Even as oil is starting to climb out of the crater it created over the last year, numerous oil companies are still in severe distress. Recovery in the sector won’t be fast or easy. Most energy companies saw their balance sheets stressed by the downturn, and some have sold assets or taken other actions which permanently impairs their ability to recover. In that sense, the oil sector appears to be on track to parallel the financial sector around the time of the 2008 recession. Many financial companies have yet to hit their pre-Recession highs even now 7 years after the recession ended.
For oil companies, recover means regaining the ability to grow and take advantage of new opportunities. The company that can recover most quickly are best poised to take advantage of the lingering chaos in the sector, and potentially to acquire distress competitors at prices that would have been unfathomable a few years ago. That recovery won’t be easy though as it means that some firms will have to restructure their operations and debts. For others, restructuring debt alone won’t be enough. Take Chesapeake and its recent debt announcement for instance.
Chesapeake Energy plans to take on a $1 billion loan to help it address its $9B debt load. The company’s efforts have been dictated by the cratering of the oil markets and the anemic recovery of optimism in the sector over the last few months. Chesapeake hired Goldman Sachs, Citi, and Mitsubishi UFJ Financial Group to arrange the deal which includes five year secured debt.
The tender offer led S&P to cut its rating on Chesapeake once again. S&P indicated that the deal amounts to a debt restructuring and a distressed transactions or “selective default”. The rating agency noted that longer dated existing notes will likely be exchanged for new notes at levels which are significantly below par value as part of the tender process. Related: Merrill Lynch Expects A 46% Jump In Oil Prices By June 2017
Chesapeake is not taking financial actions in isolation of course. The firm has been cutting production, reducing jobs, and trading in debt for equity at a furious pace in an effort to bolster the business against the ill effects of the downturn in energy prices. In addition, Chesapeake announced earlier this month that it would give away its Barnett Shale holdings to Saddle Barnett Resources, a private equity backed firm, for the benefits associated with slashing shipping and processing costs. Chesapeake also said that it had renegotiated a pipeline contract with Williams Partners LP in a move that eliminated $1.9 billion in long-term pipeline agreement liabilities. Under the deal, Chesapeake paid Williams $334M.
Chesapeake’s actions underline a broader point about the industry. Even with stocks for many energy companies looking up, the financials of those companies are still shaky at best. It will take several quarters up to potentially a couple of years before the energy sector has restructured itself sufficiently to get back to normal operations. Contract renegotiations, asset sales, and debt exchanges are all going to be common for a while.
Investors can capitalize on these opportunities in one of two ways. First, by being patient in evaluating distressed situations and waiting for the right deal to come along, investors can avoid getting in too early on firms that still have a lot of work to do. Second, investors should consider targeting the strongest energy companies as these firms will be the ones most likely to benefit from the morbidity of the sector.
By Michael McDonald of Oilprice.com
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