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Oil slick
Fields of green
Second wind
Who will buy the bargains?
The energy industry, like the rest of the economy, is suffering from
the double whammy of lower commodity prices and sapped credit. Oil
prices have fallen 70% from a record high of $147 per barrel in July to
a four-year low of less than $33 per barrel in January. Natural gas
prices have performed even worse, plummeting from a high of more than
$13 per thousand cubic feet equivalent this past July to less than $5.
By the end of January, rig counts in the U.S. had declined by 25% since
their peak in September, to 1,515. At the same time, credit has
disappeared from ailing and gun-shy banks, forcing oil and gas
companies to cut capital budgets and lay off staff.
Last month, Houston oil services giant Schlumberger Ltd. announced it would let go 5,000 employees, or 6% of its workforce around the world. ConocoPhillips
followed suit, saying Jan. 16 it would cut its capital budget by 18%,
to $12.5 billion, and lay off 4% of its workforce, or 1,350 people. It
recently reported a $31.8 billion loss in the fourth quarter of last
year.
Smaller oil and natural gas companies are also struggling. The debt
markets have slammed shut for many of them, and analysts are concerned
that several companies will trip their loan covenants this year,
including Forest Oil Corp., Chaparral Energy Inc., Berry Petroleum Co., Energy Partners Ltd., Petro Resources Corp., ATP Oil & Gas Corp., Crimson Exploration Inc. and Parallel Petroleum Corp. "It really feels like the 1980s," an investor relations chief at a large exploration and production company said recently.
If oil and gas prices continue to stay low and credit remains tight,
oil and gas companies may find themselves so strapped for cash that
they'll start filing for bankruptcy. Indeed, bankruptcy attorneys say
they began getting calls in November from creditors worried about
getting paid by potential debtors. They say the calls haven't stopped.
"When you have a lack of credit and cash flow goes way down, you
need to have bridge borrowing, and it's not there," says Rhett
Campbell, a bankruptcy attorney at Thompson & Knight LLP in Houston. "How long can you last?"
The current situation is certainly not without precedent. Oil
pioneers such as Clint Murchison Jr., T. Cullen Davis and the Hunt
Brothers were all forced to file bankruptcy in the 1980s, when they
found themselves overextended during the worst recession in 50 years.
As Bryan Burrough documents in his new book, "Big Rich: The Rise and
Fall of the Greatest Texas Oil Fortunes" (Penguin Press), conservation,
a deteriorating economy and competition from other fuels such as coal
and nuclear power cut deeply into oil demand in the '80s, causing drill
bits in Texas to "whir to a halt." Wildcatters across the state who had
borrowed heavily to drill expensive, deep wells saw the value of their
collateral fall. Loans were called in, and companies either limped into
shotgun weddings (as was the case with George W. Bush's company, Bush
Exploration Co.) or filed for bankruptcy. "How do you get a Texan
oilman out of a tree? Cut the rope," was the joke floating around
Dallas at the time.
The oil industry is obviously not yet at that dire point. But a few
companies have already succumbed to Chapter 11. Tulsa oil purchaser and
transporter Semgroup LP led the bunch last summer, buckling
under margin calls against losses of $2.4 billion in the company's
trading accounts on the New York Mercantile Exchange. (Harvey Miller
and Michael Kessler at Weil, Gotshal & Manges LLP are debtor counsel.)
Privately held natural gas exploration and production company CDX Gas -- owned in part by TCW Group Inc. -- filed for bankruptcy Dec. 12 to restructure its debt with lenders and resolve liquidity issues after Credit Suisse Securities (USA) LLC and Jefferies Randall & Dewey failed to find a buyer for the company. (It's represented by Harry Allen Perrin of Vinson & Elkins LLP.)
Then came Flying J Inc. The privately held Ogden, Utah,
exploration, refining and marketing company filed Dec. 22, blaming a
liquidity crisis brought on by plunging oil prices and margin calls by
lenders. (It's represented by Paul Basta of Kirkland & Ellis LLP in New York.)
It's just the start, many bankruptcy attorneys say. "As energy
prices have declined and access to capital continues to be constrained,
we are seeing the beginning of a softening in the energy sector," says
Sylvia Mayer, a bankruptcy partner at Weil Gotshal in Houston. "This is
particularly true for those companies that have near-term debt maturity
or interest payments and/or looming covenant defaults due to the drop
in prices or decreased demand. Barring a surge in energy prices that is
sustainable, I expect the restructuring demands in this sector to
increase."
Plunging oil prices have certainly been the culprit in those cases,
and demand predictions don't promise a better future for commodity
prices.
Cambridge Energy Research Associates Inc., or CERA, expects
global oil demand to fall by 300,000 barrels per day this year, while
the International Energy Agency predicts a fall of 500,000 barrels per
day -- which harks back to the 1980s. That's a big switch from the
beginning of 2008, when analysts projected that demand would grow by
2.1 million barrels per day this year.
"The oil price was driven to its oxygen-short heights last summer by
the 'demand shock' that came from five years of strong economic growth
and was fueled further by geopolitics, oil field costs, financial
markets and trading, and psychology," wrote Daniel Yergin, the head of
CERA and author of the Pulitzer Prize-winning book "The Prize: the Epic
Quest for Oil, Money & Power," in a recent report (the book was
recently reissued in paperback with a new epilogue). "The oil market is
being shaken mightily by a recession shock -- and not just a recession
shock for oil, but for all energy markets and industries, both
conventional and alternatives and renewables."
