Oil price slump drives small-cap US shale firms to breaking point

New York

PLUMMETING oil prices are pushing some of the small-cap companies, which flourished as part of the US shale energy boom, close to their breaking point while also prompting some well-known fund managers to aggressively buy energy stocks.

Concerns about slowing growth in Europe and a stronger dollar have helped push the price of light crude oil down about 25 per cent since June to about US$82 a barrel, creeping closer to the average marginal cost of crude production of about US$73 a barrel for US onshore work, according to a research note from Baird Equity Research. Those declines have sent the SIG Oil Exploration and Production index down 21.2 per cent over the last three months. "The market is selling all of these companies, even if it's clear that US$75 a barrel oil is not going to affect every company the same," said Mike Breard, an analyst who works on the Hodges Small-Cap fund, part of Dallas-based Hodges Capital.

It's a sudden turnabout for an industry that appears to be a victim of its own success. The high price of oil over the last decade was largely behind the push to mine shale oil through fracking, a controversial technique that uses high pressure to capture gas and oil trapped in deep rock. Fracking has helped the US become among the world's largest oil producers and led to concern that there is now an oversupply of crude. Production in the US is on pace to add a record 1.1 million barrels a day in 2014, and another 963,000 in 2015, according to the US Energy Information Administration.

Already, the share price of small-cap shale oil companies such as Forest Oil has fallen below US$1 as a result of high debt levels. Analysts now say that with the price of oil now close to the point where it's no longer profitable to drill, small-cap energy stocks laden with high costs and little cash on their balance sheets could prove vulnerable to further price declines and may become acquisition targets if oil stays below US$75 a barrel for six months or more. Shares of Halcon Resource Corp, a US$1.2 billion market cap company which produces oil and natural gas primarily in Texas and North Dakota, for example, have fallen 48 per cent over the last three months.

Goodrich Petroleum, a US$366 million market cap company which operates mainly in the Tuscaloosa Marine shale in Louisiana and Mississippi, has seen its shares fall almost 60 per cent over the last three months, largely as a result of the high costs of drilling at the site. "This is an US$85 a barrel stock," said David Deckelbaum, an analyst at KeyBanc Capital Markets, meaning that the company looks attractive only if the commodity remains above that price.

Even among the broad declines, some funds are finding what they see as bargains. Mr Breard, the Hodges analyst, said that his fund has been adding to its position in Matador Resources Corp, a US$1.7 billion market cap company whose operations are primarily focused in Texas's Eagle Ford shale and the Permian Basin. The company, which announced on Oct 14 that it had recently completed a new well in a company record 7.4 days, is one of the best-managed companies in the industry, which will give it the option to acquire leases or its rivals if prices continue to decline, Mr Breard said.

Bill Costello, a co-portfolio manager of the Westwood Small Cap Value fund, said that his firm has been adding to positions in companies such as US$1.8 billion market cap Bonanza Creek Energy and US$830 million market cap Synergy Resources Corp that have stronger balance sheets that could allow them to withstand oil prices below US$75 per barrel for up to nine months. It has been selling its position in US$412 million market cap Rex Energy, meanwhile, out of concern that its balance sheet is not as strong as the fund's other holdings. REUTERS