Bankruptcy in the US Oil and Gas Industry

The ongoing oil and gas industry crisis is bringing companies to their knees as a result of stubbornly low prices. As recovery is elusive and unpredictable, strategies to aid distressed companies and prevent bankruptcy have to be realistic, proactive, and address the obvious capital structure problems while preserving the underlying business.
One persistent problem in the oil and gas world right now is the pricing crystal ball is partly cloudy and partly sunny – that is to say there is a high degree of uncertainty around which direction prices are headed and when. Options for dealing with financial crisis are made much more complicated when opinions on the future direction of oil prices are as diverse and plentiful as subaquatic plant life.

Further, the upstream oil and gas industry is obviously a capital-intensive industry where massive reinvestment is the name of the game. Without sufficient cash flow to replace production taken out of the ground, much less add to the proved reserve base, growth is stilted. With oil prices currently hovering at levels where many companies break-even, there is little, if any, cash left over to even pay a return on current invested capital.

A painful irony is that the current crisis is in many ways a product of the industry’s success. Commercializing the production from shale was an amazing technological breakthrough and unlocked massive new supplies of hydrocarbons. As it evolved in both its efficiency and productivity, shale drilling was a seed for the oil price downturn and whether the industry saw it coming or not, the classic prisoner’s dilemma likely would have kept everyone drilling and set on the course for where we are today.

Shale drilling, the disruptive technological innovation that it was, seemed to attract ever more offers of capital, which the industry was happy to accept, further accelerating the buildup of both massive fortunes for investors and an oil supply glut.

Fast forward to today, what started last year as a supply issue both in the U.S. and globally with strong OPEC production, we are now in a world where slowing growth in emerging markets, namely China, has raised the potential for a demand pullback. Further muddying the outlook is what the impact may be from a new global war on terrorism begins to take shape in Europe and the Middle East.

And if that wasn’t enough to wreak havoc on an oil price forecast, there are a number of concerns that industry, political, and economic leaders have had for decades regarding the quality and accuracy of information in emerging markets. This impacts everything from quantifying and tracking the quantities of oil & gas reserves and production in OPEC countries to determining whether China is entering, or is already in, a recession. These all have significant impact on the duration of an oil price cycle and ultimately how you restructure a balance sheet for potentially a “new normal” oil price that is 50% of what it was last year.

In terms of the restructuring industry, there have obviously been a number of situations that have already hit crisis mode. Many of these were not news or surprises to the energy restructuring community. These companies already had unsustainable amounts of debt or the wrong kind of capital for the type of assets and were in need of restructuring regardless of what happened to prices.

Also in the first half of the year, there were a number of situations that were able to tap the capital markets and potentially fix the problems, or at least get a lifeline to fight another day. Investors were “doubling down” on shale and likely placing bets on a short trough and quick recovery of commodity prices. As we now know today, oil prices have stayed stubbornly low and many of these investments made in the first and second quarter got run over by the pain train – again.

Now in the second half of 2015, troubled companies are running out of time. The few deals that were made didn’t perform, bank extensions are slowing and hedges are burning off. There may not be that many out-of-court options or lifelines thrown to these companies to keep them out of Chapter 11 proceedings. The parts of the formula that kept some of these companies afloat – the hedges, banks’ cautious approaches, and capital investment – appear to have changed somewhat dramatically in these last months.

That being said, the timing is ripe for many struggling companies to address the crisis before running out of the necessary runway to do so. Solutions take time and in these situations, that is almost always defined by how much cash the business has. We try to stress to troubled companies that the time to address liquidity problems or take on a comprehensive balance sheet restructuring is not when you have spent your last dollar.

What options these companies have today is various and, in my view, encouraging for the right situations but players have to be realistic as well. There are still some strategic partners and capital providers of every sort out there, albeit savvier and more opportunistic now. But whether it is taking on new capital or a new buyer or any other restructuring program, these all take time. The more time you have, the more options and the better the company will be. In the restructuring world, cash is king. If you run low on cash, you run low on time and options rapidly diminish.

As far as industry-wide recovery, it is anybody’s guess what will happen and anything is possible. Some are bullish and think we are poised for recovery. Some think we are stuck in a U-shaped recovery or potentially a W-shaped recovery where we will see volatility before stability.

As far as solutions, the industry has been advocating this for more than a year now a lift on the decade-long ban on exporting oil. As we have an oil glut in the nation, another outlet would alleviate the oversupply.

Other than the lift on that ban, there is little government can do. Strangely, it was recently announced that the federal government was planning to sell production out of the Strategic Petroleum Reserve in order to raise additional funds for general purposes. Although the incremental supply in the market is unlikely to have any pricing impact, it’s quite the opposite strategy one would expect if you have the capacity to store oil to decide to sell at prices that are near six year lows. I am still trying to figure that one out.

Distressed companies should not wait for recovery, but seek options now before situations became too critical to stay out bankruptcy. Unfortunately, I think we will see many more industry bankruptcies before prices turn a corner.