U.S. energy capital markets took a hit in 2018 with the upstream oil and gas industry bearing a greater brunt of the decline than any other sector, particularly at the end of the year.

A recent Drillinginfo report found total energy offerings last year were down 20% year-over-year. Combined, bond and equity deals raised $106.8 billion from 201 issuances in 2018 compared to the $133 billion raised from 271 deals in 2017.

During the fourth quarter, the energy sector raised about $20.1 billion through equity and debt offerings, down 4% sequentially and down 34% year-over-year. About $3.9 billion was raised from public stock offerings and $16.2 billion from bond issuances.

The optics of public equity in fourth-quarter 2018 would suggest a relative comeback for the year. However, Drillinginfo noted that after removing the $2.1 billion issued by Baker Hughes Inc. (NYSE: BHGE) in November, the reality is “one of the worst quarters this decade.”

Christopher George, director of Drillinginfo’s Capitalize tracking platform, told Hart Energy he believes the decline reflects the current state of investor sentiment as the weight of energy in the S&P 500 index continues to fall and the number of public oil and gas companies dwindles.

“Up to 10 years ago, the energy sector had a 13%-15% weighted allocation within the S&P,” George said. “Now, we’re at 5%-6% … institutional investors are not interested in the space.”

IPOs Full Stop

The industry also took a hit in the fourth quarter after oil prices dropped by roughly 40% by the end of the year.

“Several IPOs were taken off the market,” George said. “We had five S-1s across the sectors get pulled that did not go public. When price is the driver of valuation and the commodity price tanks, nobody wants to sell at a perceived discount.”

As a result, both public and private equity slowed down dramatically over the course of the year. IPOs came to a full stop in the second half of 2018, despite starting the year off strong.

In 2018, the energy industry raised about $3 billion via nine IPOs compared to 23 offerings in 2017 that raised $8.7 billion.

Oilfield services dominated the 2018 IPO market with six offerings raising $2 billion all in the first quarter. Meanwhile, the upstream industry accounted for only three IPOs, all of which were made by special purpose acquisition companies (SPAC).

Berry Petroleum Corp.’s (NASDAQ: BRY) IPO in July was not included in Drillinginfo’s report, George said, since the company was a public prior to its acquisition by Linn Energy in 2013 and subsequent spin-off a few years later.

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Along those lines, George said the last “true,” non-SPAC IPO for upstream was Jagged Peak Energy Inc. (NYSE: JAG) back in 2017, which he noted says something by itself.

Upstream Equity Struggles

Overall, the upstream industry has “definitely been the hardest hit,” he said.

Fourth-quarter 2018 saw upstream debt and equity markets total a meager $1.54 billion in the quarter. Drillinginfo noted this was the first time since third-quarter 2015 that upstream companies raised less than $5 billion through capital markets.

Further, the upstream industry experienced its worst quarter for equity issuances since 2010 in the fourth quarter with two equity deals raising $67.5 million. This was down 94% from third-quarter 2018 and down 97% from the $2.2 billion raised a year ago.

Upstream bond issuances were also down during the fourth quarter, with $1.47 billion raised from three issuances. This is a 79% drop from the $7.01 billion in debt raised from 16 deals in fourth-quarter 2017.

Along with the closing of public capital markets, private-equity (PE) sponsors also began decelerating backing new upstream portfolio companies. George attributed the slowdown to few exit strategies for PE-backed teams due to the lack of an IPO option and A&D activity grinding to a halt in the fourth quarter.

In 2018, Drillinginfo identified roughly $82 billion of North American energy-related PE fund closures with only 10% of the funds dedicated specifically to upstream investment. However, oilfield services (OFS) and midstream dedicated funds soared—about $16 billion oilfield service funds closed in 2018 and $14 billion midstream. Nearly 50% of all closed funds had a multi-faceted approach, which allows for more latitude, the Drillinginfo report said.

Additionally, roughly 30% of new commitments were directed to the OFS sector with sponsors focusing on the information technology and drilling and completion segments.

“Public markets have tapped the brakes but capital has to find new opportunities. We saw a change in focus within private equity with investment being directed towards OFS and midstream,” George said.

Wave Of Debt

As equity markets grew increasingly challenged throughout 2018, George said debt markets may be soon to follow as Federal Reserve rate hikes make borrowing more expensive and $700 billion in corporate maturities across all sectors are set to arrive in 2019.

The latest rate hikes bring the new Fed Funds rate to 2.25%-2.5%. However, investment-grade issuers still managed to get some multibillion bonds out the door before year-end.

For the full year, bond issues fell 24% year-over-year with the industry issuing 137 separate bonds with an aggregate principal amount of $90.3 billion. The previous year, $96.6 billion was sold through 158 bonds issued.

In fourth-quarter 2018, Drillinginfo tracked the issuance of $16 billion principal amount across 21 bond floats. Investment-grade issuers sold 71% of the bonds floated during the quarter, or 15 issues out of 21, as the group acted before the forecast interest rate hike, George said.

As for the foreboding amount of corporate maturities due in 2019, George said he believes it will become a major driver for the next year or so.

“There’s a wave of debt coming due that will be refinanced with more expensive paper,” he said. “That’s where my mind is at the moment, to focus on the debt side of the equation. If your debt comes due and markets tighten—then you’ve got a real problem.”

As for the year ahead, George said he’s already hearing strategies and perceptions change in the market which he finds encouraging.

“There’s a lot of smart guys in this space that figure this stuff out and when one strategy ends, another one begins,” he said. “We’ve seen down periods in the past and this won’t be the last one, but we always figure out a way to work our way out of it.”

Emily Patsy can be reached at epatsy@hartenergy.com.

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