Many doubted its ability to weather a sustained period of low oil prices, but the US shale sector has come out of the glut stronger. Melodie Michel reports.
A year and a half ago, GTR published an article about how US shale companies could hope to position themselves on the global oil stage, and stressed structural issues that could affect their future.
At the time, there were concerns about the high debt levels of the major players, which, combined with what was considered by many as inefﬁcient cost models, were giving cold sweats to many investors. Sure enough, the prolonged oil glut and limited bank willingness to give companies leeway has led to a signiﬁcant wave of producers going bust.
Law ﬁrm Haynes & Boone has been tracking North American energy bankruptcies since January 2015, and its latest report dated September 2016 counted 58 cases this year alone, representing about US$50.4bn in cumulative debt. This is added to the 42 companies that folded last year, and despite the recent oil price recovery, the ﬁrm expects more ﬁlings by the end of 2016.
According to Doug Getten, a partner in the securities and capital markets practice at law ﬁrm Paul Hastings, what has made the difference between success and failure is geography. “Companies that are focused on the Permian and Delaware basins have weathered this incredibly well. If you’re in Bakken shale [located mostly in North Dakota], those operators require higher oil prices for their business to work,” he tells GTR.
“I’m working on a restructuring right now so I have a list of exploration and production (E&P) companies that have ﬁled for bankruptcy over the course of the last year, and at the bottom you have Triangle Petroleum, which is Bakken shale, Sandridge and Breitburn are Mid-Continent. It depends on where you are, so when you think about US shale you have to look at the different subsets of the different basins in the country.”
According to him, Eagle Ford and Northern Louisiana shale should recover along with oil prices, which bodes well for some of the local operators that ﬁled for bankruptcy earlier in the year and are now emerging from the episode with a better-balanced cost structure – think Goodrich Petroleum.
While not all companies have survived, those that have managed to weather the crisis have had to change their ﬁnancing practices. Paul Hastings, for example, has worked on a lot of liability management transactions, where, Getten explains, a company may try to capitalise on the trading prices of its public debt, trading at less than par in exchange for a second security.
“We worked on rescue capital deals for public companies where alternative lenders would go in and lend money on a second-lien basis. Midstates Petroleum did a debt-for-equity swap as part of its bankruptcy. The market was previously encouraging most upstream E&P companies to take on debt versus selling equity to ﬁnance their activities, because the market generally doesn’t want to see dilution. Many companies had a lot of debt and that was a lot of the uncertainty, but there have been many liability management transactions that have gone on to get balance sheets right-sized and restructured,” he says.
Thomas Pugh, a commodities analyst at Capital Economics, is impressed by the way the US shale sector has handled the crisis. “I think it’s been surprisingly resilient. I don’t think anybody expected them to be able to cut costs and raise efﬁciency as dramatically as they have done – that’s been the most impressive thing. Every month, efﬁciency increases, costs are cut down. Production has fallen, but by nowhere near what you would have anticipated given the fall in prices and in drilling rigs. It really is a story of how in desperate times, people will ﬁnd a way to adapt,” he tells GTR.
The OPEC effect
A turning point in the shale sector’s recovery was the September 2016 OPEC meeting in Algiers, during which the oil ministers of the various member countries announced an intention to cut output in an effort to revive prices. The news sent oil prices over the US$50-a-barrel threshold, and shale producers lost no time in reopening their taps: oil ﬁeld services ﬁrm Baker Hughes counted 432 US oil rigs on October 14, up from 418 on September 23 (before the announcement).
These companies were now keeping the oil price around the US$50 mark at the time of writing, preventing it from rising along with the hype around the November OPEC meeting, where a plan on how to cut output was expected to be announced.
“The minute the prices rose above US$50, there were reports of a surge in hedging by shale producers for the rest of this year and next year. Even at US$50, plenty of them will be quite proﬁtable. There’s a lag of about three months to get production up and running, so OPEC might enjoy a small window of higher prices, but US production is consistently increasing,” Pugh explains.
Shale companies are not the only ones that are bullish about the sector’s prospects: after a few years of very low activities, investors are once again excited by the opportunity. In October, Denver-based Extraction Oil & Gas was the ﬁrst energy company to run an initial public offering (IPO) in two years and the results were outstanding: the ﬁrm sold 33.3 million shares for US$19 apiece. The shares ended their ﬁrst day of trading up 15% at US$21.85 on October 12, valuing the company at about US$2.4bn.
The IPO sent a message to the market, and is set to be followed by many more. “Right now a lot of companies are in dual-track processes, where you have a private company that’s big enough and has scale to go public, and it’s a question of whether they choose to access the capital market and execute an IPO, or sell to another public company through an M&A deal,” says Getten.
He adds: “I think there’s a lot of companies that aren’t just prepared for an IPO but have taken the afﬁrmative steps of conﬁdentially ﬁling for IPO with the Securities and Exchange Commission as an emerging growth company. I think there’s probably a pretty long list lining up to try to execute their IPO offerings in Q1 2017.”
Going public would bring many beneﬁts to shale companies that have to deal with oil price volatility: instead of being limited to bank or alternative lender debt, they could access the high-yield bond and equity capital markets. “You have more tools in your toolbox as a CFO at a company that’s public,” says Getten.
According to that logic, the more shale companies go public, the more resilient the sector will be in the future. This could give shale producers more weight on the global oil scene. In a Forbes column in October, energy consultant David Blackmon wrote that the shale “cartel” was the only one that mattered anymore: “Regardless of what OPEC does or does not ultimately agree to at its next formal gathering in late November, the mid and long-term impact on the global price picture for crude oil will depend almost entirely on how the US shale cartel responds.”
According to Pugh, shale producers will always be different from OPEC as they are not homogeneous and are purely interested in making a proﬁt, “whereas OPEC [members] will do all sorts of shenanigans to maximise their own market share into their rivals whilst talking up the market”.
But he concedes that if most shale companies continue to increase output for a prolonged period, the resulting downward pressure on price could lead to another power play with OPEC, where OPEC could even be forced to cut output the way it did during the oil price crisis of the 1980s. Whether that happens or not, the shale market is set to become more significant.