Turmoil in the US shale industry

December 2015  |  FEATURE  |  SECTOR ANALYSIS

Financier Worldwide Magazine

Few sectors have experienced as tumultuous a time in recent years as the energy fraternity – a period of turmoil which has seen oil & gas prices plummet and traumatised shale producers in the US. Once upon a time, US shale companies looking to capitalise on the shale boom found raising capital by selling debt or equities to be a relatively straightforward endeavour. But with the price of oil & gas currently stagnating, the industry has been struggling. As a consequence of the strain, defaults have become commonplace, with approximately 20 companies forced to take this unhappy road in 2015 so far.

In September 2015, vice president of Fearn Oil, Michael Moore, claimed that oil prices lower than $30 would “cause mass debt defaults and bankruptcies of US shale companies.” He also warned that in order for shale companies to stay operational, the price for crude oil would need to reside above $50.

For so long seemingly immune to the effects of the global economic downturn, the US shale industry, including its top plays, is under pressure. Although its head is still above water, times are changing with the industry currently finding itself at something of a crossroads.

Are the good times over?

Any attempt to characterise the current health of the US shale industry more often than not tends to result in a view couched in doom-laden terminology, putting forth the belief that the industry’s days of relatively easy capital raising have irrefutably come to an end. Rightly or wrongly, true or not, what is certain is that the industry is going through a troubling and testing time. “The shale industry has been critically impacted by depressed commodity prices,” notes Brian Schartz, a partner at Kirkland & Ellis. “That decline has impacted firms’ bottom line as well as their ability to continue or expand drilling programmes.”

That said, the decline in the price of oil did not immediately impact the availability of capital. “Throughout the spring and early summer, we saw firms raise significant amounts of debt capital, frequently on a secured basis priming existing unsecured bondholders,” confirms Matt Pacey, a partner at Kirkland & Ellis. “But, as commodity prices have stayed low, this debt has traded poorly and finding new-money investors has become more difficult. We do have the sense that some distressed investors are waiting for the market to ‘hit bottom’, so we wouldn’t be surprised to see a modest uptick in new investment to the extent some believe that has occurred. However, we expect it to be at higher prices than we saw in the spring.”

Cash and liquidity will continue to be one of the main problems, with firms obligated to spend on interest payments or principal while simultaneously needing to cut their capital expenditure programmes. Furthermore, as firms lay down rigs, they begin to see declines in production and cash flow as natural production declines are no longer offset by new wells coming on line.

Easing the strain

In terms of the methods available to help ease the strain, many strategies, such as reducing capex and sales of non-core assets, are already being deployed by shale companies. However, these tools ultimately lead to a reduction in cash flow and, in some cases, amplify borrowing base reductions due to reduced reserves.

“A number of firms are pursuing asset level transactions such as drilling joint ventures and de-levering transactions such as debt-for-debt exchanges, but those tools have limits,” says Mr Schartz. “As banks face increasing regulatory pressure to minimise exposure to bad assets, upcoming borrowing base redeterminations are likely to significantly reduce liquidity for many operators.”

US shale industry: future health

With the International Energy Agency (IEA) forecasting that global oil prices will continue to fall in 2016 due to decreased demand, the short-term future of the US shale industry seems ominous at best. Further defaults and a downsizing of the industry are likely scenarios. “We expect the market will continue to be distressed through at least 2016,” says Mr Pacey. “As a result, the economics of a particular basin and the quality of a company’s acreage within that basin will be key.” An additional burden for the industry is that companies with business plans that are contingent on oil at $70 or $80 per barrel are going to find themselves with a number of difficult decisions to make.

On a more positive note, companies that complete restructurings early and have strengthened their balance sheet may be in a position to take advantage of acquisition and growth opportunities. This may benefit the market as a whole at some point in the future by, for example, reducing overall debt and facilitating potential efficiencies through consolidation.

Although claims that US shale production is effectively moribund are likely to be construed as wide of the mark, it does appear that the industry’s halcyon days are over and there is a need for reinvention.

© Financier Worldwide

BY

Fraser Tennant