The energy industry is experiencing unprecedented volatility today, as oil prices had the largest single-day drop since the U.S. invaded Iraq in 1991 and company stock prices plunged, despite a 15 minute trading halt. Blame coronavirus fears that are dampening demand and Russia refusing to cut production along with OPEC to help prop up oil prices, with Saudi Arabia reportedly launching an oil price war.
In the midst of the crisis, Dan Pickering, who left Tudor, Pickering, Holt in September to launch his own independent asset management business, urged the sector – in a report titled “Energy Industry: Save Yourself” – to work toward generating more free cash by dramatically lowering spending and cutting production.
“Free cash gives companies flexibility – to acquire wounded competitors, to pay down worrisome debt, to make it through this ugly downcycle and have a chance to thrive in the next recovery,” he said.
The growth-minded companies that need to ramp down capital spending “immediately,” he said, include Exxon, Chevron, EOG Resources and Diamondback Energy. Companies spending more than their cash flows that should cut capex now: Centennial Resource and Southwestern Energy, among others.
“A more rational investment cadence will lower volumes, conserve cash and help the oversupplied market heal more quickly,” he said.
Analysts at TPH estimate the average upstream producer they cover has a cash operating cost including general and administrative expenses, interest and royalties, etc., of $17 to $22 per barrel, which would drastically compress cash flow at current prices.
“With crude below $35/bbl WTI [per barrel of West Texas Intermediate], we believe the industry should quickly shift to drop completions crews as most are on well-to-well or month-to-month contracts and wait until commodity prices rise before trying to stabilize production,” they said.
The coronavirus already has had an impact on dealmaking, with Akin Gump Strauss Hauer & Feld saying today that companies have postponed or canceled proposed cross-border transactions that were in the diligence/bidding stages.
“While earlier this year such considerations were linked to businesses that had direct or indirect links to China, it is clear that the problem has since become substantially more international, particularly given the recent downturn in global trading markets,” the firm said. “As such, we are seeing potential initial public offerings (IPOs), mergers and acquisitions (M&A) deals and private equity transactions with no particular nexus to China being impacted by considerations related to the coronavirus.”
Winston & Strawn energy partner Eric Johnson in Houston told The Texas Lawbook on Monday that the combination of the coronavirus and the feud between Russia and the Saudis “is the perfect storm of facts and circumstances” that will likely cause many current oil M&A deals to stall or die.
Johnson said greatly reduced oil prices will have an even more dramatic impact on the oil industry if they continue for several months and extend through the reserve base lending determinations done by banks starting April 1.
“If we have a real nasty revision of the borrowing base, then it would have a seriously negative impact on E&P [exploration and production] companies as well as the service companies,” he says.
If the pain on smaller and mid-sized E&P operations continues for several months, the oil companies that have been treading water for the past year will face serious financial crisis and may be forced to sell to private equity funds and strategics, which have significant cash on hand and are seeking opportunistic deal-making, he said.
Bankruptcy may be inevitable for some oil and gas companies, who were already struggling after taking on too much debt during the go-go years and are faced with depressed cash flows and limited financial flexibility to spend on drilling, analysts say.
Jefferies analyst Jason Gammel said integrated oil and gas companies will be in “survival mode” and will need to figure out where they can cut capex quickly, as the average breakeven in the sector is $55 per barrel “and the price realizations will now likely be much lower through 2020.”
As for oilfield services, Gammel said the primary impact will be felt through lower awards as projects are deferred or “pushed to the right.” He said balance sheets have been largely improved/restructured since the 2014 oil price correction for some companies but backlogs in some cases have yet to recover. And while pressure on the U.S. shale industry will ratchet up again, he believes “resilience and value still has a place.”
Bill Herbert, a longtime analyst at Simmons, which is owned by Piper Sandler, said energy stocks have already been “eviscerated” (declining by around 35% to 40% year-to-date), but given recent developments, he believes that additional “non-trivial downside” will be forthcoming.
“During the late-2014 to mid-2016 meltdown, stocks imploded by 45% to 50% – but this was when the illusion of shale vitality was alive and well,” he said. “Given the stigmatization of the industry, the redefinition of balance sheets as a result of biblical asset impairments and write-downs and the industry’s penal cost of capital, downside valuation support today is an unknown.”
“In an unfettered Darwinian market share war for oil, there is no place to hide in energy,” he added.
While the collapse is painful, TPH said a move to around $35 WTI for the rest of this year and about $40 WTI in 2021 could lead to a rollover in U.S. production.
“If demand recovers in the back half of 2020 and normalizes in 2021, a vast majority of the excess capacity that OPEC-plus has voluntarily curtailed could be fundamentally consumed,” they said. “At that point, we believe crude should tighten as OPEC will be back in the driver’s seat to control price and U.S. shale still needs $55 to $60 WTI to recover towards healthy returns.”
TPH said it’s “not rushing” to buy stocks today but its short list of defensive names remains ConocoPhillips, EOG Resources and Concho Resources and maybe Parsley Energy on the oil side. Any producer that has leverage over 2 times net debt to EBITDA at $50 WTI “should be avoided in this market,” the firm said.
On the natural gas side, TPH singles out Cabot Oil & Gas Corp., as the firm thinks natural gas prices could possibly rise to $3 per thousand cubic feet equivalent if $30 oil “has any sort of duration,” which would leave the market undersupplied.