Shale companies’ debts have been forgiven. Will investors forget?
Former drilling giants are testing their footing in the public markets after a near record number of reorganizations in 2020. It was the second-largest year for oil-and-gas producer bankruptcies—measured by debt volume—since the law firm Haynes and Boone started tracking the numbers in 2015.
Chesapeake Energy, once the second-largest natural-gas producer in the U.S., started trading on the Nasdaq last week as a shell of its former self: Its market capitalization is roughly $4 billion, a little over a tenth of what it was at its peak. Whiting Petroleum and Oasis Petroleum emerged from bankruptcy in late 2020, also at fractions of their heyday valuations. Their shares are up 59% and 65%, respectively, since they started trading after emerging from bankruptcy.
Their re-entry is well timed with oil prices back to pre-pandemic levels: U.S. benchmark oil prices are now more than $10 a barrel higher than what it costs an average U.S. producer to profitably drill a new well, and natural-gas prices are back above the $3 per million British thermal units mark, buoyed by cold weather.
Yet prime conditions can be a slippery slope for a boom-and-bust industry prone to drilling too much when prospects look up. The temptation is especially high when capital is easy to raise, as it is now with investors hungry for yield. While not many energy companies have tested the waters with new equity issues, plenty of investors are interested in buying existing shares: A broad basket of exploration and production companies have fully recovered to pre-pandemic levels. Borrowing is easy, too. Demand is sky-high for riskier bonds, a bucket that many energy companies’ debt falls into.
There are natural buffers in place that could put a brake on drillers’ return to a growth mentality. Previously burned lenders wound up with equity in reorganized companies and have a say in appointing new board members. Yet that mechanism alone isn’t enough, as companies that double-dipped illustrate. Ultra Petroleum and Chaparral Energy are among companies that filed twice for bankruptcy—once in 2016 and then again in 2020. Both have emerged from restructuring and have been taken private.
Is anything different this time around? One important change is more-conservative assumptions. When a wave of energy companies went bust in 2016, they shuffled their capital structures with the expectation that prices would bounce back quickly, as they did in the aftermath of the previous global recession, Patrick Hughes, partner at Haynes and Boone, points out. That left companies with heavier debt burdens than they could handle.
During the 2008 crash, West Texas Intermediate oil prices plunged below $40 a barrel but recovered to $60 in just six months. By 2011, prices crossed the $100 mark. But the situation was different eight years following the crash when the U.S. was producing 77% more oil using much cheaper methods. As Dan Pickering, chief investment officer of Pickering Energy Partners, notes, “We learned that the U.S. can oversupply the market.” Prices plunged to $30 a barrel in 2016 and took two years to return $60. The double whammy of the Saudi-Russia price war and the global pandemic sent prices plummeting again last year.
For now, that experience might be enough to keep companies and investors from returning to a “drill, baby, drill” mentality. So is the prospect of major exporters loosening the spigots. Saudi Arabia already plans to increase oil output in coming months, as The Wall Street Journal has reported. “We’ll have to see prices in the $50-$60 range for at least a year before a combination of companies and Wall Street are willing to think about growth again,” according to Mr. Pickering.
What hasn’t changed? Basic human psychology. When prospects look good, neither company executives nor their investors can resist growth. That is true of equity markets in general, but especially so in a depletion business like drilling, where no investment means no future returns.
In this choose-your-own-adventure story, chapter 11 remains a tough one to avoid.
This story has been published from a wire agency feed without modifications to the text.