Oil Producers Not Alone in Downturn
By Anthony Jerdine | March 30, 2016
Much is written about the plight of shale oil producers stemming from the downturn in oil prices. Forty-two oil companies declared bankruptcy in the U.S. in 2015, according to Haynes and Boone, and management consulting companies like Deloitte predict much more will experience the same fate in 2016. (For more, see: 5 Energy Companies Crushed by Low Oil in 2016.) Oil producers are not the only ones suffering in the oil downturn. Many other sectors related to oil production are also facing challenges as the number of Exploration and Production (E&P) companies declaring bankruptcy grows.
Oil transportation companies, also known as midstream companies, are feeling the pressure of low oil prices. E&P companies, or upstream companies, are hoping to exit deals made with these midstream transportation companies as oil producers seek bankruptcy protection under Chapter 11 restructuring, reports Oil & Gas 360. It is an unusual move because these transport contracts are usually unbreakable and remain in place even after production is sold to a new owner post-bankruptcy. In this lower oil price environment; however, upstream companies that are burdened with high debt loads are seeking alternative ways to free themselves from other financial obligations to provide more flexibility during bankruptcy proceedings.
This is a real headache for midstream companies that negotiated transportation contracts when oil prices were significantly higher than they are today. Bankrupt E&P companies are no longer able to pay previously negotiated prices and are trying to cancel pipeline contracts to clear the way for possible acquisition deals. For example, Quicksilver Resources Inc. is seeking to cancel its pipeline transportation contract with Crestwood Midstream Partners LP(CEQP) by March 31 to close the sale of its U.S. assets to BlueStone Natural Resources for $245 million, Reuters reports.
In another deal, Sabine Oil & Gas filed a motion in court to cancel its midstream contracts. Sabine argued that it “could not deliver the required minimum amounts of gas and condensate and that rejection would save Sabine as much as $115 million,” according to the law firm Jones Day. Fitch Ratings, a credit rating agency, said in a press release related to Sabine Oil & Gas’s motion to cancel its contracts with the midstream service providers that “counterparty risks continue to be a concern for the midstream service space given expectations for continued E&P bankruptcy activity.”
Another sector that is under a lot of pressure is the offshore drilling sector. Moody’s, another credit rating agency, says the offshore drilling industry is going through a severe cyclical downturn, and the agency expects day-rates to remain depressed over the next several years because of low producer spending and rig oversupply.
Paragon Offshore plc filed for bankruptcy on February 15, affecting $2.4 billion worth of debt, according to Moody’s. Paragon joins several other energy companies that have sought creditor protection amid the oil rout. Hercules Offshore Inc., the owner of the largest fleet of shallow-water drilling rigs in the Gulf of Mexico, said Feb. 11 that it’s exploring strategic alternatives — just three months after emerging from bankruptcy, Bloomberg reports.
At the end of February, Moody’s concluded rating reviews on six U.S. offshore drilling companies. Moody’s downgraded two companies’ ratings three notches, three companies’ ratings four notches and one company’s rating (Ensco plc) five notches to B1 from Baa2. The sharp downgrade reflects Moody’s view that Ensco’s leverage will increase to very high levels as more of its rigs roll off contracts in an extremely challenging offshore contract drilling market.
Multiple notch rating moves are rare for the rating agencies and are usually reserved for industries or companies under considerable financial strain.
Rig contractors have suffered the double blow of declining customer demand due to tumbling oil prices and a glut of vessels that continue to be built to meet orders made before the rout, Rigzone reports. Transocean Ltd. (RIG) leads the industry in reducing its fleet, with 24 rigs scrapped since the downturn began and it could retire another eight to ten over the next year to 18 months. In the meantime, Schlumberger (another oil industry service provider) said it’s not expecting a meaningful recovery in its own activity until next year.
Bank Loan Exposure
Debt has fuelled the shale boom, but as prices fell, companies that borrowed too much have started to find themselves under strain. This is also putting pressure on the banks that lent to these companies to fund the expansion. IMF economists warned in February that commodity price shocks could weaken banks in developing economies. It is not just regional banks in the US that are feeling the pain—big international banks have exposure to the oil sector too.
As an example, bankrupt Paragon Offshore mentioned earlier, has debt that includes $708 million due under a revolving credit agreement and $642 million due under a secured term loan, both organized by JPMorgan Chase Bank, Bloomberg reports. As a result, several major banks are reducing their exposure to the energy sector by attempting to sell off souring loans, declining to renew them or clamping down on the ability of oil and gas companies to tap credit lines for cash, the Wall Street Journal reports.
It is not just production companies that are hurting from the drop in oil prices. Everyone from businesses that sell ancillary services such as transportation to the banks that finance the industry is feeling the effects of low prices. If oil prices stay at depressed levels for an extended period, then the number of companies filing for bankruptcy is likely to rise and will extend beyond just the upstream producers.