The Fuse

In the Shale Patch: 42 Bankruptcies, and Counting

by Matt Piotrowski | January 22, 2016

The number of bankruptcies in the shale oil and gas sector is reaching alarming levels, and may continue to rise. In 2015 in the North American oil patch, there were 42 bankruptcies with company debt totaling $17 billion, according to data from Haynes and Boone, a law firm that tracks developments in the energy sector.

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In 2015 in the North American oil patch, there were 42 bankruptcies with company debt totaling $17 billion. More are expected this year.

The shale boom that led to the massive rise in production from 2011-2015 was underpinned by small and mid-size independent producers that had easy access to capital. With oil prices having lost more than 70 percent in a little more than a year and a half and banks taking on too much debt, companies are going through severe pain, with some having to shut down or sell assets. Ironically, oil production has dipped only slightly despite the carnage seen throughout the industry. The situation appears likely to worsen throughout 2016, particularly now that oil prices are at $30 per barrel, with many companies not able to cover marginal costs and most hedges having rolled off the board, leaving the sector even more vulnerable to current price levels.

“Some prominent analysts feel that very few, if any, companies in the shale play are cash-flow positive right now,” William Arnold, a professor at Rice University and formerly the Director of International Government Relations at Royal Dutch Shell, told The Fuse. “Why are they still producing? There’s this feeling that they may be able to ride it out by jettisoning non-core assets.”

Arnold added: “There’s been a general psychology in the industry that the market will rebound, but it could be more hope than logic.”

Shale oil production from the seven biggest plays totals 4.95 million barrels per day, according to the Energy Information Administration (EIA), more than half of the country’s output. For the most part, all companies involved in shale production are at risk in the low price environment.

“Every non-major in the shale oil patch, whether an E&P or services company, is vulnerable to bankruptcy.”

“Every non-major in the shale oil patch, whether an E&P or services company, is vulnerable to bankruptcy,” Marc Schwartz, principal and co-founder of Houston-based HSSK, told The Fuse. Schwartz’s firm says it is expecting a 30 percent increase in bankruptcy filings in Texas this year, with most being in oil and gas.

“2016 will be worse than 2015,” Patrick Hughes, the managing partner in the Denver office of Haynes and Boone, told The Fuse. “There will be a lot more bankruptcies, M&A, and restructuring.”

Almost half of all bankruptcies took place in Texas in 2015.

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Some companies have adapted better than others, while break-even costs vary among plays. There’s also the issue of improved efficiency allowing companies to squeeze out more oil from operating rigs. Companies in the shale patch are not all the same, and the ones that are most vulnerable to bankruptcy are those that have poor-performing assets, high debt, little cash flow, and limited or no protection through hedges.

Since shale producers have negative cash flow, they have depended heavily on capital market injections to stay afloat. “Companies are very, very, very cash conscious,” said Schwartz. “There’s cash management like you’ve never seen before.”

Schwartz notes how important it is for companies to show proper cash management, improved technology, and enhanced efficiency to lenders in order to get new injections of capital.

Even though a large number of companies are filing for Chapter 11 bankruptcy, their assets continue to produce even when creditors take possession. As noted in The Fuse last September: “Bankruptcies without production shut-ins won’t rebalance the market—ultimately, shutting down production in fringe and marginal areas will be required.”

“Ownership is at risk more so than production,” said Schwartz. “Companies won’t drill additional wells, but there’s already a huge amount of oil in the bank, or in the ground, so to speak.”

Haynes and Boone’s Hughes said: “Bankruptcies will definitely put a damper on drilling activity. In most cases, companies will try to maintain activity, but they won’t be able to further develop activity, so there’ll be a natural decline.”

The EIA sees a .7 mbd drop in total U.S. production this year. If this forecast is realized, it would be a relatively modest decline given the number of expected bankruptcies, the persistently low oil price environment, higher interest rates, and limited access to capital for the sector.

All firms getting slammed

Smaller firms are the most exposed. Just this month, ZaZa Energy in Houston, which was founded in 2008 and began operations in 2012, shut down its website and its phones after not being able to make payroll last year and being delisted from the Nasdaq. The company was focused on unconventional plays and had good acreage in the prolific Eagle Ford play in Texas, but it couldn’t operate with current price levels.

But larger companies are also getting hit. For instance, Samson Resources Corp. filed for bankruptcy in September and had total debt of $4.33 billion. The company, which has had a number of forays into unconventional wells in the U.S., has been around since the early 1970s and has operated outside of the U.S. Big firms such as Chesapeake, Energen Corp. and Concho Resources had large amounts of supply hedged last year, allowing them to weather the precipitous drop in prices. But not so much in 2016. Carbon Tracker wrote, in the middle of 2015, that in order to compensate for losing hedging gains this year, companies would have to “use a range of options, including capital raisings and asset sales, lower capital expenditure, or even debt restructuring.”

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The fact that companies don’t need to rely solely on banks for capital has helped shale firms wade through the current turmoil, with non-bank lenders such as private equity firms playing a major role.

The fact that companies don’t need to rely solely on banks for capital has helped shale firms wade through the current turmoil, with non-bank lenders such as private equity firms playing a major role, and likely to continue to do so since they are not subjected to the same regulations as banks. In the current environment, bank lenders must continually re-evaluate the value of companies’ reserves. With oil prices dropping, the value of the reserves obviously goes down too. Against this backdrop, companies can’t renew loans with banks—hence, the attractiveness of non-traditional lenders.

These conditions make today’s price collapse unique. “The situation is different than the price collapses of 1986 and 2008,” said Arnold. “Companies have been able to get capital from not only banks, but also from other sources of debt and equity instruments.”

Industry will need manpower again when prices rise

One other major difference between now and the 1980s, when the oil sector and banks were decimated by the oil price downturn, is that the industry is maintaining its infrastructure and workforce. Thus, when oil prices rebound, it will have the technology and manpower to boost activity and keep up with demand.

The shale patch is clearly in uncharted waters right now, and while many companies have adapted, not all will survive. The cliché is that it will have to get worse before it gets better—which appears to still be the case.

But there’s a catch here—the enhanced efficiency and technological gains seen in the shale sector amid the price drop make much of the workforce redundant. When prices eventually rise again and activity grows, companies will have to hire more manpower in order to capitalize on the rebound. However, they don’t want a repeat of what happened after the 1980s, when personnel fled and the industry had a shortage of skilled workers. Companies are cognizant of this issue and understand the risks. Oil services company Schlumberger, for instance, has taken up “re-training,” which is training skilled workers to become proficient in performing the tasks of two or three skilled workers in order to fill any gaps that may come up.

The shale patch is clearly in uncharted waters right now, and while many companies have adapted, not all will survive. The cliché is that it will have to get worse before it gets better—which appears to still be the case.