Still think shale oil will make America oil independent? Still believe the clap trap voiced by most politicians and mainstream media cheerleaders about how shale oil will save us? Perhaps it’s time to reexamine the shale oil industry and the cash requirements of drilling well after well.
The main thing to understand about shale oil wells is that they deplete like crazy. After about two years of production most wells are about done. That means shale oil companies are faced with what’s known as the “Red Queen” problem. They have to drill more and more wells to keep production up.
Drilling all those wells is expensive. Wall Street has come to the rescue and raised boatloads of money from investors who bought into the hype and chased after high yield investments. It’s been another home run for Wall Street. Gullible investors were chasing after the dream of buying into low-grade debt (junk) without worrying about quality.
Now with oil at $50 a barrel and heading lower many shale oil companies have a problem. They cannot service the debt. Not only do the shale oil companies have a problem. Investors in high yield debt are going to get hosed. Wall Street has done it again. With oil above $100 a barrel The “hot market” of the day made for a good story. Now not so much. With financing cut off and the price of oil crashing shale oil companies are in deep trouble. WBH Energy will be the first of many filling for bankruptcy.
The First Shale Casualty: WBH Energy Files For Bankruptcy; Many More Coming
Submitted by Tyler Durden, Zero Hedge, on 01/07/2015
“There are too many ugly balance sheets,” warns one energy industry analyst, adding simply that “the group is not positioned for this downturn.” While the mainstream media continues to chant the happy-clappy side of lower oil prices, spewing various ‘statistics’ about how the down-side of low oil prices is ‘contained’ and the huge colossal massive tax cut means ‘everything is awesome’ for America, the data – and now actions – do not bear this out. Macro data has done nothing but disappoint and now, we have the first casualty of the shale oil leverage debacle as WSJ reports, on Sunday, a private company that drills in Texas, WBH Energy LP, and its partners, filed for bankruptcy protection, saying a lender refused to advance more money. There are many more to come…
In December we illustrated the problem names (in the publicly traded markets) among the most-levered energy companies in America…
American oil and gas companies have gone heavily into debt during the energy boom, increasing their borrowings by 55% since 2010, to almost $200 billion.
Their need to service that debt helps explain why U.S. producers plan to continue pumping oil even as crude trades for less than $50 a barrel, down 55% since last June.
But signs of strain are building in the oil patch, where revenue growth hasn’t kept pace with borrowing. On Sunday, a private company that drills in Texas, WBH Energy LP, and its partners, filed for bankruptcy protection, saying a lender refused to advance more money and citing debt of between $10 million and $50 million. Neither the Austin-based company nor its lawyers responded to requests for comment.
Energy analysts warn defaults could be coming. “The group is not positioned for this downturn,” said Daniel Katzenberg, an analyst at Robert W. Baird & Co. “There are too many ugly balance sheets.”
In 2010, U.S. companies focused on producing oil and gas had $128 billion in combined total debt, according to financial data collected by S&P Capital IQ.
As of their latest quarter, such companies had $199 billion of combined total debt.
Before crude prices began falling, U.S. oil and gas producers were able to acquire leases and drill wells even if that meant outspending their incomes. Debt was used to bridge the cash shortfall so that companies could develop oil fields in Texas, North Dakota and newer locations including Colorado.
Now that is coming back to bite.
The upshot of cash conservation and higher borrowing costs will be less money spent on producing oil and natural gas. Concho Resources Inc. said late Monday that it was cutting its capital spending budget by a third, to $2 billion.
The common perception is that the collapse in oil prices is a good thing. For some people this thought is correct. But for the world as a whole the collapse in oil prices makes an already unstable world even more unstable. There are winners and losers.
Overall the collapse of a major asset class is dangerous. We all like the lower prices for gas at the pump, but may not like at all many of the adjustments in financial matters lower prices will bring.
The Oil Collapse: How Seasoned Traders Are Responding
Jared Dillian, Editor, The 10th Man
I was in Memphis last week visiting some folks. I found myself in a conference room with some very seasoned commodity traders… veterans of the floor, some going back to the ‘70s. Let me tell you something: if you ever find yourself talking to a 40-year veteran of the commodities markets, you should listen to what he has to say. Anyone who can last that long trading futures is pretty smart.
Funny thing is, I’ve been around long enough that now I am one of the old traders!
