On non-OPEC distress & the road ahead

Having spent the entire week gauging the oil market mood in Houston, Texas, several key themes seem to be emerging. US shale oil exploration has come to symbolise non-OPEC production rises over the past three years and how it performs over the coming years would go some way towards providing an indication on when the market rebalances and where the oil price goes from here.

In that respect, the Oilholic’s third outing at the Baker & McKenzie Oil & Gas Institute provided some invaluable insight. Delegates at the Institute and various panels over the course of the event invariably touched on the subject, largely opining that many fringe shale players might well be on life support, but the industry as a whole is not dead in the water (see above left).

The problem is the paucity of high-yield debt for the oil & gas sector, where private equity (PE) firms were supposed to step into the breach vacated by big banks, but it is something which is not (currently) being meaningfully reflected in the data. 

One got a sense, both at the Institute and via other meetings across town, that PE firms are not quite having it their own way as buyers, and at the same time from sellers’ perspective there is also a fair bit of denial in a cash-strapped shale industry when it comes to relinquishing asset, acreage or corporate control.

Sooner, rather than later, some struggling players might have little choice and PE firms might get more aggressive in their pursuit of quality assets over the coming months, according to Mona Dajani, partner at Baker & McKenzie.

“You must remember that the PE market is quite cyclical. The way I view it, now would be as good a time as any for a PE firm to size-up and buy a mid-sized exploration and production (E&P) company as the oil price gradually creeps upwards. Jury is mixed on bid/ask differentials narrowing, but from what I see, it is happening already,” she added. 

William Snyder, Principal at Deloitte Transactions and Business Analytics, said, “To an extent hedge positions have protected cashflow. Going forward, PE is the answer right now, for it will be a while before high-yield comes back into the oil & gas market.”

The Deloitte expert has a point; most studies point to massive capital starvation in the lower 48 US states. So those looking to refinance or simply seeking working capital to survive currently have limited options. 

Problem is the PE community is cagey too as it is embarking on a learning curve of its own, according to John Howie, Managing Director of Parallel Resource Partners. “Energy specific funds are spending time working on their own balance sheets, while the generalists are seeking quality assets of the sort that have (so far) not materialised.”

Infrastructure funds could be another option, Dajani noted. “These (infrastructure) funds coming in at the mezzanine level are offering a very attractive cost of debt, and from a legal perspective they are very covenant light.”

Nonetheless, given the level of distress in the sector, the Oilholic got a sense having spoken to selected PE firms that they are eyeing huge opportunities but are not willing to pay barmy valuations some sellers are coming up with. The thinking is just as valid for behemoths like BlackRock PE and KKR, as it is for boutique energy PE specialists from around the US whom Houston is playing host to on a near daily basis these days. 

There are zombie E&P companies walking around that should not really be there, and it is highly unlikely that PE firms will conduct some sort of a false rescue act for them at Chapter 11 stage. Better to wait for the E&P company to go under and then swoop when there is fire-sale of assets and acreage. 

Nonetheless, while we are obsessing over the level of industry distress, one mute point is getting somewhat lost in the ruckus – process efficiencies brought about by E&P players in a era of ‘lower for longer’ oil prices, according to John England, US Oil & Gas Leader at Deloitte (see right, click to enlarge). 

Addressing the Mergermarket Energy Forum 2016, England said, “Of course, capital expenditure cuts have triggered sharp declines in rig counts globally except for the Middle East. However, production decline has not been as steep as some in the industry feared. 

“This has been a tribute to the innovations and efficiencies of scale across North America, and several other non-OPEC oil production centres. A sub-$30 per barrel oil price – which we recently saw in January – drives innovation too; for a lower oil price environment motivates producers to think differently.”

Over nearly twenty meetings spread across legal, accounting, financial and debt advisory circles as well as industry players in Texas, and attendance at three industry events gives one the vibe that many seem to think the worst is over.

Yet, the Oilholic believes things are likely worsen further before they get better. Meanwhile, Houston is trying to keep its chin up as always. That’s all from the oil & gas capital of the world on this trip, as its time for the plane home to London. Keep reading, keep it crude!

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© Gaurav Sharma, 2016. Photo I: Panel at the Baker & McKenzie Oil & Gas Institute 2016 © Lizzy Lozano, Baker & McKenzie. Photo II: John England of Deloitte addresses the Mergermarket Energy Forum 2016 © Gaurav Sharma.

It’s about the ‘crude’ bid/ask differential stupid!

That there are distressed oil and gas assets stateside is pretty obvious. The damage was done, or rather the distress was caused, long before the crude oil price started lurking in its current $40-50 per barrel range, with no guarantees and only calculated guesses on where it is going next.

Actually, nowhere but the current range, as some, including the Oilholic, say. We’d agree that the high yield debt market is in the doldrums, and pretty much since the oil price slump began in 2014 we are told private equity players are sizing up the level of distress and waiting for a timely swoop for assets armed with billions of dollars. 

There is only one problem – the bid/ask differential. Some, not all, sellers of distressed assets are still in denial and holding out for a better price. Buyers themselves, to be read as private equity buyers, are no mugs either and won’t buy any old asset at any old price. It then bottles down to the buying the right asset at the right price in a high stakes game, to quote not one but several of this blogger’s friends who addressed the Baker & McKenzie Oil & Gas Institute.

Then again other industry contacts, whom yours truly interacted with at the Mergermarket Energy Forum, say there is evidence of the bid/ask differential narrowing considerably relative to last May because some sellers literally have no choice and are desperate.

But now the PE guys want ‘quality’ distressed assets and some, as has become apparent in the Oilholic’s discussions with no less than 20 industry contacts and having participated in three oil and gas events (and counting) since Monday.

Anecdotes go something like this – some PE firms no longer want to buy an asset from a distressed oil and gas firm in Chapter 11 bankruptcy proceedings, but rather wait for it to actually go bust and then go for the target asset on much better terms, despite the obvious risk of losing out on the deal should another suitor emerge during the game of brinkmanship.

The debate will rumble on for much of 2016 with close to 70 US oil and gas firms having filed for bankruptcy this year alone! You get a sense in Houston that PE firms have the upper hand, but aren’t having it quite their own way, just as plenty of zombie small to mid-sized oil and gas companies that do not deserve to survive continue to muddle along. That’s all for the moment from Houston folks; keep reading, keep it crude!

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© Gaurav Sharma 2016. Photo: Oil pump jacks in Texas, USA © National Geographic Society.