The Examiners: Curtailed Spending Could Prolong Industry Pain

How much stress can we expect to see for oil and gas producers and related companies as a result of the current low prices?  And what special issues does this industry face when it’s time to restructure or file for bankruptcy?

Over the course of seven months, the price of West Texas Intermediate crude oil dropped to $44 per barrel in January 2015 from a high of $107 per barrel during July 2014—a 59% decrease. Although a small rebound occurred, WTI prices have continued to hover below $50 per barrel, reaching $48.87 per barrel on March 27. A similar but less severe decrease has occurred in natural gas prices. These decreases will have significant impact on oil and gas companies and several related sectors in a series of waves that have already begun and will most likely continue for some time.

A number of highly-levered producers have already been overwhelmed by the abrupt commodity price decreases and as a result have missed interest payments. Several have file for protection under chapter 11 of the bankruptcy code. As producers search for liquidity, we will likely see attractive midstream assets offered for sale by integrated oil companies, accompanied by an increase in sale and merger activity involving independent producers.

The magnitude of the recent oil price drop is not without precedent; during 2008, WTI fell to $34 per barrel from $145 per barrel in less than six months.

Consistent with industry reactions to previous price declines, producers are already curtailing capital expenditure budgets by significant amounts. Several recent surveys indicate that producers are cutting capital expenditures by as much as 20% to 30% as compared to 2014 levels. These reductions will severely affect companies providing services to oil- and-gas producers over the next 12 months and will likely spawn another wave of restructurings and bankruptcy filings.

Thus far, service providers have announced layoffs impacting 58,000 jobs, with Schlumberger, an industry leader, accounting for 9,000 of those. Cal Dive International Inc., an early casualty, filed for bankruptcy on March 3. While the industry faces many of the same issues as other industries, it requires a high level of technical expertise that is unique to oil and gas, and energy in general.

Although reductions to capital expenditures can help producers to bridge short-term liquidity needs, they also reduce cash flow and impair value in the long term. Resulting reductions in cash flow could prolong some of the “pain” in the industry, even after a partial recovery in commodity pricing.

Prolonged reductions in producer cash flow could impact borrowers’ ability to service debt, which will affect lenders with significant exposure to oil and gas producers and their complementary service companies. The Wall Street Journal reports that a number of major banks are facing significant losses on loans made to energy companies. In addition to affecting the financial results of these lending institutions, such losses will likely reduce new lending into the sector, exacerbating the degree of financial distress in the industry.

Ralph S. Tuliano is chief executive officer of financial advisory firm Mesirow Financial Consulting LLC and a member of the American Bankruptcy Institute’s board of directors.