But I’m not a commodities guy by training. I’m one of those slicked-back-hair moneychanger guys who is never going to get to heaven. But I always learn a lot when I go to Memphis—which, by the way, is the third-biggest futures trading city after Chicago and New York. There are quite a few large trading firms that specialize in grains, meats, and cotton. Memphis is a big deal, and probably the best-kept secret in the financial world.
So I asked about what it was like to trade live cattle during the BSE (mad cow) outbreak about 10 years ago. “How about limit down for an entire week?” they said. Small traders went under. Cattle ranchers went under, guys who lifted their hedges at exactly the wrong time. It was downright ugly.
That was bad.
But what’s happening to oil is a million times worse.
There are a lot of folks who get pretty angry when you suggest that a near-50% drop in the price of oil might be a negative in the short term. They look at you like you’re dumb. They talk about the massive benefit to consumers, the synthetic “tax cut” that everyone’s getting, what it’s going to do to consumption, etc.
All of this is true. But if you take a major commodity and slice it in half in the span of a month or two, there are going to be major consequences.
When I say that the commodities markets haven’t seen anything like this since 1980 when gold went haywire, I mean it. And you don’t put gold in your gas tank. Sure, there have been some minor calamities, like when cotton went parabolic a few years ago, but crude oil is perhaps the world’s most important commodity when you take into account both its economic and geopolitical significance. People go to war over the stuff. Routinely. And with oil falling from $105 to $57 in just six months, it might happen again.
We’ll get to that in a second. But for perspective, when people look at this move in oil 10 years from now, they’re going to call it the “Crash of ‘14.” That’s my prediction. A move of this magnitude in a short amount of time is a crash. When stocks went down 19% in a week in 2008, that was also a crash.
What’s the definition of a crash? I say any move over six standard deviations. For comparison, the Crash of ‘87 was 25 standard deviations—a move so uncommon, so statistically rare, that it wasn’t supposed to happen in a length of time greater than the age of the universe.
I haven’t done the math on oil yet, but if it’s not six standard deviations, it’s close.
* * * *
As you probably know by now, the move in oil has been more of a supply story than a demand story. We were drilling holes all over the planet in search of it. My wife works in the Turkana Basin, on the border of northwest Kenya and Ethiopia, which is one of the most remote spots in the world. They were drilling for it there, too.
That’s what happens when oil gets to $140 a barrel. People are incentivized to look for it. It takes time to explore and produce the stuff. It takes years for wells to finally come online and for supply to hit the market.
There are still projects that may never be completed, like Vaca Muerta in Argentina, that Yacimientos Petrolíferos Fiscales (YPF) is developing in conjunction with Chevron. The poor Argentinians—screwed again.
And like we’ve been seeing in the mining industry, once a company has brought production online, it’s difficult to take it offline. It’s hard to start it back up again, to get all the permits, to hire everyone back. So people will continue to produce at uneconomic levels for a long time, hoping that the price will come back, while simultaneously ensuring that it won’t for a long time.
So back to my earlier point—is it bullish or bearish for the US? It’s not a hard question to answer. People are making it hard. 20 years ago, it would have been unequivocally bullish. Now, maybe not. We produce slightly more oil than we consume. There will be winners and losers, which is being reflected in the stock market.
For some countries, it’s unequivocally bearish, especially for adversaries like Venezuela, Iran, and Russia. But also for allies, like Canada, which is probably in the most precarious economic position of any country in the world.
The takeaway is: an oil crash makes the world less stable.
Bubbles do not end well. Wall Street sucked investors into the high yield junk bond market with the expectation oil prices would continue to rise. With oil prices plunging these investors now face huge losses. With oil at $60 a barrel many oil companies, especially oil fracking companies, will not be able to service the debt.
Kind of like the false premise home prices would never fall. Investors seem to never learn. Wall Street make money fast brokers tell a good story. Too bad most don’t end well.
Fed Bubble Bursts in $550 Billion of Energy Debt: Credit Markets
By Christine Idzelis and Craig Torres Dec 11, 2014
The danger of stimulus-induced bubbles is starting to play out in the market for energy-company debt.
Since early 2010, energy producers have raised $550 billion of new bonds and loans as the Federal Reserve held borrowing costs near zero, according to Deutsche Bank AG. With oil prices plunging, investors are questioning the ability of some issuers to meet their debt obligations. Research firm CreditSights Inc. predicts the default rate for energy junk bonds will double to eight percent next year.
“Anything that becomes a mania — it ends badly,” said Tim Gramatovich, who helps manage more than $800 million as chief investment officer of Santa Barbara, California-based Peritus Asset Management. “And this is a mania.”
