Is 2020 Peak In Restructuring Or Only A Step To New Future?
“Records are being set in the oil service sector for bankruptcy filings. Current industry activity and pricing levels suggest restructuring pain will continue in 2021. The E&P sector may be better off, but it too faces challenges. ”
As we pass the sixth anniversary of the infamous OPEC meeting in Vienna on Thanksgiving Day 2014, at which Saudi Arabia abandoned support of oil prices in favor of restoring its lost market share, the operative word for the oil and gas industry has become consolidation. Everyone – executives, investors, and investment bankers – believes the oil and gas industry, broadly defined, needs to be consolidated. How else can the industry deal with the dramatic overcapacity in its many sectors? As long as customers perceive an abundance of assets that can meet their needs, pricing in oilfield support industries will not improve, or improve sufficiently to restore profitability for companies. By profits, we mean companies earning more than their depreciation is costing them. In other words, companies generate cash flow that covers all their operating costs, as well as reinvestment needs, while hopefully producing a return for investors.
When we examine the oil patch bankruptcy data collected and reported by law firm Haynes and Boone, we see how much more impactful the current downturn has been in pushing companies, especially those in the oil service sector, into bankruptcy restructurings. So far this year, there has been more carnage among the service industry than the E&P sector, if we measure it by the number of companies resorting to bankruptcy.
We have been tracking the annual total of companies filing for bankruptcy, as well as the amounts of secured and unsecured debt involved. Haynes and Boone started reporting the data quarterly in 2015, and monthly beginning this year. Thus, with one month to go in 2020, we can see that the oil service sector has already established several new records: more companies filing for bankruptcy, and greater amounts of unsecured and total debt involved, compared to 2017’s record year.
The latest monthly figures offer some interesting contrasts. In the oil service sector, November saw three companies with a total of $11 million of secured and unsecured debt filing for bankruptcy protection. Surprisingly, the three companies had almost equal amounts of debt involved, ranging between $3.4 and $3.8 million. In contrast, in the E&P sector, there were only two companies filing for bankruptcy protection. Of the $3.1 billion in total debt involved in these filings, almost all of it was accounted for by one company – Gulfport Energy Corp. with just over $3 billion of debt. Canaan Resources LLC, the other filer, had only $22.8 million of total debt.
Exhibit 1. Oil Service Companies Set Bankruptcy Records SOURCE: Haynes and Boone, PPHB
The E&P sector has seen only one record broken – the amount of secured debt involved in bankruptcy filings. This sector has had fewer companies filing, and considerably less unsecured debt involved, compared to the record year of 2016. It should be noted that the E&P record bankruptcies came in 2016, while the oil service sector’s filings didn’t peak until the following year. This is the normal flow of money in the oil patch – from producers to service companies. So, when the cash flows of producers shrank, and asset values collapsed, producers were forced to cut back their activity. Without activity, oil service companies saw their revenues dry up, forcing them to shrink and eventually collapse under the mountains of debt they had used to build their businesses.
Exhibit 2. E&P Bankruptcies Trailing 2016 Record Year SOURCE: Haynes and Boone, PPHB
It will be interesting to see how many additional bankruptcy filings are announced during the final days of December. Pressure to resolve financial restructurings often increases for lenders and investors as they approach calendar year-ends, given the desire to include outcomes from these restructurings in their annual tax reports. We already know of one large oil service bankruptcy filing – Superior Energy Services with at least $1.3 billion of debt – that will be in the December data. Many of the bankruptcies we have seen in recent months have involved small, private companies, so they often are not reported by the general press. The post-Christmas week could be an active one for filings, assuming we are not through with the industry’s restructuring – something we are sorry to say will likely continue in the new year.
The other tool of restructuring – mergers and acquisitions – also was on display recently, as Diamondback Energy Inc. announced it was purchasing two competitors in stock and cash deals, totaling $3.2 billion including debt assumed. The company is acquiring QEP Resources in a stock-and-debt swap valued at about $2.2 billion. It is also purchasing the lease interests and assets of private equity Blackstone Group-backed Guidon Operating LLC for about $850 million. Both deals will add to Diamondback’s Permian Basin acreage and output, with the QEP assets in the Williston area of Canada likely to be sold. The consolidation in the Permian follows on Pioneer Natural Resource Co.’s acquisition of Parsley Energy Inc. and ConocoPhillips purchase of Concho Resources Inc. All of this consolidation activity is not good news for employees, as combined companies need fewer workers.
M&A in the E&P sector is much easier to accomplish as there is little involved in the transfer or integration of leases and wells. The people can be released. That is not the case in the oil service sector where assets require people to operate and maintain them. Low activity levels, however, mean many assets are parked not earning any money. The oil service sector will struggle longer to consolidate, suggesting that more bankruptcies will be experienced in this sector during 2021.