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Gaurav Agnihotri By

Gaurav Agnihotri

Gaurav Agnihotri, a Mechanical engineer and an MBA -Marketing from ICFAI (Institute of Chartered Financial Accountants), Mumbai, is a result oriented and a business focused…

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The Coming Financial Apocalypse For U.S. Shale

The Coming Financial Apocalypse For U.S. Shale

With the price of both Brent and WTI hovering around $60 per barrel, the short to medium term outlook for oil remains uncertain, owing to the persistent oversupply in the global market.

Investment firm Goldman Sachs has even bearishly predicted $55 per barrel in 2020. With OPEC unwilling to reduce its production levels, and a worsening economic crisis in Greece , the near term outlook of oil remains mostly pessimistic despite reduced U.S. domestic crude stockpiles.

The World Bank has even predicted that the global economy would grow at 2.8 percent this year, down from the 3 percent predicted back in January. Does this mean that sustained low oil prices will result in financial apocalypse for the oil sector ?

The positives…..

The equity market has been one of the biggest saviors for troubled oil companies, almost 25 of whom have reportedly raised capital of more than $8.3 billion in order to repay their rising debt. Big oil companies such as Exxon Mobil, BP, Total, Statoil and Chevron have raised around $31 billion in debt between January and February 2015.

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“Credit markets have played a big role in keeping the entire sector alive,” said Amrita Sen of London based consulting firm Energy Aspects Ltd. Another emerging trend, according to research by Morgan Stanley, is the raising of funds for potential acquisitions, which are expected to pick up in the third and fourth quarters of this year. Apart from Shell’s upcoming acquisition of BG group, other oil majors like Statoil are actively hunting for reasonably priced opportunities.

However, there are some investment firms and trade pundits that expect a rebound in oil prices thanks to increased global demand and declining U.S. production.

Image Source: The Telegraph

Insch capital management, a Swiss hedge fund, has even predicted that oil will trade at $82 per barrel by first quarter of 2016.

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The negatives…..

It was expected that mergers and acquisitions would be the best bet for oil industry when most companies were shying away from investing in new projects and reducing their drilling costs. However, that hasn’t happened in earnest yet. As a recent PWC report stated, the number of M&A deals in the U.S. oil and gas industry during the first quarter of 2015 was less than the last quarter of 2014.

Total M&A deal value for U.S. oil and gas industry

Image Source: www.pwc.com

Things are not looking that good for the U.S. shale industry either as several drillers are using a substantial part of their revenues to pay off interest. According to a recent Bloomberg report, Continental Resource Inc, a company that has a large share in North Dakota’s Bakken Shale, is spending a huge part of its revenues on interest payments, spending as much as Exxon Mobil, a company almost 20 times larger.

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Bloomberg finds that driller’s debts increased to almost $235 billion by the end of the first quarter this year. Meanwhile, a recent S&P report says that oil and gas companies accounted for almost one third of the total global corporate debt defaults so far this year, the biggest reason being their inability to make interest payments.

Quicksilver Inc. was one of the companies that missed a debt payment in February and ultimately filed for bankruptcy. “The financial troubles of the smaller players become amplified with lower oil prices,” said Amrita Sen. The coming two quarters will be crucial for oil companies, especially the small players, as oil prices will either make or break them.

Conclusion

The oil industry is at a crossroads. Many oil companies will continue to suffer if oil prices remain low, and rising debt could lead to more defaults. Some bullish analysts expect oil prices to increase towards the end of this year. That might be the only thing that rescues a lot of companies from drowning in red ink.

By Gaurav Agnihotri of Oilprice.com

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