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It’s just a gut feeling, but doesn’t it seem like the oil and gas industry is on the verge of acceleration? Over the past year, most E&Ps have tuned up their balance sheets by tapping the public markets, selling assets and even enduring restructuring. Add to that an oil price that has once again crawled back to $50 and natural gas hovering near $3, and it feels like the rolling start after the track announcer has shouted “Start your engines!” just before the green flag has been waved.
Anticipation hangs in the air.
“Most of the industry has recapitalized itself,” confirms David Heikkinen, CEO of equity research firm Heikkinen Energy Advi¬sors. That’s good news, although he won’t say unequivocally that the sector is out of the woods just yet. “It’s more like a sigh of relief that a floor has been put on the oil price in the mid-$40s,” he said.
That tenuous stability has put commercial banks in a more comfortable position, con¬trasted with the spring when concerns flared over how much credit capacity would be avail¬able in the upstream space. Companies on the financial bubble were put on notice regarding impending fall redeterminations.
“Now, banks don’t seem as worried. Price decks are higher, and we hear of very few banks cutting back on revolvers and requiring additional securitization.”
Debt and equity markets are “wide open,” Heikkinen noted. He pointed to recent bond issuances by Oasis Petroleum and Gulfport Energy as examples of levered companies extending their runways on maturities. “Dura¬tion is a key component of risk and reward.” Terming out the debt “extends the duration of the option imbedded in your equity.”
For many, though, the recapitalization efforts have come at the expense of shareholders, Heikkinen said. Notably, some companies have used upsized equity issuances to fund acquisi¬tions and pad the balance sheet, a combined offensive/defensive move that Heikkinen has mixed feelings about.
“Timing is everything,” he said. Rice Ener¬gy’s play for Vantage Energy and SM Ener¬gy’s move on Rock Oil Holdings were timed when their share prices were relatively strong. Yet Range Resources’ merger with Memorial Resource Development was announced when gas prices were at a low for the year, reflected in its shares.
“Issuing equity at the lows in the late winter and early spring was tremendously dilutive for a lot of companies,” he said. “When you make those decisions, that’s tougher to generate a higher shareholder return.”
Heikkinen has high regard for Continental Resources, which has not issued equity at all during the downturn and instead turned to asset sales or other means to support the bal¬ance sheet. “They didn’t dilute anybody.”
Another recapitalized group re-entering the field: the bankrupt.
When prices juked the wrong way this past winter, bringing out the yellow flag, companies with no other viable options chose to rebuild their engines via prepackaged bankrupt¬cies. While ownership structures drastically changed—with previous equity holders out and former bondholders taking control—these companies are now looking to make up lost time by growing production and acquiring.
Take Halcon Resources and Swift Energy as recent examples. “They’re not re-emerging to do nothing,” he said.
Although most E&Ps are out of the woods, a few companies remain on the “tenuous razor’s edge,” he said. These tend to be smaller-cap names. Out of Heikkinen’s coverage list, he identified Comstock Resources, Bonanza Creek Energy, Gastar Exploration, Rex Energy and even Sanchez Energy—still rela¬tively levered and selling assets—as compa¬nies that could tilt toward bankruptcy without a price tailwind.
The catalyst to acceleration, perhaps, is OPEC’s signal that it intends to cap production at this month’s meeting of members, two years post its Thanksgiving surprise. Regardless of whether they actually agree to terms, the mes¬sage is an important psychological shift in the oil markets, Heikkinen emphasized.
“It’s setting a floor for price. Saudi Arabia is basically saying to the world that they do not want oil to go below $40 again.” So think about this in terms of making a risk-reward investment, he postulated. “If the risk is set at $40 or higher, the downside is in. You can eliminate the big down tail. You now have a better case for an upside in the commodities and equities market.”
The resulting upward bump in oil has moti¬vated many producers to protect cash flow with hedges. “With that cash flow locked in at $50-plus, they’ll then accelerate drilling activ¬ity” into 2017, he said.
Maybe the pace car will now exit the track, and next year will be a green flag year. Let the race begin.
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