Imagine that you are in the position of a high cost crude oil producer that has a lot of debt to service. ?The price that you can sell your oil for is high enough?that you make some?cash over your variable cost. ?The price is low enough that you are not recouping the cost of what you paid to buy the right to develop the oil, the development cost, and cost of equity capital employed.

In this awkward situation you continue to produce oil, because it may keep you from defaulting on your debts, even though you are not earning what is needed to justify the GAAP book value of your firm. ?You’re destroying value by producing, but because of the debt, you don’t have the option of waiting because not surviving loses more money than pumping oil and seeing if you can survive.

Where there is life, there is hope. ?Who knows, one of three?things could “go right:”

1. Enough competitors could fail such that global industry capacity reduces and prices rise.
2. Demand for oil could rise because it is cheap, leading prices to rise.
3. You could get bought out by a more solvent competitor with a longer time horizon, who sees the assets as eventually valuable.

Trouble is with #1, you could fail first. ?With #2, the process is slow, and who knows how much the Saudis will pump. ?With #3, the price that an acquirer could pay might not be enough for shareholders, or worse, they could buy out your competitors and not you, leaving you in a worse competitive position.

One more thought: think of the Saudis, the Venezuelans, etc… all of the national oil companies. ?They’re not in all that different a spot than you are. ?They need cash to fund government programs or they may face unrest. ?For some like the Saudis, who assets in reserve, the odds are lower. ?For the Venezuelans, who have had their economy destroyed by the politics of Chavez, the odds are a lot higher.

There will be failures among energy producers, and that could include nations. ?Failures with?each will be temporary as debts get worked through/compromised and new management takes over, and high cost supply gets shut down. ?The question is: who will fail and who won’t. ?The job of the hypothetical firm that I posited at the beginning of this article is to survive until prices rise. ?What will a survivor look like?

• Relatively high contribution margins (Price – variable cost per barrel)
• Relatively little debt
• Debt has long maturities and/or low coupons.

Now, I’m going to give you 40% of the answer here… I’m still working on the contribution margin question, but I can give you a useful measure regarding debt. ?My summary measure is total debt as a ratio of market capitalization. ?It’s crude, but I think it is a good first pass on debt stress, because the market capitalization figures carry an implicit estimate of the probability of bankruptcy.

Anyway here’s a list of all of the oil companies in the database that have debt greater than their market cap:

Company	Country	ticker	Mkt cap	Debt / Market Cap
Energy XXI Ltd	Bermuda	EXXI	171	26.93
SandRidge Energy Inc.	United States	SD	264	16.63
Comstock Resources Inc	United States	CRK	146	9.45
Linn Energy LLC	United States	LINE	1,172	8.81
EXCO Resources Inc	United States	XCO	213	7.2
Cosan Limited(USA)	Brazil	CZZ	1,015	6.34
W&T Offshore, Inc.	United States	WTI	245	6
Halcon Resources Corp	United States	HK	620	5.89
BreitBurn Energy Partners L.P.	United States	BBEP	614	5.05
Magnum Hunter Resources Corp	United States	MHR	188	5.05
California Resources Corp	United States	CRC	1,325	4.92
Sanchez Energy Corp	United States	SN	368	4.74
Crestwood Equity Partners LP	United States	CEQP	543	4.64
Rex Energy Corporation	United States	REXX	171	4.51
Penn West Petroleum Ltd (USA)	Canada	PWE	403	4.19
Atlas Resource Partners, L.P.	United States	ARP	365	4.09
Gastar Exploration Inc	United States	GST	108	3.8
Petroleo Brasileiro Petrobras	Brazil	PBR	35,748	3.71
Stone Energy Corporation	United States	SGY	292	3.59
Bill Barrett Corporation	United States	BBG	252	3.19
EP Energy Corp	United States	EPE	1,552	3.15
Memorial Production Partners L	United States	MEMP	599	3.05
Premier Oil PLC (ADR)	United Kingdom	PMOIY	828	2.95
Triangle Petroleum Corporation	United States	TPLM	286	2.88
Ultra Petroleum Corp.	United States	UPL	1,281	2.68
Bonanza Creek Energy Inc	United States	BCEI	333	2.55
Northern Oil & Gas, Inc.	United States	NOG	359	2.47
Denbury Resources Inc.	United States	DNR	1,479	2.37
Jones Energy Inc	United States	JONE	354	2.36
Chesapeake Energy Corporation	United States	CHK	4,917	2.35
Vanguard Natural Resources, LL	United States	VNR	833	2.27
LRR Energy LP	United States	LRE	128	2.23
Pengrowth Energy Corp (USA)	Canada	PGH	705	2.21
Legacy Reserves LP	United States	LGCY	461	2.1
Aegean Marine Petroleum Networ	Greece	ANW	391	1.85
GeoPark Ltd	Chile	GPRK	202	1.8
Mitsui & Co Ltd (ADR)	Japan	MITSY	23,727	1.74
Oasis Petroleum Inc.	United States	OAS	1,390	1.69
Santos Ltd (ADR)	Australia	SSLTY	3,813	1.59
Whiting Petroleum Corp	United States	WLL	3,593	1.46
Midcoast Energy Partners LP	United States	MEP	558	1.45
Paramount Resources Ltd (USA)	Canada	PRMRF	1,006	1.35
Encana Corporation (USA)	Canada	ECA	5,944	1.33
Clayton Williams Energy, Inc.	United States	CWEI	597	1.25
Clean Energy Fuels Corp	United States	CLNE	468	1.23
EV Energy Partners, L.P.	United States	EVEP	405	1.23
WPX Energy Inc	United States	WPX	1,660	1.2
Baytex Energy Corp (USA)	Canada	BTE	1,068	1.19
ONEOK, Inc.	United States	OKE	7,453	1.18
SunCoke Energy Partners LP	United States	SXCP	505	1.18
TransAtlantic Petroleum Ltd	United States	TAT	126	1.13
Global Partners LP	United States	GLP	1,071	1.12
NGL Energy Partners LP	United States	NGL	2,659	1.12
Sprague Resources LP	United States	SRLP	495	1.11
Amyris Inc	United States	AMRS	266	1.07
Sunoco LP	United States	SUN	1,605	1.06
SM Energy Co	United States	SM	2,360	1.05
Solazyme Inc	United States	SZYM	202	1

 

This isn’t a complete analysis by any means. Personally, I would be skeptical of holding any company twice as much debt as market cap without a significant analysis. ?Have at it your own way, but be careful, there will be a lot of stress on oil companies with high debt.