Crude Collapse Has Investors Braced for ’80s-Like Oil Casualties

By Rebecca Penty and Zain Shauk

When a glut of crude flooded the market in the 1980s, scores of energy companies disappeared through almost five years of depressed prices. Investors are worried history is repeating itself.
The supply overhang led to a 66 percent slide in prices over four months, starting in November 1985. Bankruptcies and mergers reduced the number of U.S. producers by 54 percent before a price rebound took hold in 1990.
While the rout of the past seven months hasn’t yet led to the carnage of three decades ago, there are ominous signs. North American producers are cutting spending, staff and dividends to stay afloat amid forecasts for U.S. crude below $40 a barrel. Investors are fleeing those most at risk. Vulnerable companies are already defaulting on debt or seeking protection from creditors.
“As bad as it feels today, it can be worse,” said Timothy Parker, a Baltimore-based fund manager at T. Rowe Price Group Inc., which sold stakes in
two debt-laden shale operators. “What pain have you seen in two months? Not much.”
Banks will probably push high-debt companies to sell assets and restructure in the coming months, said Chad Mabry, an analyst at MLV & Co LLC in Houston. If prices stay low into September, defaults will probably rise, he said.
UBS AG said last month that default rates by high-yield energy companies may rise to 10 percent as they fail to service some of the $200 billion of bonds outstanding from a borrowing spree that fueled the shale boom.
Lenders are already being tested.
GASFRAC Energy Services Inc., a Calgary-based well service company, said Jan. 15 it had filed for creditor protection. Oil-sands developer Southern Pacific Resource Corp. risks default after skipping an interest payment last month. Closely held Laricina Energy Ltd., another Canadian oil-sands developer, defaulted on its debt this month. Quicksilver Resources Inc., a producer based in Forth Worth, Texas, had its shares delisted from the New York Stock Exchange this month.

Survival Mode

“E&Ps right now are in survival mode and they’re just trying to live another day,” Mabry said of exploration and production companies. “The more leverage they have right now, the more out of favor.”
More small companies will probably file for bankruptcy protection while larger operators may be forced to restructure, said Marty Sosland, a partner who leads the finance and restructuring group at Weil, Gotshal & Manges LLP in Dallas. Either scenario is bad for shareholders.
“If there’s a conversion of the debt to equity, then the equity is losing value,” Sosland said.
In the U.S., investors take note when a producer’s net debt exceeds three times its latest quarterly earnings before interest, taxes, depreciation and amortization, said Parker of T. Rowe Price. In Canada, fund managers get queasy with debt multiples higher than two, he said.

High Debt

Energy XXI Ltd., Bill Barrett Corp., SandRidge Energy Inc., Magnum Hunter Resources Corp., Oasis Petroleum Inc., Quicksilver and Laredo Petroleum Inc. are among U.S. producers with debt multiples exceeding three, according to data compiled by Bloomberg. In Canada, Legacy Oil & Gas Inc., Connacher Oil and Gas Ltd. and Lightstream Resources Ltd. have debt multiples higher than two.
Lightstream, Legacy, Southern Pacific, Connacher, GASFRAC and Quicksilver didn’t return requests for comment. Heidi Christensen Brown, a spokeswoman for Laricina, declined in an e-mail to comment.
SandRidge, Oasis and Laredo are among the 10 worst-performing companies on the Russell 1000 Energy Index in the last six months, while Legacy and Lightstream have fallen the most on the Standard & Poor’s/TSX Energy Index.
Lightstream announced the suspension of its dividend and an asset sale Monday. Low oil prices could threaten one of the terms of a $1.15-billion credit facility before the end of the year, the company said in a statement.
SandRidge, Oasis, Energy XXI, Bill Barrett and Magnum Hunter didn't respond to e-mail and phone messages seeking comment. Laredo declined to comment in an e-mail.

Default Risk

Anchorage-based McKinley Capital Management LLC sold its entire stake in Laredo, which was worth $9.3 million early last year, regulatory filings show. The risk of default is spreading throughout the energy industry, said Rob Gillam, chief investment officer at McKinley.
“Everything from earnings to revenue to cash flow and those kinds of statistics are compressed and falling,” Gillam said. “That means that bond covenants and those types of issues are going to raise their ugly heads.”
More than a third of analysts following SandRidge are advising investors to sell the stock, the largest negative rating on the company ever.
“I’ve been telling people to get out for whatever they can get for it,” said Jason Wangler, an analyst for Wunderlich Securities in Houston.

Tight Oil

Not everyone is sure it will take as long for prices to recover as it did after the 1986 crash. Then, the world faced a supply overhang from conventional wells that continued pumping after prices collapsed, Michael Levi, the David M. Rubenstein Senior Fellow for Energy and the Environment at the Council on Foreign Relations in Washington, wrote Jan. 15 in a blog.
Today, it’s from a surge of tight oil from shale that will drop sharply once investment stops, he said.
The price rout of the 1980s reduced the number of U.S. producers from 11,370 in 1985 to 5,231 in 1989, according to data from the Independent Petroleum Association of America. Among the casualties were two companies closely held by the fabled Hunt family of Texas, Penrod Drilling Co. and Placid Oil Co., which emerged out of two years of bankruptcy protection in 1988 after a deal with bankers.
This time around, predictions for a slow recovery and a rise in producer defaults on debt are piling up. Goldman Sachs Group Inc. said last week that U.S. crude will fall to $39 a barrel, holding there for the first half of the year.

Holding Shares

Some companies with high debt still hold value. SPO Advisory Corp., a hedge fund based in Mill Valley, California, now holds 11 percent of Oasis’s shares after adding to a position in the Bakken Shale producer first disclosed on Dec. 29. SPO probably sees value in Oasis, a company whose stock has underperformed but has assets with a lot of potential, said Will Green, an analyst for Stephens Inc. in Fort Worth, Texas. SPO didn’t return a phone message seeking comment.
Still, with the lowest oil prices in 5 1/2 years, it’s not worth betting on the most leveraged energy companies, said Eric Nuttall, a fund manager at Sprott Asset Management LP in Toronto.
You’ll probably lose money “if your strategy is flawed on timing in the rebound of the oil price,” Nuttall said.