Posted on : 10 Apr 2016
NEW YORK/LONDON, April 6 2016 – Investors backed a record amount of new share issuance by U.S. shale oil and gas producers in the first three months of this year, even after a period of lower oil prices has left struggling companies more battered than ever, found a new report commissioned by the Carbon Tracker Initiative, “Beyond the Shale: Aboard the Price Roller Coaster”, with analysis led by GWG Energy’s Gerard Wynn.
Equity investors may be betting on bargains among U.S. shale oil and gas exploration and production (E&P) companies, expecting a rebound in oil and gas prices.
There are two grounds for caution, according to the new analysis. First, U.S. E&P valuations have fallen by an aggregate $340 billion since last May, the last time investors were betting on higher oil and gas prices. Second, more indebted companies are now even more leveraged than 10 months ago, and some, including Chesapeake and Whiting Petroleum, have had to re-negotiate their borrowing terms after leverage ratios looked set to exceed former credit facility covenants.
Four charts illustrate some considerations for equity investors in U.S. shale. First, investors are pumping cash back into a weakened U.S. shale industry in record amounts, with the first quarter this year seeing the highest E&P equity issuance since at least 2011.
Chart 1. U.S. E&P equity issuance and WTI oil price, 2014 to late March 2016
But U.S. E&P equity valuations have fallen by an aggregate $340 billion since May 2015, the last time investors were talking up the prospect of a rebound in oil and gas prices.
Chart 2. Market capitalisation of S&P U.S. Oil and Gas Exploration and Production Select Industry Index, May 2015 to March 8 2016
The prospects for 2016 are especially concerning for some. Most E&P companies project lower output, and many will see less robust hedging. The result will be lower pre-tax earnings, or EBITDAX. Creditors often specify a leverage ratio, in their borrowing terms to E&P companies, defined as net debt divided by EBITDAX. Creditors often specify a maximum leverage ratio of four; a value of four is also the threshold which the US Office of the Comptroller of the Currency uses to define “sub-standard” E&P bank loans.
The chart below shows how Chesapeake’s leverage ratio is expected to exceed four at any conceivable oil and gas price this year. Both Chesapeake and Whiting Petroleum have had to suspend total leverage ratios, under their credit facilities.
Chart 3. Scenario analysis of Chesapeake, 2016, Net debt/ Consolidated EBITDAX ratio
Finally, while equity issuance soared in the first three months of this year, U.S. E&P bond issuance has remained below recent historical levels, suggesting prospective creditors are exercising greater caution. Do bond investors know something equity investors do not?
Chart 4. Bond issuance by quarter, U.S. E&P companies, 2014-2016 (as of March 8)