Companies can sell assets to boost liquidity, like Oklahoma City oil explorer Chesapeake Energy Corp. has done by selling rights to various packages of oil and gas properties to British oil giant BP plc, Norway's StatoilHydro ASA and Tulsa, Okla., billionaire George Kaiser for almost $10 billion.
But right now, analysts and dealmakers say companies can't get
anywhere near what their properties are worth and potential buyers
can't get the financing to buy them, so many are having to wait until
commodity prices increase or the credit markets loosen up.
There's still not much credit out there, either, especially now that
some investment banks have become banks with tougher lending
restrictions. "We're doing some plain-vanilla deals, but we're more
careful now that we've been approved to become a bank," said one such
banker on the sidelines of the IPAA conference. The debt markets for
energy companies appeared to thaw, however, with Chesapeake's
announcement Jan. 28 that it plans to issue $500 million in long-term
debt to pay off some of its bank debt, which is secured by the value of
its undrilled gas reserves. That value has plummeted along with natural
gas prices, which may lead its banks to cut their credit lines when
they come up for renewal.
Executives don't expect it to improve anytime soon. Nearly
three-quarters of oil and gas CFOs polled in a recent survey by
accounting firm BDO Seidman LLP said they expect the U.S.
economic crisis to affect their ability to borrow money or extend bank
debt in 2009. In addition, well over half the 100 executives surveyed
said that credit capacity restraints, including access to capital, will
be their greatest challenge next year, followed by falling oil or
natural gas prices. "They feel gravely concerned about raising money,"
says Charles Dewhurst, a partner at the firm and leader of its national
energy practice in Houston.
Dewhurst says the credit drain may lead more companies to consider
buyouts or bankruptcy as a solution. "With less credit and lower
prices, smaller [exploration and production] companies are going to be
attractive acquisition targets for larger companies, and because of
debt constraints, many are going to feel compelled to sell," he says.
Companies that put together projects and borrowed money based on
$150 barrel oil will be most vulnerable. "I've heard from clients and
others that more conservatively managed companies used a lower price,"
he says. "Those companies that were aggressive in borrowing to the max
are going to have constraints and will have to make substantial
payments to the banks."
This spring, when banks set borrowing bases, they will be looking at
their oil and gas customers' reserves and commodity prices and may
start tightening their credit even further, which could hurt smaller,
fast-growing explorers.
"If the banks start using lower oil and gas prices, companies could
see reductions in their borrowing basis, which could result in them not
having enough liquidity," says Steve Berman, a senior research analyst
at Pritchard Capital Partners LLC in New York.
Berman thinks bankruptcy is a "strong possibility" for some oil and
gas production companies that have covenant violations, but how
widespread it is depends on how willing lenders are to work with
companies.
"I don't think the banks want to own E&P assets," Berman says.
"In most cases, they'll work with the companies. We've seen periods
before where that's what happened."
Berman says a lot of companies across the sector are talking about
"drilling within cash flow" and cutting back to reduce costs. But does
he think it will be as bad as the 1980s? "I don't think so," he says.
"Companies have adjusted, we've had a lot of advances in technology and
they're more efficient."
Dan Pickering, research director at Tudor Pickering Holt & Co. Securities Inc. in Houston, doesn't think the sector will see widespread bankruptcy until next year, and only if commodity prices stay low.
"Following 20% cuts to 2009 [capital expenditures], none of our 29
coverage companies are outspending cash flows in 2009 with $50 per
barrel, $5 per [million cubic feet of gas] commodity pricing," he wrote
in a recent report. "Keep prices low for longer and sector health would
deteriorate noticeably."
In the meantime, transactions have fallen apart, putting some companies' futures in serious jeopardy. For example, Houston's Edge Petroleum Corp.
and Chaparral Energy of Oklahoma City announced Dec. 15 that they
canceled their merger because they were unlikely to get debt and equity
financing. (J.P. Morgan Chase Bank NA had committed the original
financing.) The companies also canceled Chaparral's $150 million sale
of preferred stock to investment firm Magnetar Capital LLC.
Edge is considering other options, including a sale or a merger, asset
sales and debt or equity financing, and Chaparral has had its debt
downgraded by Moody's Investors Service because of concerns over liquidity and debt issues.
Moody's believes the current market turmoil may trigger a new round
of M&A activity, as many of the larger integrated companies, which
have experienced flat to negative production growth over the past few
years, feel the pressure to deliver organic growth. Many of them also
have robust balance sheets and a solid base of mature cash-generating
assets as well as have access to capital markets.
"These large companies could take advantage of the financial woes
currently afflicting smaller E&P players, resulting in increased
M&A activity in the sector," Moody's senior vice president Tom
Coleman said in a recent report. There's hope yet.
The mood was somber at the Independent Petroleum Association of America's Private Capital Conference at the Houstonian Hotel in Houston in mid-January, where oil and gas executives gathered to discuss the state of the industry. There was a lot of talk of opportunity but not a lot of talk of available financing to expand companies, much less do deals.