The Fed’s decision to keep benchmark interest rates at record lows for six years has encouraged investors to funnel cash into speculative-grade securities to generate returns, raising concern that risks were being overlooked. A report from Moody’s Investors Service this week found that investor protections in corporate debt are at an all-time low, while average yields on junk bonds were recently lower than what investment-grade companies were paying before the credit crisis.
Borrowing costs for energy companies have skyrocketed in the past six months as West Texas Intermediate crude, the U.S. benchmark, has dropped 44 percent to $60.46 a barrel since reaching this year’s peak of $107.26 in June.
Yields on junk-rated energy bonds climbed to a more-than-five-year high of 9.5 percent this week from 5.7 percent in June, according to Bank of America Merrill Lynch index data. At least three energy-related borrowers, including C&J Energy Services Inc. (CJES), postponed financings this month as sentiment soured.
“It’s been super cheap” for energy companies to obtain financing over the past five years, said Brian Gibbons, a senior analyst for oil and gas at CreditSights in New York. Now, companies with ratings of B or below are “virtually shut out of the market” and will have to “rely on a combination of asset sales” and their credit lines, he said.
Companies rated Ba1 and lower by Moody’s and BB+ and below by Standard & Poor’s are considered speculative grade.
The Fed’s three rounds of bond buying were a gift to small companies in the capital-intensive energy that needed cheap borrowing costs to thrive, according to Chris Lafakis, a senior economist at Moody’s Analytics in West Chester, Pennsylvania.
Quantitative easing “has been one of the keys to the fast, breakneck pace of the growth in U.S. oil production which requires abundant capital,” Lafakis said.
One of those to take advantage was Energy XXI Ltd. (EXXI), an oil and gas explorer, which has raised more than $2 billion in the bond market in the past four years.
The Houston-based company’s $750 million of 9.25 percent notes, issued in December 2010, have tumbled to 64 cents on the dollar from 106.3 cents in September, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. They yield 27.7 percent.
Energy XXI got its lenders in August to waive a potential violation of its credit agreement because its debt had risen relative to its earnings, according to a regulatory filing. In September, lenders agreed to increase the amount of leverage allowed.
Greg Smith, a vice president in Energy XXI’s investor relations department, didn’t return a call seeking comment.
The debt rout is one of the latest examples of a boom and bust in U.S. markets as unprecedented Fed stimulus fuels a hunt for yield. The fallout has been limited so far, yet the longer the Fed holds its benchmark lending rate near zero, the greater the risk of more consequential bubbles, according to former Fed governor Jeremy Stein.
“To the extent that highly accommodative monetary policy courts risks to the economy further down the road, there is more of a live trade-off than there was at 8 percent unemployment” said Stein, now a Harvard University professor.
Joblessness of 5.8 percent in November was about half a percentage point away from the Fed’s estimate of full employment, or the lowest level of labor market slack the economy can sustain before companies bid up wages.
Employment in support services for oil and gas operations has surged 70 percent since the U.S. expansion began in June 2009, while oil and gas extraction payrolls have climbed 34 percent.
“There are distortions in multiple markets,” said Lawrence Goodman, president of the Center for Financial Stability, a monetary research group in New York. “It is like a Whac-A-Mole game: You don’t know where it is going to pop up next.”
Fed Chair Janet Yellen said in a July 2 speech in Washington that she saw “pockets of increased risk-taking,” including in the corporate debt markets.
Midstates Petroleum Co. (MPO) is spending about $1.15 drilling for every dollar earned selling oil and gas. Outspending cash flow is the norm for many companies in the U.S. shale boom.
The Houston-based company’s $700 million of 9.25 percent notes due in June 2021 have plummeted to 53.5 cents from 108 cents at the beginning of September, according to Trace. The debt is rated Caa1 by Moody’s and B- by S&P.
Representatives of Midstates didn’t respond to phone calls and e-mails seeking comment.
The fall in oil prices has winners and losers. The drastic reduction in gasoline prices will be like a raise for most consumers. Airlines will benefit as jet fuel cost drop. Jet fuel is airlines greatest operating expense.
It is nations that depend on oil sales to fund the major part of their budgets that will hurt the most. Nations such as Iran, Iraq, Nigeria, Venezuela, Algeria, Angola, even Saudi Arabia, will likely be forced to cut back on benefits to citizens and social programs. This will cause widespread unrest in a world already on fire with many hot spots.
