Oil col­lapse couldn't come at worse time for in­dus­try

The Pak Banker - - INTERNATIONAL BUSINESS/SPORTS -

The US energy in­dus­try was lick­ing its wounds when oil re­cov­ered to the $60 level in April. Now, with the price of a bar­rel back in the $40s, the in­dus­try mood is dark, with an out­look for lower oil prices well into next year, mean­ing more shelved projects, deeper cost cuts and tighter-than-ex­pected fund­ing.

Fund­ing is the life blood of U.S. energy sup­ply, as it pro­vides cash flow for an in­dus­try that needs to make cap­i­tal ex­pen­di­tures in or­der to make money. A cut­back in fund­ing could mean less drilling, which is bullish for the price of oil, but neg­a­tive for com­pa­nies seek­ing to gen­er­ate cash flow.

That makes the price of oil the wild card-and all the more im­por­tant as fall ap­proaches. Oc­to­ber is when bank lenders per­form a bian­nual re­view of the loans and re­volv­ing credit they make avail­able to ex­plo­ration and pro­duc­tion com­pa­nies, par­tic­u­larly those in the high-yield space. But be­cause of the sharp drop in crude prices and weak out­look, banks are look­ing more broadly at their ex­po­sure across the in­dus­try. And for a small uni­verse of the riski­est names, credit lines could be re­duced or cut­off.

"We're in a new reg­u­la­tory world for banks. They have less flex­i­bil­ity to be for­giv­ing, less abil­ity to be flex­i­ble, so pro­duc­ers are go­ing to feel the fi­nan­cial pres­sures. The ma­jors, with their cut­backs in in­vest­ments, are gird­ing for a pe­riod of lower prices, not nec­es­sar­ily in the $40s, but they're pre­par­ing for a more bear­ish out­look for oil," said Daniel Yer­gin, vice chair­man of IHS. "Com­ing out of the sec­ond quar­ter earn­ings, the out­look is more bear­ish at least into 2016."

Daniel Pickering, co-pres­i­dent of Tu­dor, Pickering, Holt and Co., said he does not ex­pect the in­dus- try to take a big hit in terms of bor­row­ing abil­ity this Oc­to­ber, but the weaker com­pa­nies could feel the pinch.

"The com­bi­na­tion of the low prices and debt, that can be a tsunami. Debt in and of it­self is not that big a deal if the price is medi­ocre. It's a much big­ger deal if the price is bad, and a much big­ger deal if the price is bad for a long time," he said. "If it goes to $30 and is sit­ting at $30 in Oc­to­ber, that could be very mean­ing­ful. Oil at $45 is pretty mean­ing­ful. Oil at $60 is not that mean­ing­ful."

Pickering said that as far as oil pro­duc­tion goes, the fund­ing cut- back this fall should af­fect only a trickle of U.S. out­put. The next re­view, in April, could be much more im­pact­ful, ex­perts say.

The drop in oil has slammed com­pa­nies from Exxon to the smaller names in the high yield space. None have been spared the pain of a sharp re­ver­sal in crude, and ma­jors like Royal Dutch Shell (Lon­don Stock Ex­change: RDSAGB) and Chevron (NYSE: CVX) are putting aside fu­ture in­vest­ment and shav­ing costs. Chevron has frozen its div­i­dend, and Shell, re­port­ing lower earn­ings, said last month it was cut­ting back in­vest­ment and lay­ing off 6,500 work­ers.

The oil sec­tor has been pun­ished in the mar­kets, with the big­gest names, rep­re­sented by the S&P energy sec­tor, down al­most 30 per­cent in the past year. Ac­cord­ing to UBS, the earn­ings of up­stream energy names in the sec­tor were down 74 per­cent in the sec­ond quar­ter, re­flect­ing the dra­matic re­duc­tion in energy com­mod­ity prices.

But some smaller com­pa­nies that are heav­ily de­pen­dent on lever­age, such as Mid­States Petroleum (NYSE: MPO). have seen even more dra­matic declines in the mar­ket. Mid­States' stock fell from the $70s last sum­mer to un­der $3, and its debt was re­cently trad­ing at less than 40 cents on the dol­lar.

The ma­jor­ity of bor­row­ing in the oil patch has been in the cor­po­rate debt mar­ket. While there are plenty of in­vest­ment-grade com­pa­nies, E&P com­pa­nies com­prise about 7 per­cent of the high-yield debt mar­ket. About 41 per­cent of that is dis­tressed, ac­cord­ing to Michael Con­topou­los, head of high-yield strat­egy at Bank of Amer­ica Mer­rill Lynch.

If the price of oil re­mains at cur­rent low lev­els, de­faults could go from a cur­rent pace of 10 per­cent in the energy sec­tor to 20 per­cent, he said.

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