Dan Pickering has seen a thing or two in his 30-plus years in the oil and gas industry. He’s worked at ARCO Alaska, energy-focused investment bank Simmons and Tudor, Pickering, Holt, which he started in 2004 with former Goldman Sachs investment bankers Bobby Tudor and Maynard Holt.
This past fall, he left to start his own asset management firm, Pickering Energy Partners. The Texas Lawbook caught up with him after the markets closed Monday, which saw a dramatic drop in oil prices and energy stocks due to disagreement between Saudi Arabia and Russia over production cuts. He offered his views of what it all means plus how it will affect dealmaking.
Q: What a depressing day for oil and gas stocks. How would you characterize it? And how does it compare with previous market shocks?
A: That’s the best place to start. The last time OPEC changed course, it was 2014. We went from $100 oil to $80 oil, then over 18 months to below $30. Now we’ve gone from the high $40s to the low $30s in two days. It’s been dramatic, driven by what happened in 2014 and 2016 and an overall market environment that’s more risk adverse. It was brutal. We’re still in the same downturn, we’ve all seen the playbook, it will force the industry to deal with this more quickly. The industry is running sensitivities, how much to scale back and how quickly. And I think that compared with 2014 to 2015, that scale back will be more meaningful and quicker. Hopefully companies protect themselves while demand comes back into balance.
Q: How long could it take?
A: If we assume that Saudi Arabia and Russia don’t come back to the table and resolve their differences, it’s going to take a couple of years. Saudi’s back in the market and Russia will produce a little bit more. We [the U.S.] were already a couple of million barrels out of market and the coronavirus made it worse. The shock absorber is going to be supply from U.S. shale. It’s going to contract significantly; those volumes will come down over 18 months.
Q: What if the Saudis and the Russians do go back to the table and resolve things?
A: For the U.S. industry, the non-OPEC oil business, this is a jarring wakeup call. The world can change really fast when supply and demand are artificially managed via production cuts by OPEC. Let’s pretend they resolve differences next month: You’ll still see a retrenchment in the business by non-OPEC players. You have to prepare for a riskier environment.
Q: Those companies with cash and free cash flows will certainly benefit from optionality, including paying down debt and making acquisitions. Who is the strongest and could pick up some bargains? Who is the weakest and might be targeted?
A: You have to segment the market. You have small cap, terminally impaired companies with too much debt. And whether they’re gone now or later, they’ll be gone in this oil price environment. You’ll have the untouchables because of balance sheet or assets or both. Then you have the strong players on the top – Exxon, Chevron and ConocoPhillips – and a few others with good balance sheets – EOG, Diamondback, Concho and Pioneer. The untouchables might merge with each other and the strong players may end up merging together.
Then there’s the everyone else category, which is going to be really dependent on who would fit where. Oxy [Occidental Petroleum] would fit in that category. It took on debt for the Anadarko acquisition that made it scary. You also have Devon, Apache, WPX and Continental [Resources]. They might merge with each other or might be a target from the stronger players.
Then there’s the question of fit, valuation and timing. It will be hard for folks to do deals in the next three or four months because there are so many moving parts. What will oil prices do? What will your potential partner will do? It will take a settling period, and then maybe you get a few deals, and then if the world starts to get better, you’ll get a lot of deals. Everyone is going to start filling out their dance cards over the next three to six months, then they’ll scramble to get their partner. At $30 oil, it might be too scary, but at $40, they might be afraid of losing their dance partner.
Q: Will the fallout lead to a spike in bankruptcies in the oil and gas sector? If so, when do you think we’ll see those?
A: Forget about stock prices right now. There’s a panic, a liquidity-driven “sell what you can,” an anxiety-driven “sell what I own.” I don’t know that what stocks did today and what debt did today was that efficient, but with oil at $30, there are companies that have too much debt and won’t make it. Does it mean they’ll file immediately? Not necessarily. Debt maturities start in 2021 or 2022, so the banks aren’t going to be coming. The spring redeterminations [for bank credit] will be ugly. Some companies have cushion on their revolvers. But if oil stays at these levels this year and next, there will be lot of Chapter 11’s and restructuring.
Q: Who might be in that group?
A: Pick any name and run a screen where stocks are trading at less than $2 or bonds are trading at 60 cents or below. While $2 is a pretty arbitrary number, it’s a pretty good screen for distress.
Q: Could Oxy be in distress?
A: Oxy is a big company with a lot of assets and a lot of levers to pull. The risk to Oxy is the amount of debt they have and the timing. They may never have the potential to be the company they wanted to be. The levers they would have to pull might negate that from happening.
Q: So will Oxy’s acquisition of Anadarko go down as the worst deal ever?
A: In hindsight, it’s hard to see how it’s a good deal. But it’s also the best deal Chevron didn’t do.
Q: So are you telling clients to jump back into the market? Or wait and see how things shake out?
A: There are a lot of dislocations in the market right now but there are a lot of good values right now. You dip your toe in the water and do your work. Like Warren Buffett says, it doesn’t matter what time you pick a stock if you pick it for the long run. If you’re buying good companies at low prices when markets are panicking, there are some good opportunities. They might get a little bit better. A value buyer should get involved here, but you don’t want to shoot all of your bullets at once.
Q: Could conditions get worse?
A: If $30 oil goes to $25 and hangs around for a while, if the coronavirus lasts a year rather than two quarters, if the world goes into recession and oil demand doesn’t grow for a while, stocks would go lower.
Q: Would Conoco be in your buy column?
A: Yes, Conoco, along with Chevron, EOG and Diamondback. Could these stocks go lower? Absolutely. But these companies are going to be around over the long haul. Some of them have good assets but don’t need to drill them. They can save the money, put it in their back pocket for strategic moves down the road or give the money to shareholders and grow when the environment is better. These assets aren’t going anywhere, most everything is leased in shale these days. So what’s the harm in waiting a little bit? This won’t be Diamondback’s and other companies’ only activity reduction. They will scale back several times per year.