If prices reach $40 a barrel the US fracking industry will see weaker companies going broke. American oil production will suffer. The next few months will become a nightmare for companies in the oil service industry. Deflationary pressures will become intense.
Oil at $40 Possible as Market Transforms Caracas to Iran
By Gregory Viscusi, Tara Patel and Simon Kennedy Nov 30, 2014
Oil’s declineis proving to be the worst since the collapse of the financial system in 2008 and threatening to have the same global impact of falling prices three decades ago that led to the Mexican debt crisis and the end of the Soviet Union.
Russia, the world’s largest producer, can no longer rely on the same oil revenues to rescue an economy suffering from European and U.S. sanctions. Iran, also reeling from similar sanctions, will need to reduce subsidies that have partly insulated its growing population. Nigeria, fighting an Islamic insurgency, and Venezuela, crippled by failing political and economic policies, also rank among the biggest losers from the decision by the Organization of Petroleum Exporting Countries last week to let the force of the market determine what some experts say will be the first free-fall in decades.
“This is a big shock in Caracas, it’s a shock in Tehran, it’s a shock in Abuja,” Daniel Yergin, vice chairman of Englewood, Colorado-based consultant IHS Inc. andauthor of a Pulitzer Prize-winning history of oil, told Bloomberg Radio. “There’s a change in psychology. There’s going to be a higher degree of uncertainty.”
A world already unsettled by Russian-inspired insurrection in Ukraine to the onslaught of Islamic State in the Middle East is about be roiled further as crude prices plunge. Global energy markets have been upended by an unprecedented North American oil boom brought on by hydraulic fracturing, the process of blasting shale rocks to release oil and gas.
Few expected the extent or speed of the U.S. oil resurgence. As wildcatters unlocked new energy supplies, some oil exporters abroad failed to invest in diversifying their economies. Coddled by years of $100 crude, governments instead spent that windfall subsidizing everything from 5 cents-per-gallon gasoline to cheap housing that kept a growing population of underemployed citizens content.
Those handouts are now at risk.
“If the governments aren’t able to spend to keep the kids off the streets they will go back to the streets, and we could start to see political disruption and upheaval,” said Paul Stevens, distinguished fellow for energy, environment and resources at Chatham House in London, a U.K. policy group. “The majority of members of OPEC need well over $100 a barrel to balance their budgets. If they start cutting expenditure, this is likely to cause problems.”
Costs as Benchmark
Oil has dropped 37 percent this year and, in theory, production can continue to flow until prices fall below the day-to-day costs at existing wells. Stevens said some U.S. shale producers may break even at $40 a barrel or less. The International Energy Agency estimates most drilling in the Bakken formation — the shale producers that OPEC seeks to drive out of business — return cash at $42 a barrel.
“Right now we’re seeing a price shock coming out of the meeting and it will be a couple of weeks until we see where the price really falls,” said Yergin. Officials “have to figure out where the new price range is, and that’s the drama that’s going to play out in the weeks ahead.”
Brent crude finished last week around $70, and New York oil near $66. Brent is now at its lowest since the financial crisis — when it bottomed around $36.
Not All Suffer
To be sure, not all oil producers are suffering. The International Monetary Fund in October assessed the oil price different governments needed to balance their budgets. At one end were Kuwait, Qatar and the United Arab Emirates, which can break even with oil at about $70 a barrel. At the other extreme: Iran needs $136, and Venezuela and Nigeria $120. Russia can manage at $101 a barrel, the IMF said.
“Saudi Arabia, U.A.E. and Qatar can live with relatively lower oil prices for a while, but this isn’t the case for Iran, Iraq, Nigeria, Venezuela, Algeria and Angola,” said Marie-Claire Aoun, director of the energy center at the French Institute for International Relations in Paris. “Strong demographic pressure is feeding their energy and budgetary requirements. The price of crude is paramount for their economies because they have failed to diversify.”
Brent crude is poised for the biggest annual decline since 2008 after OPEC last week rejected calls for production cuts that would address a global glut.
Like this year’s decline, oil’s crash in the 1980s was brought on by a Saudi-led decision to defend its market share, sending crude to about $12 a barrel.
“Russia in particular seems vulnerable,” said Allan von Mehren, chief analyst at Danske Banke A/S in Copenhagen. “A big decline in the oil price in 1997-98 was one factor causing pressure that eventually led to Russian default in August 1998.”
