipated a long-lasting downturn in crude prices already moved to pay down debt, consolidate loans, or raise capital earlier. Those prescient firms are now much better positioned to weather the coming credit crunch. On the other side of the equation, private equity firms are now approaching a feast of oil asset opportunities that could offer the potential for quick turnarounds.