FIGURE 1: PERFORMANCE OF OIL AND GAS MAJORS
Description: Figure 1 highlights the performance of the oil and gas industry year-to-date (x-axis) and the performance of the 11 months prior to March 2016.
Brent Crude and WTI Crude prices were up 12% and 20 %, respectively, since the beginning of March. The recent oil price rally raised hopes among producers that the worst may be over when it comes to a slump that has persisted for 14 months now. Speculation of a production freeze/cut by the combined cartel of Russia and the Organization of the Petroleum Exporting Countries (OPEC) fuelled the current rise in crude oil prices. The Energy Information Administration’s (EIA) short-term energy outlook report forecasting a drop in average U.S. oil production from 9.4 million barrels per day (b/d) in 2015, to 8.7 million b/d in 2016 and 8.2 million b/d in 2017, also supported the rally. This is clear evidence that market forces are working their magic and higher cost producers are cutting output.
However, as mentioned in our prior newsletter, if oil prices reach US$ 50/b, instead of decreasing, U.S. production will likely increase because many of the shale oil drillers, on the brink of insolvency, will boost production to remain in business. A recent study shows that in a few areas in North Dakota’s Bakken shale, the Eagle Ford shale and Permian Basin in Texas, drilling was possible even if crude prices dropped to $25/b. Jim Volker, Chairman and CEO of Whiting Petroleum Corp, told analysts that his company would stop fracking new wells by the end of March; however, if prices reached $40 to $45 a barrel, they would “consider completing some of these wells”. Similarly, John Hart, CFO of Continental Resources Inc., said his company would likely increase capital spending to boost 2017 production by more than 10 percent if crude prices reached the low- to mid-$40s range.
Meanwhile, some cash-strapped U.S. oil and gas companies are considering creating an unusual layer of debt as a way of surviving the low prices. Severely distressed companies might issue so-called 1.5 lien debt, sandwiched between the first and second liens, to raise new capital. Investors with a stomach for risk would get a better yield than for the top debt, and have a stronger claim than junior creditors if the company filed for bankruptcy. Chesapeake Energy Corp., for example, is considering the strategy to swap some of its roughly-$9 billion debt. The swap would make sense for Chesapeake because its bonds maturing in 2017 and 2018 are trading at depressed levels. Senior debtholders, usually banks that have extended revolving credit lines to oil and gas companies, often balk at 1.5 lien debt because it could reduce their control over the collateral. Second-lien lenders might protest because the new layer of debt would come above theirs. Companies considering such deals might have an uphill battle trying to convince investors that the new liens would be worth anything.
Lastly, a new, massive funding source is emerging in the oil and gas industry. Indian oil and gas firms are embarking on a potentially big spending spree when it comes to overseas assets. Dharmendra Pradhan, India’s Minister of State for petroleum and natural gas recently said that Indian oil companies are looking to take advantage of the changing geopolitical scenario and secure international oil and gas assets. For one, India’s largest state-owned refiner, Indian Oil Corp (IOC), said this week it has set aside a massive budget for new projects. With IOC officials saying they have earmarked US $26 billion for new investments over the next five to seven years. The most interesting part was a report from IOC officials that some of this budget will be used to buy direct stakes in oil and gas projects overseas. If that wasn’t enough, Russian producer Rosneft announced that it sold a 29.9 percent stake in the Taas-Yuryakh project to a consortium of Indian firms consisting of Oil India, Indian Oil, and Bharat Petroresources. Although the price tag for the deal wasn’t announced, the deal was likely around US $750 million – signaling that kind of fire power the Indian firms are wielding and the scale of capital deployment that could be coming from Indian petroleum companies in various parts of the world. All of which is good news for the oil and gas developers globally.
Shares of Marathon Oil are up 44% as the price for WTI Crude increased 20%, since the beginning of March, and on positive inventory news from the Energy Information Administration (EIA). In February, Marathon Oil reported its first annual loss in 20 years, due to low oil prices. The company plans to reduce its capital expenditures by more than 50% to cope with lower commodity prices. Also, Marathon Oil announced a sizeable equity offering at the beginning of the month. The offering, 145 million shares, was priced at $7.65 per share, ~7% discount to its close on Feb 29th. The equity raise comes at the price of a significant equity dilution as the company’s share count will increase by ~25%. The equity raise relieves the pressure on CEO Lee Tillman, who announced last month that the company has planned to sell between $750 million and $1 billion in non-core assets this year in hopes of raising money to survive the market downturn. Marathon exited 2015 with $1.2 billion in cash and cash equivalents versus $7.3 billion of debt. The company’s $3 billion revolving credit facility was undrawn. The equity raise should also enable Marathon to preserve a sizeable cash pile at the end of 2016, alleviating uncertainties with regard to the company’s liquidity needs in 2017.
Disclosure: VCI has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.