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Oil rout ratchets up pressure on producers to sell
[NEW YORK] The rout in crude oil is turning out to be more than just a blip, and producers that are feeling the pinch may have to start selling.
All of the energy company bonds tracked in a Bloomberg high-yield index - representing a combined face amount of about US$180 billion - are now trading at levels considered distressed. The gauge includes explorers such as Halcon Resources Corp, Energy XXI Ltd and Goodrich Petroleum Corp, all of which could turn to asset sales to shore up their finances.
Others may follow the lead of Talisman Energy Inc and decide a takeover premium to today's depressed prices is a better solution. Lightstream Resources Ltd put its oil-rich Bakken shale assets on the block last month, though its plunge to an all-time low could draw bids for the whole company, said Kyle Preston of National Bank Financial. The selling pressure will give buyers with cash to spend and a willingness to ride out market volatility plenty to choose from.
"In December, there was still a lot of thought that we were going to have this rebound," Neal Dingmann of SunTrust Banks Inc said in a phone interview from Houston. "As those attitudes change, you're going to have these deals start to happen sooner rather than later. You can only sort of kick the can down the road so long."
West Texas Intermediate crude has plunged more than 50 per cent from its peak last year and last week fell to as low as US$44.20 a barrel. The Russell 1000 Energy Index has lost more than US$500 billion in market value over the same time period.
Tanking oil prices will mean less cash flow to repay the debt that producers took on amid record-low interest rates. CreditSights Inc predicted the default rate for energy junk bonds will double this year. Since producers' borrowing capacity is tied to the value of their reserves, companies may also find it harder to refinance or get new loans, especially if they have low credit ratings. Spending cuts may only go so far, leaving asset sales as the next best option to raise cash.
"A lot of these companies are having some heart-to-heart discussions with their lending groups right now," Chad Mabry, a Houston-based analyst at MLV & Co, said by phone. "We're definitely going to see some tough love doled out. That's what's going to be really the catalyst for M&A activity."
Some producers have already taken steps to cut costs and shed assets. Others are likely to follow. Goodrich Petroleum is exploring options for all or part of its Eagle Ford shale assets after losing about 90 per cent of its market value in the oil rout. The company had about US$610 million in debt at the end of September, or more than four times its current market value.
Halcon Resources has the most debt relative to its market value among similar-sized North American peers, according to data compiled by Bloomberg. The company this month said it would focus its reduced drilling budget on just three rigs, two in the Fort Berthold area of the Williston Basin and one in its El Halcon property in East Texas. It had planned to have as many as 11 rigs in 2015.
The cutback opens up the possibility that Halcon could try to sell some of the acreage where it's not currently drilling, said Dingmann of SunTrust. The US$507 million company also has acreage in the Tuscaloosa Marine and Utica shale formations, according to its website.
With sustained low oil prices, "companies will start to sell off the family silver," David Meats, a Chicago-based analyst at Morningstar Inc, said by phone. Halcon and Goodrich are among those that "need to keep an eye on their liquidity the most. They are the most likely candidates" to sell assets.
Others to watch include Clayton Williams Energy Inc and Denbury Resources Inc, according to Mr Dingmann. Clayton Williams can withstand the downturn, chief operating officer Mel Riggs said in a phone interview. The company's main positions in the Eagle Ford and Delaware Basin aren't for sale, though it would consider selling non-core assets if approached, he said.
On the Canadian side, heavily indebted companies such Penn West Petroleum Ltd and Bonavista Energy Corp will also need to do something to raise cash, Mr Preston said.
For some producers, a plan for asset sales could turn into a full-blown change of control. Lightstream was already feeling the pressure of its debt load last month when oil was about US$56 a barrel and the Calgary-based operator announced plans to sell all or part of its Bakken assets over the next two years. With crude now even lower and its stock cheaper, buyers may just bid for the whole company instead, said Preston of National Bank Financial.
Mr Preston values the Bakken assets at about C$1 billion, compared with Lightstream's market capitalization of just C$204 million. Crescent Point Energy Corp, a possible suitor for the assets or company, "is in the driver seat and Lightstream is backed into a corner," Mr Preston said.
While Lightstream Monday announced the suspension of dividend payments and a small asset sale, the company's debt is poised to amount to almost 10 times its cash flow this year, which violates debt covenants, Mr Preston said in a note, recommending shareholders sell the stock.
Most takeover interest will focus on producers with stronger balance sheets that have become more affordable with oil's plunge, said Mabry of MLV. Major oil companies certainly have money to spend. Private-equity funds have also been stalking the oil patch for deals.
"Once the better-capitalized companies, the larger cap companies see a bottoming here, they're going to snatch up what they see as attractive deals for quality assets," he said. "It's going to be all about quality."
Mr Mabry puts Carrizo Oil & Gas Inc and PDC Energy Inc in that category. Mr Dingmann of SunTrust pointed to Continental Resources Inc and Whiting Petroleum Corp, two of the largest operators in the Bakken shale formation.
Global Targets Other buyers are looking beyond North America. Schlumberger Ltd, the world's largest oilfield-services provider, on Tuesday said it will pay US$1.7 billion for a stake in Eurasia Drilling Co, which operates in Russia. Elsewhere, Tullow Oil Plc's management is concerned the British company could be vulnerable to an approach after plunging oil prices eroded its market value, people familiar with the matter said last month.
Santos Ltd, an Australian oil explorer that's building an US$18.5 billion gas export project, could also tempt suitors. The company said in December that it may sell assets.
Representatives for Denbury; Carrizo; PDC Energy; Goodrich; Halcon; Bonavista; Lightstream, and Continental Resources didn't respond to requests for comment. Representatives for Penn West, Tullow, Whiting Petroleum and Santos declined to comment.
Buyers may hold off until oil prices stabilize, said Chris Feltin of Macquarie Group Ltd. Right now, sellers are likely holding onto dreams of their pre-collapse valuations and not interested in striking deals at such depressed prices, he said.
Those that do agree to transactions will probably push for all-stock deals so that their investors can take advantage of an eventual recovery in oil prices, said Michael Dillard, managing partner for the Houston office of Latham & Watkins LLP.
Even so, Repsol SA's US$8.3 billion deal for Talisman in December shows that there are willing buyers and sellers. Repsol offered US$8 a share for the Canadian explorer, a 60 per cent premium that was enough to clinch the deal even though Talisman had traded above that level as recently as October.
"They just said, 'Hey, let's get a nice juicy premium over the current trading price and call a spade a spade - it's a very challenging environment and this is an easy exit,'" Mr Meats of Morningstar said. "You could apply the same logic to other companies."