Oil Patch Bankruptcies In 2020 Set Records
“Record amounts of companies and debt were involved in the oil patch bankruptcies last year, according to Haynes and Boone’s data. We examine the historical record and look for any interesting patterns. ”
The year 2020 is now behind us, and virtually everyone would say Good Riddance! Covid-19 altered everyone’s life and work, and unfortunately, it took too many lives. Those in the oil patch experienced a once-in-a-lifetime event – oil prices falling into negative territory. They are hopeful last year marked the bottom in this cycle and 2021 begins the next cyclical upturn. The move by Saudi Arabia to support higher oil prices – regardless of its specific rationale – was a welcomed development. Some people, however, may be worried they are merely walking through a swinging door and at some time in 2021 they will get slammed in the face when the door swings back. The most recent mobility/congestion data for cities around the world and in the United States has shown a slump, as government response to the latest coronavirus outbreak has been to reinstate economic lockdowns, which is depressing activity. That is not a good sign for oil demand during the balance of the winter months, and people wonder with mutant virus strains whether the battle to control the virus will prove as successful as many forecasters are predicting.
The move by OPEC+ to keep tight control on oil supplies has helped boost oil futures prices. The cold weather in the Northern Hemisphere, especially Asia and Europe, is lifting optimism that the $50 a barrel oil price marker will soon become a price floor, even if demand slips slightly due to the Covid-19 outbreak. As confidence that $50 is the new price floor grows, petroleum industry spending will start to ramp higher. The pace of that activity increase will become the new focal point on assessing the fortunes for the petroleum industry. Will the rig count climb quickly? Will producers, who have already announced modest spending increases for 2021, suddenly revise their spending plans higher? Watching each trend and parsing the words of energy CEOs at investor conferences will become the new sport.
In putting 2020 to bed, law firm Haynes and Boone recently published its bankruptcy tracking data for December. The firm noted that E&P debt involved in bankruptcies in 2020 was comparable to 2016’s record year. Moreover, $175 billion of E&P debt has been involved in bankruptcies since 2015, with 2020 accounting for over 30% of that total. Last year was also marked by an increase in billion-dollar filings, as the E&P sector recorded 14 such cases, while the oilfield services sector only had nine. Possibly the most telling oil patch data point is that since 2015, there have been more than 500 Chapter 11 filings of E&P, oilfield service and midstream companies. This explains why it’s hard to get a bankruptcy lawyer on the phone these days. But that figure also reflects the highly fragmented structure of the petroleum industry and the magnitude of the devastation the industry experienced.
To remind readers, the law firm switched from reporting quarterly to monthly the petroleum industry bankruptcy filings and the amounts of secured and unsecured debt involved, to provide a better measure of what was happening to the industry. With the December data, we are able to update our charts showing the annual amounts of debt by class and the number of companies in each of the oilfield services and E&P sectors involved in bankruptcies. For the first time, we are also publishing sector charts with the monthly data, enabling us to examine if there was any pattern to the filings that might provide a clue to what may happen in 2021.
Thankfully, last year, the E&P sector did not match the record number of companies filing for bankruptcy protection in 2016 (46 versus 70). Neither did 2020 match the total amount of debt involved in the annual filings ($53.1 billion versus $56.8 billion). Oil prices recovered somewhat in 2017, which helped keep it from setting new records. In fact, the number of E&P bankruptcies in 2017 fell by nearly two-thirds from 2016, and the total amount of debt involved was only 15% of 2016’s total.
Last year marked the fourth consecutive year of increasing E&P bankruptcy filings since 2016. This suggests the financial pain experienced in 2020 was just as or possibly more intense than the industry experienced in 2016. Part of what we saw in 2016, barely two years after the collapse in oil prices, was the initial economic reckoning for shale producers. For years, almost from the start of the shale revolution at the tail end of the 2000s, there were skeptics of the potential for producers to be profitable while exploiting shale formations due to the large number of wells needing to be drilled, the high cost of drilling and completing the wells, and the rapid declines in well production. The critics claimed that the unprofitable shale producers were being supported by oil that was priced in the $100 a barrel range. Once oil prices dropped, the unprofitable producers became clear.
Oil prices peaked in June 2014 and began a slow, but steady decline until Thanksgiving Day when the OPEC meeting shattered the oil market, leading to a collapse in prices. Producers could no-longer continue to drill expensive wells in order to boost production in hopes of generating sufficient revenue to stave off the inevitable financial reckoning. One could describe the record bankruptcies in 2016 as ‘blowing the foam off a head of the beer.’ Others might call 2016 the ‘bursting of the shale bubble.’ In whatever way you describe it, the shape of the oil and gas producing sector was changed, and continues to evolve even today.
