Oil Crash Poses Extinction Risk for Some Shale Producers

With bankruptcy looming over energy companies in the wake of plummeting oil prices and soaring bond yields, executives across the shale sector are deliberating new ways of survival.

Although the long-term impact on demand prices is still unclear, the unprecedented uncertainty of the upstream sector is a strong indication that companies must act quickly in order to survive the storm, according to Basil Karampelas, managing director and head of the Houston office at advisory firm SierraConstellation Partners LLC.

“The prices of crude have collapsed to a point where it’s hard to imagine any of the producers—even the most successful ones in the Permian—being able to generate substantial cash flows,” Karampelas told Hart Energy.

The current state of the industry is very different compared to the price collapse in 2016, when a lot of companies were able to survive because of their hedging program. In contrast, he said the recent crash of the energy market is a twofold problem—low prices for sustained period of time and the grind down to the current price level, which is volatile, making hedging expensive.

“If you think of the world as a simple two-by-two matrix, with one dimension being price and the other being volatility, we are in the low price-high volatility quadrant which is the least desirable for an E&P company,” he said.

Additionally, Karampelas sees no solace for gas producers either as the already-depressed natural gas prices have fallen to their lowest level in years.

“We have gone from an adjustment period to what could end up being as an extinction event particularly for oil and gas producers that are not well-capitalized,” he said.

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Karampelas expects the next three to six months will be “very turbulent” for the industry.

“We are already beginning to see of some bankruptcies and restructurings, which is going to create a lot of uncertainty and a real strain on the system,” he said.

A large part of the industry will go into a “financial intensive care unit” over the next few months, he said. As a result, this will require negotiations between creditors, suppliers and customers to at least stabilize companies to a point where they can be restructured. 

In order to survive the downturn, Karampelas said it’s crucial that oil and gas companies focus on three themes—liquidity, objectivity and creativity.

“It’s really making it through the initial critical period,” he said, adding that liquidity will be the coin of the realm in the current environment. “Companies need to focus on what steps they need to take operationally, financially and strategically to maintain liquidity until the current environment improves. Near-term liquidity will provide stabilization that can hopefully allow companies to make informed decisions about their business without worrying about an extinction event.”

Oil and gas producers will need objectivity in terms of deciding a path forward.

“There is no room for any emotional attachment to assets or projects,” he said. “Companies need to look gimlet-eyed at the reality of where they are and what works in this current environment. Being able to be objective and decisive will pay large dividends for companies.”

Producers will also need to get creative, which Karampelas added is a necessity created by the current situation.

“Whether it means offering a discount to get aged accounts receivable paid or doing ‘blend and extend’ structures with vendors in order to stretch out purchasing and payables in order to maintain vendor relationships, creativity can be a tremendous help,” he said.

With existing stretched balance sheets and lower margins, the price collapse will see refinancing and the restructuring of business models, where headcount cuts and bankruptcies will be inevitable, according to a recent report by Wood Mackenzie. Companies must drive efficiencies to extract the same or similar production for lower investment, defer the sanction of new projects and reduce activity levels and costs including short-cycle investment, exploration and operating costs, the report stated.

During the past week, several oil majors including Exxon Mobil Corp., Royal Dutch Shell Plc and Total SA announced significant spending cuts to protect their balance sheets from the oil price crash. Karampelas noted two reasons why oil majors are making these capex cuts, including maintaining some level of “attractive dividend.”

“Secondly, and more importantly, I believe that there is going to be a tectonic shift in terms of oil majors moving into smaller and quicker payback period, focusing on projects that have higher near-term visibility and quicker payback and smaller capital investment per project, so they can be more nimble and flexible to deal with the volatility, which will last for at least the next year if not longer,” he said.