The Examiners: Higher Interest Rates Could Heighten Industry’s Troub...

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?

The stresses within the oil and gas industry are unique due to the size of the industry and its direct ties to the global economic and political environment. Affected by an uncertain global economy, weak demand and an increase in supply, the recent drop in global oil prices is further compounded by OPEC’s maintenance of current production levels.

Keeping prices low will likely disadvantage OPEC less. And as such, it may rather maintain production, keep prices low and maintain or maybe increase its market share. Sustained low prices will benefit certain players in countries, while other regions will be more disadvantaged.

Beyond the oil- and gas-exploration and production companies, we will likely continue to see the trickle-down impact to other companies affected by falling oil prices, beyond the obvious pricing pressure within the midstream and oil field services sector.

U.S. airlines, for example, have not cut fare prices and are likely to see improved profit margins. Other consumer-based companies, including global industrial products and retailers will see both positive and negative impacts in sales driven outside the U.S.—specifically increased consumer spending in areas benefiting from lower prices and decreased spending in regions negatively impacted by lower oil and gas prices.

This industry has historically been highly leveraged, and a significant portion of the high-yield-debt market sits within the oil and gas industry. The drop in prices has led to decreased capital spending and investments within those companies directly affected. However, decreased capital spending doesn’t necessarily mean decreased production.

Producers continue to get more from less and are actively allocating investments to lower cost, higher production wells. And this is not true for everyone. Higher cost producers are laying down rigs entirely and the knock on impact is significant.

Where there is less drilling and reduced production, there is pricing pressure on service providers—and worse—the idling of rigs, reduced processing, and a curtailment of gathering system build-outs.  Less revenues and related cash flows are expected to impact debt service payments. Bond prices are also declining, increasing the risk for default.  Many financial sponsor-backed companies are actively buying back their own debt. The strong U.S. dollar adds to stress in this global industry.

We may see the most stress if and when the U.S. Federal Reserve raises interest rates. Any company with significant leverage may struggle to service their debt and continue to make upcoming interest payments. This will likely affect the oil and gas industry specifically as it struggles with cash flows resulting from lower oil prices, hedges rolling off and borrowing base redeterminations.

The highly leveraged U.S. oil and gas market will continue to monitor production, cash flows and debt service as companies seek to optimize cash flows in a compressed commodity price environment. Lenders are responding to these efforts, but the credit markets is expected to remain tight as uncertainty around sustained low prices continues.

Perry Mandarino is the U.S. Business Recovery Services leader for PricewaterhouseCoopers, based in New York. Follow him on Twitter @Perrymandarino