Exhibit 1. A Tough Year For E&P Companies SOURCE: Haynes and Boone, PPHB
The unanswered question at the moment for the E&P sector is whether a $50 per barrel oil price environment is sufficient to stem the financial bleeding of producers. Will companies be able to sustain their production, while beginning to reduce their debt levels more rapidly, providing creditors with a runway to a healthier company – a situation that was not as evident in 2020, especially after the collapse of oil prices in April. If E&P company managements demonstrate they are exercising ‘financial discipline’ and can navigate onto the runway to profitability that is emerging, creditors are likely to give them more time to dig out from their debt morass. Remember, bankers are not interested in becoming oil producers unless that is the only alternative available. A higher oil price environment may also facilitate a more dramatic restructuring of the E&P industry via mergers and acquisitions. The financially stronger producers may be more willing to take on more-highly leveraged competitors whereby the combined company remains financially strong and enhances its asset portfolio. Such a scenario may be a plus for creditors who will get some or all of their money back, or receive a blend of cash and stock that may help them recover most of their loans. These are welcomed outcomes for creditors who are stuck with unprofitable E&P companies.
If oil prices suddenly fall back, then demand has dropped rather than advanced due to the virus and a double-dip global economic recession. The question of the day will quickly become whether 2021 will mark the fifth year of rising E&P bankruptcies. The answer will lie with the attitude of creditors. As 2021 opens, producers are finding that they are losing financial flexibility as the climate change movement works successfully to force commercial banks, insurance companies and pension funds to cease financing fossil fuel producers. Lower oil and gas prices, reduced demand and weaker cash flows will challenge producers to avoid transitioning into self-liquidating entities. If they fail to stop such a transition, more bankruptcies may lie ahead.
In contrast to the E&P sector, the oilfield service sector did set bankruptcy records in 2020. With 61 companies filing for Chapter 11 protection, the sector exceeded by nearly 18% the number of filings in 2017’s record year. Total unsecured debt of $26.3 billion last year was more than double the $12.2 billion involved in the 2017 bankruptcies. Total debt involved in bankruptcies last year was nearly 28% more than the total from the prior record year of 2017 ($45.1 billion versus $35.3 billion).
Exhibit 2. OFS Sector Sets Several Records SOURCE: Haynes and Boone, PPHB
The most surprising observation about the pattern of monthly E&P bankruptcy filings was how, at the start of the year and the last half of 2020, most of the filings were small companies with limited amounts of debt. That doesn’t mean they weren’t upside down in their financial affairs, only that the larger indebted E&P companies seemed to all file in the late spring and summer months. A coincidence? We don’t know. But if we were to guess, it probably related to the timing of the annual bank lending reassessment process, which is based on reviewing the latest valuation of a company’s producing assets. That is usually done after producers file their annual financials for the prior year, generally by April. There is a high likelihood that once companies found the amount of their bank lines was being cut, or possibly that their asset values did not support their current borrowings, producers faced the reality they needed to restructure their balance sheets, oftentimes best done under Chapter 11 protection.
Exhibit 3. E&P Filings Likely Reflect Bank Loan Reviews SOURCE: Haynes and Boone, PPHB
When it comes to the pattern of monthly bankruptcy filings for oilfield service companies, there is no pattern. The large monthly amounts of debt involved in cases seems to be spread out almost evenly – every other month or two. The types of companies and the amounts of debt involved varied dramatically from month to month. In January and April, the nearly $10 billion and $12 billion of total debt was accounted for by one company and then by two companies, respectively. On the other hand, the $9, $6 and $4 billion total debt amounts involved in July, October and December, reflected seven, nine and five companies, respectively. In other words, there were a few very large, indebted companies involved in Chapter 11 filings in certain months, while there were many smaller, less indebted companies in other months.
Exhibit 4. No Pattern To OFS Bankruptcy Filings SOURCE: Haynes and Boone
Speculating on the number and timing of possible oilfield service company bankruptcy filings in 2021 is difficult. It will depend on three factors: the level of oilfield activity, which is a function of oil and gas prices and producer spending; where E&P spending is directed – drilling, completions and/or production, onshore or offshore, domestic or international; and the financial health of the service company. Therefore, we could continue to see Chapter 11 filings in the oilfield service sector, as reduced activity continues to hurt many smaller companies. We would like to think that after 251 oilfield service company bankruptcies over the last six years, maybe the worst is behind the industry. The reality is that major oil industry downturns wreak havoc on its sectors that often require years to resolve. Dealing with too many assets (‘iron’) is a major stumbling block in financial restructurings of oilfield service companies. A better 2021 for the oil patch will still see more bankruptcy filings – something that keeps the bankruptcy lawyers employed – but maybe not set new records. A recent study by Rystad Energy suggests 21 more E&P bankruptcies in 2021 followed by 12 in 2022. Let’s hope they are wrong, but we wouldn’t bet against their forecast.