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Tick Tock: Time Running Out for Struggling Oil and Gas Drillers

Tick Tock: Time Running Out for Struggling Oil and Gas Drillers

The 18th oil and gas driller so far this year is in the process of filing for bankruptcy protection, as the company ran out of funds. As reported by Fuel Fix, the Fort Worth-based Energy & Exploration Partners, which drills for oil and gas in East Texas, had the unfortunate timing of going public in 2014 just as oil prices began collapsing.

The company’s revenues sank along with low oil prices, but the nail in the coffin is the sudden tightfistedness from credit markets. Without the ability to access new loans, Energy & Exploration Partners had no other choice but to go through the bankruptcy process.

“The impact of the depression in oil prices on the debtors’ business cannot be overstated,” John Castellano, a managing director of AlixPartners and also the company’s interim chief financial officer, said in court documents, according to Fuel Fix. Related: Strippers Suffering From Low Oil Prices

The gloom over the health of the energy sector is reflected in the rapid deterioration of the value of energy bonds. While the share prices for energy companies have plummeted, more recently bond prices have also collapsed. That suggests a growing consensus that more defaults are likely. As the WSJ notes, the price for credit-default swaps, which act as insurance against the possibility of default, for Chesapeake Energy have quadrupled in just the past three months. The markets are currently putting the chance of default for the second largest gas driller in the U.S. at 95 percent within the next five years.

Low oil prices, not surprisingly, have led to the energy sector’s incredibly poor performance this year. Mutual funds specializing in the energy sector have lost 15.4 percent for the three months ending on November 30, “by far the worst among all sector funds,” according to Investor’s Business Daily.

S&P says that the number of global corporate defaults has exceeded 100 so far in 2015, double the rate from last year, and the highest rate of defaults since the financial crisis in 2009. More than one-third of the global defaults in 2015 occurred in the energy industry. Related:This Suggests An Oil Price Recovery Might Be On Its Way

In November, Barclays predicted that the default rate for speculative-grade companies – increasingly made up of oil and gas firms – will double over the next year. “No one is putting up new capital here,” Bruce Richards, co-founder of Marathon Asset Management, told Bloomberg in a November interview. “It’s been eerily silent in the whole high-yield energy sector, including oil, gas, services and coal.”

Indeed, the default rate could accelerate as financing becomes increasingly scarce. “Next year is when you'll see the wave of defaults. Companies got financing, but will have burnt through it,” Nicholas Colas, chief market strategist for ConvergEx, told CNN.

To make matters worse, the Federal Reserve is slated to increase interest rates. Although the Fed won’t hike rates by much, any increase in the cost of finance will add to the woes of the energy industry. Much of the drilling in the U.S. shale patch over the past decade was built on cheap finance, and low interest rates opened up a tidal wave of credit that fueled the drilling boom (and the subsequent bust). If interest rates rise, other less-risky investments will be relatively more attractive. And having already been badly burned by shale drilling, a growing number of banks, hedge funds, and other forms of credit will shy away from indebted companies. Related: What Will Iran Do With its Enriched Uranium?

The U.S. still has not seen a massive fall off in oil production yet, although even a small reduction after several years of rapid growth amounts to a significant downturn. The EIA said on December 8 that it believes U.S. oil production dipped by 60,000 barrels per day in November.

As many analysts have noted over the past year, the resulting “shakeout” is what many believe is necessary in order to bring oil supply and demand back into balance. Unprofitable production must be forced out of the market, which will then cause oil prices to rise again. The expected increase in defaults, then, might be seen as the necessary correction that many have been waiting for.

By Nick Cunningham of Oilprice.com

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