John Dizard for the FT: “You would think, what with the recent oil price crash, the people who finance US oil and gas producers would have learnt their lesson. But not yet.”
“For the past several years, and despite the once again widening gap between capital spending and cash flow, Wall Streeters have stepped in like an overindulgent parent to pay for the producers’ drilling habit. “Isn’t he cute!” they exclaim, as an exploration and production boy crashes another budget. “So talented! Did you see how many frac stages he can do now, and how tight his well spacing is?”
Of course the exploration and production companies and their lenders have been to expensive accounting therapy sessions, where the concerned Wall Street family, accompanied by the sullen E&P operators, are told that they have to make a really sincere effort to match finding, drilling and completion expenditures to internally generated cash flow. Everyone promises the accountant that that irresponsible land purchase or midstream commitment was the last mistake. From now on, cash flow break-even.
By now, though, there is an astonishing amount of debt that continues to build up on the smaller E&P companies’ balance sheets. According to Gavekal, the research group, even before the oil price plunge, aggregate debt-to-equity ratios in the smaller publicly traded energy companies are now at 93 per cent, up from around 70 per cent in 2012 and 2013, and around 50 per cent between 2005 and 2011. This in a highly cyclical industry that used to go through periodic banker-driven shakeouts and even bankruptcies.
Particularly in the gas and natural gas liquids drilling directed sector, every operator (and their financier) is waiting for every other operator to stop or slow their drilling programmes, so there can be some recovery in the supply-demand balance. I have been hearing a lot of buzz about cutbacks in drilling budgets for 2015, but we will not really know until the companies begin to report in January and February. Then we will find out if they really are cutting back, using their profits on in-the-money hedge programmes to keep their debt under control, and taking impairment charges on properties that did not really pay off.
One gas-orientated industry man in Houston I know thinks that the banks are going to call a halt to the madness of permanent negative operating cash flows. “What is the timing of their borrowing base renegotiations (with the banks)? That is the most important thing; can they borrow more money?” If not, he believes drilling and producing on uneconomic terms will slow or stop, and with the high depletion rates of unconventional reserves, such as shale gas, supplies will fall and gas prices will rise.
Then, the hope goes, if gas is selling for around $6 per mBtu or more, those who have not bet large amounts of other people’s money will finally be able to make an honest buck. Another freezing winter in the northeast and Midwest, with a temporary jump in spot gas prices, will not be enough to get the gas-directed E&P companies back on to the path of positive, or at least break-even, cash flows. Prices need to rise on what they call “the back end of the strip”, that is, futures prices going out two or three years.
The cliché about the hydrocarbon business is that the cure for low prices is low prices, meaning that excess production should lead to insolvencies, cutbacks in activity and eventual price recovery for the rational, hardy survivors. But in the US in 2014, that does not seem to be happening. If the bankers reduce the borrowing base for the E&P companies, there could be a lot of private equity or high-yield investors with covenant-light deals to offer who might take their place. Not to mention cash-rich majors who would like to take the billions they can no longer put into Russia or Venezuela, who would not mind picking up more North American properties on the cheap.
It is not enough to find the cash to bail out the feckless E&P drilling addicts. So much gas is being developed in the Marcellus and Utica resources of the northeastern US that it really cannot be absorbed by the US market. Suzanne Minter, manager of oil and gas consulting at Bentek in Denver points out: “Over the next five years, daily production in the US is forecast to grow by more than 16bn cubic feet per day, with about 10bcf of that coming from the northeast. Of that, at least 8.5bcf has to be exported. Domestic demand does not grow enough.”
To make that work, there are a whole bunch of pipelines, processing plants and export terminals that will need to be built quickly, and for that to happen, there may have to be better co-operation between Congress, the White House and the Environmental Protection Agency. Also, there is probably a bit of a mismatch in the US labour force; perhaps it would be possible to retrain our excess political commentators and media studies lecturers as welders and fitters. Otherwise, with all the pipes and plants on drawing boards, the US could run into large-project delays such as those plaguing Australia.
However, if the permits are stamped with approvals, and the labour force can be conjured up, it appears that Wall Street is willing to finance the facilities needed to export the excess natural gas and natural gas liquids. US gas and gas liquids prices are low enough to take share in world markets, even with the extra processing and transportation costs. So if natgas and NGL producers can hold on until 2018 or 2019, they may survive into old age.
Even long-time energy industry people cannot remember an overinvestment cycle lasting as long as the one in unconventional US resources. It is not just the hydrocarbon engineers who have created this bubble; there are the financial engineers who came up with new ways to pay for it.”
Future Today
