WUEG March 2015 Newsletter

in their pipelines and processing plants. With
oil prices falling - and with no end in sight -
producers have been forced to sell pipes and
plants for some quick cash in order to stay in
the black (on top of layoffs and spending cuts).
One such deal involved Canadian gas giant
Encana Corp., who solds its Bakken pipeline
network for $3 billion to Kinder Morgan last
month. Back in December, Encana also sold
gas pipelines and plants in Western Canada’s
Montney shale region for a sum of $328 million.
Other companies that have done the same
include Royal Dutch Shell and Devon Energy.
Meanwhile, fellow producer Pioneer Natural
Resources is seeking a similar deal for its Eagle
Ford shale interests for an expected sale price
of over $3 billion.
Conversely, some shale producers are
continuing to pump the black gold out of the
ground, with the US shale oil industry as a
whole pushing output to 30-year highs and
contributing to stockpiles that are at their
largest since tracking first began in 2004. It
appears at first to go against business sense to
do so with oil prices where they are, but
studies suggest that doing otherwise would
leave the producers severely in debt.
Many in the industry have borrowed to risky
levels of leverage, at more than three times
operating profits. From a paper by derivatives
expert Satyajit Das, if firms don’t meet existing
debt commitments, then the resulting
decrease in available funding and higher costs
as debt markets close for these firms will create
a negative spiral. Inability to borrow sharply
reduces production capacity, and this lower
production combined with low prices reduces
cash flows to the point of possible default.
Another study out of the Bank of International
Settlements similarly revealed that American
oil companies have developed quite the
appetite for debt, with capital expenditures far
exceeding cash flow. Thus, “highly leveraged
producers may attempt to maintain, or even
increase, output levels even as the oil prices
falls in order to remain liquid and to meet
interest payments and tighter credit
conditions.”
But the US isn’t the only country where shale
producers are continuing to pump at a loss.
Russia’s Rosneft and Brazil’s Petrobras are also
overleveraged due to annual increases in
borrowing by 13 percent in Russia, 25 percent
in Brazil, and 31 percent in China. However,
these companies have a distinct advantage in
that they are all government-backed, so their
financing needs are met by treasury or
sovereign funds.
Most forecasts for oil prices have crude staying
fairly low for the near future, with futures
markets as of writing putting WTI prices sub-
$60 through December 2016. Therefore, one
can expect both trends to continue as long as
the market stays constrained. However, with
the furious activity in the industry that has
taken place, there may be a breaking point
approaching where companies reach some
sort of new normal where $50 oil is the
benchmark, at least until oil’s next big move.
Sources:
Bloomberg
Economonitor