VTB Group, Russia’s second-largest bank, OAO Gazprombank, its third-largest lender, and Russian Agricultural Bank are already seeking government aid to replenish capital after sanctions cut them off from international financial markets. Now with sputtering economic growth, they also face a rise in bad loans.
Oil and gas provide 68 percent of Russia’s exports and 50 percent of its federal budget. Russia has already lost almost $90 billion of its currency reserves this year, equal to 4.5 percent of its economy, as it tried to prevent the ruble from tumbling after Western countries imposed sanctions to punish Russian meddling in Ukraine. The ruble is down 31 percent against the dollar since June.
This Will Pass
While the country’s economy minister and some oil executives have warned of tough times ahead, President Vladimir Putin is sanguine, suggesting falling oil won’t force him to meet Western demands that he curb his country’s interference in Ukraine.
“Winter is coming and I am sure the market will come into balance again in the first quarter or toward the middle of next year,” he said Nov. 28 in Sochi.
Even before the price tumble, Iran’s oil exports were already crumbling because of sanctions imposed over its nuclear program. Production is at a 20-year low, exports have fallen by half since early 2012 to 1 million barrels a day, and the rial has plummeted 80 percent on the black market, says the IMF.
Lower oil may increase the pain on Iran’s population, though it may be insufficient to push its leaders to accept an end to the nuclear program, which they insist is peaceful.
“The oil price decline is not a game changer for Iran,” said Suzanne Maloney, senior fellow at the Brookings Institution, a Washington-based research organization, who specializes on Iran. “The Iranians were already losing so many billions of dollars because of the sanctions that the oil price decline is just icing on the cake.”
While oil’s decline wrenches oil-rich nations that squandered the profits from recent high prices, the world economy overall may benefit. The Organization for Economic Cooperation and Development estimates a $20 drop in price adds 0.4 percentage point to growth of its members after two years. By knocking down inflation by 0.5 point over the same period, cheaper oil could also persuade central banks to either keep interest rates low or even add stimulus.
Energy accounts for 10 percent to 12 percent of consumer spending in European countries such as France and Germany, HSBC Holdings Plc said.
As developed oil-importing nations benefit, some of the world’s poorest suffer. Nigeria’s authorities, which rely on oil for 75 percent of government revenue, have tightened monetary policy, devalued the naira and plan to cut public spending by 6 percent next year. Oil and gas account for 35 percent of Nigeria’s economic output and 90 percent of its exports, according to OPEC.
“The current drop in oil prices poses stark challenges for Nigeria’s external and fiscal accounts and puts heavy pressure on the exchange rate,” Oliver Masetti, an economist at Deutsche Bank AG, said in a report this month. “If oil prices remain at their current lows, Nigeria will face tough choices.”
Even before oil’s rout, Venezuela was teetering.
The nation is running a budget deficit of 16 percent of gross domestic product, partly because much of its declining oil production is sold domestically at subsidized prices. Oil is 95 percent of exports and 25 percent of GDP, OPEC says.
“Venezuela already qualifies for fiscal chaos,” Yergin said.
The country was paralyzed by deadly riots earlier this year after police repressed protests about spiraling inflation, shortages of consumer goods and worsening crime.
“The dire state of the economy is likely to trigger renewed social unrest, while it seems that the government is running out of hard currency,” Capital Economics, a London research firm, wrote in a Nov. 28 report.
Declining oil may force the government to take steps to avoid a default including devaluing the currency, cutting imports, raising domestic energy prices and cutting subsidies shipments to poorer countries in the region, according to Francisco Rodriguez, an economist at Bank of America Merrill Lynch.
“Though all these entail difficult choices, default is not an appealing alternative,” he said. “Were Venezuela to default, bondholders would almost surely move to attach the country’s refineries and oil shipments abroad.”
In an address on state television Nov. 28, President Nicolas Maduro said Venezuela would maintain social spending while pledging to form a commission to identify unnecessary spending to cut. He also said he was sending the economy minister to China to discuss development projects.
Mexico shows how an oil nation can build new industries and avoid relying on one commodity. Falling crude demand and prices in the early 1980s helped send the nation into a debt crisis.
Oil’s share of Mexico’s exports fell to 13 percent in 2013 from 38 percent in 1990, even as total exports more than quadrupled. Electronics and cars now account for a greater share of the country’s shipments. Though oil still accounts for 32 percent of government revenue, the Mexican government has based its 2015 budget on an average price of $79 a barrel.