US indies batten down the hatches
The sector is largely relying on balance sheet resilience to outlast the downturn. But without an imminent oil price recovery the threat of bankruptcy looms large
Oil market pundits have been prophets of doom even since first unconstrained supply and then coronavirus-related global demand destruction cratered prices. The collapse of Whiting Petroleum into bankruptcy was seen as ominous, even before negative WTI prices at the end of April significantly increased gloominess.
Company results for the first quarter are now gradually trickling in, showcasing the extent of the financial damage and preparing investors for the remainder of a gruelling operating year.
Almost uniformly, firms have taken similar measures to protect their balance sheets. Hedging strategies are delaying heavy financial losses and producers have cut capex budgets to the minimum.
Production guidance has similarly been hacked back and continues to be monitored. Consultancy Rystad Energy estimates US oil curtailments will rise from 256,000bl/d in April to almost 900,000bl/d in June. A second peak in Covid-19 infections also risks a return to strict lockdowns in the US and Europe, which in turn would severely affect global oil demand and potentially trigger further cuts.
“The oil price crisis and the impact of Covid-19 has resulted in the most dramatic collapse of the US land rig market in history” Abramov, Rystad
Weathering the storm
Permian producers are bearing the brunt of the cuts. In June, around 42pc of US curtailments will take place among pure play Permian-focused firms. US shale is particularly at risk due to companies struggling to find available storage space and lack of adequate midstream takeaway capacity.
Reduced output has sent the US rig count plummeting. Since the middle of March, the count has dropped by 54pc and could fall even further if oil prices remain low. “The oil price crisis and the impact of Covid-19 has resulted in the most dramatic collapse of the US land rig market in history,” says Artem Abramov, head of US shale at Rystad.
And while everyone is cutting back costly production, some US indies lead the pack. EOG Resources aims to reduce output by 225,000bl/d across May and June, amounting to a 23.5pc share of its total output for Q1. The producer announced net income of $10mn for the quarter against $635mn over the same period in 2019.
Not far behind, Continental Resources has committed to lowering output by 70pc in May, a total volume of 141,000bl/d. The firm posted a net loss of $185.7mn for the quarter compared with $186.9mn in net earnings during Q1 2019. Other notable companies with additional curtailments in the second quarter include Occidental Petroleum, Ovintiv and Noble Energy.
Investor confidence in US indies was low even before the financial impacts of the Covid-19 pandemic and oil price collapse became apparent. The S&P Oil & Gas Exploration & Production Select Industry Index lost 60pc of its value between October 2018 and February 2020 even though WTI crude fell by only 30pc.
Current economic conditions are considerably more challenging and will depress the sector’s investor appeal much further, especially given there is no obvious timeline for a recovery in the demand for or price of oil.
900,000bl/d – US cuts forecast in June
Many firms have already flagged financial fears. Extraction Oil & Gas, California Resources, Chaparral Energy and Chesapeake Energy have all hired financial advisers, while Callon Petroleum, Highpoint Resources, Lonestar Resources and Oasis Petroleum announced doubts about their ability to continue as going concerns in their latest filings.
Chesapeake withdrew its financial outlook for the year after posting a net loss of $8.3bn for Q1. The company has seen the value of its shares tumble by over 90pc since January. “The most high-profile US independent under the threat of bankruptcy is obviously Chesapeake,” says Hillary Cacanando, senior vice president, equity and fixed income research, at US bank Odeon Capital Group. “They will likely breach their leverage covenant by October and have prepaid incentive compensation to their top 21 executives to incentivise them to remain at the firm for the next 12 months.”
Deferring the inevitable?
While most firms are likely to hold off bankruptcy in 2020 due to strong hedging and adequate liquidity, the situation for many will substantially change if the downturn extends into next year. “If oil prices remained very low as hedges roll off, companies with strained liquidity and near-term debt obligations are the most likely candidates for bankruptcy,” says Leo Mariani, energy analyst at US broker-dealer NatAlliance Securities.
“The most high-profile US independent under the threat of bankruptcy is obviously Chesapeake” Cacanando, Odeon Capital Group
Continental Resources, which has hedged nothing in 2020, is relatively safe only because of its low-cost structure and strong liquidity. But the producer has $1.1bn in bonds due in 2022, making the firm more susceptible to financial stresses if oil prices fail to recover, Mariani adds.
Producers with limited access to external capital over the near-term will be ever more reliant on their existing liquidity for survival. Similarly, long-term bank credit may be more challenging to obtain, with credit-facilities often being asset-backed, determined largely by oil prices.
Extraction Oil & Gas saw its revolving credit facility lowered from $950mn to $650mn during Q1. While many firms have limited bond maturities to pay off in the near-term, if oil prices remain at their low levels into 2021 then access to credit and to options for refinancing maturities will likely dry up and increase the prospect of widescale bankruptcies.
And while some firms may want to offload unwanted assets to boost their balance sheets, interest from potential buyers may be difficult to find given market conditions. “We are not expecting widespread M&A because potential acquirers are also struggling and would have a hard time justifying a large deal to their boards,” says David Meats, senior equity analyst for US investment researcher Morningstar. The reaction to the big Occidental deal last year, in which the company purchased fellow US independent Anadarko Petroleum, spooked many management teams, he adds.
Top of the tree
But some US indies stand out for their strong financial position. EOG, Pioneer Resources, Concho Resources and Talos Energy are all in good shape due to their robust cash flow and minimum long-term commitments. “I think that having a fortress balance sheet is so important in this market,” says Cacanando. “Producers that have no or minimum debt are best positioned to endure the severe economic conditions.
$55/bl – US shale breakeven
Talos notably posted $157.7mn in net income for Q1 compared with a $109.6mn loss over the same period the previous year. “As prices declined in the second half of the quarter, our strong hedge began to provide material cash flow benefits, helping to sustain strong Ebitda margins of over 80pc,” says Talos CFO Shannon Young.
Other companies that stand out for their strong liquidity and little near-term maturities include Diamondback Energy, Continental Resources and Cabot Energy.
Sailing into the unknown
However, the crucial factor affecting long-term bankruptcies will be the speed and breadth of the oil demand recovery as well as potential structural changes caused by Covid-19 to the global economy.
Morningstar estimates that annual oil demand will drop by around 1.2pc over the next five years if working from home becomes the new norm. If there is a deep economic recession and the global economy loses 5pc annually in GDP then oil demand will decline by a further 5pc each year. Assuming both scenarios play out, it forecasts an oil price still around $40/bl in 2025.
With the current US shale breakeven at around $55/bl, this would require further efficiency gains and cost-cutting beyond the reach of most operators. “US shale operators were already prioritising high efficiency development before this year's downturn. We do not think operators will be able to (sustainably) eke out even more efficiency gains in response to the lower prices,” says Meats. “The low-hanging fruit is gone.”