We Still Have a Buck in the Till; We’re Solvent!

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:

CompanyCountrytickerMkt capDebt / Market Cap
Energy XXI LtdBermudaEXXI17126.93
SandRidge Energy Inc.United StatesSD26416.63
Comstock Resources IncUnited StatesCRK1469.45
Linn Energy LLCUnited StatesLINE1,1728.81
EXCO Resources IncUnited StatesXCO2137.2
Cosan Limited(USA)BrazilCZZ1,0156.34
W&T Offshore, Inc.United StatesWTI2456
Halcon Resources CorpUnited StatesHK6205.89
BreitBurn Energy Partners L.P.United StatesBBEP6145.05
Magnum Hunter Resources CorpUnited StatesMHR1885.05
California Resources CorpUnited StatesCRC1,3254.92
Sanchez Energy CorpUnited StatesSN3684.74
Crestwood Equity Partners LPUnited StatesCEQP5434.64
Rex Energy CorporationUnited StatesREXX1714.51
Penn West Petroleum Ltd (USA)CanadaPWE4034.19
Atlas Resource Partners, L.P.United StatesARP3654.09
Gastar Exploration IncUnited StatesGST1083.8
Petroleo Brasileiro PetrobrasBrazilPBR35,7483.71
Stone Energy CorporationUnited StatesSGY2923.59
Bill Barrett CorporationUnited StatesBBG2523.19
EP Energy CorpUnited StatesEPE1,5523.15
Memorial Production Partners LUnited StatesMEMP5993.05
Premier Oil PLC (ADR)United KingdomPMOIY8282.95
Triangle Petroleum CorporationUnited StatesTPLM2862.88
Ultra Petroleum Corp.United StatesUPL1,2812.68
Bonanza Creek Energy IncUnited StatesBCEI3332.55
Northern Oil & Gas, Inc.United StatesNOG3592.47
Denbury Resources Inc.United StatesDNR1,4792.37
Jones Energy IncUnited StatesJONE3542.36
Chesapeake Energy CorporationUnited StatesCHK4,9172.35
Vanguard Natural Resources, LLUnited StatesVNR8332.27
LRR Energy LPUnited StatesLRE1282.23
Pengrowth Energy Corp (USA)CanadaPGH7052.21
Legacy Reserves LPUnited StatesLGCY4612.1
Aegean Marine Petroleum NetworGreeceANW3911.85
GeoPark LtdChileGPRK2021.8
Mitsui & Co Ltd (ADR)JapanMITSY23,7271.74
Oasis Petroleum Inc.United StatesOAS1,3901.69
Santos Ltd (ADR)AustraliaSSLTY3,8131.59
Whiting Petroleum CorpUnited StatesWLL3,5931.46
Midcoast Energy Partners LPUnited StatesMEP5581.45
Paramount Resources Ltd (USA)CanadaPRMRF1,0061.35
Encana Corporation (USA)CanadaECA5,9441.33
Clayton Williams Energy, Inc.United StatesCWEI5971.25
Clean Energy Fuels CorpUnited StatesCLNE4681.23
EV Energy Partners, L.P.United StatesEVEP4051.23
WPX Energy IncUnited StatesWPX1,6601.2
Baytex Energy Corp (USA)CanadaBTE1,0681.19
ONEOK, Inc.United StatesOKE7,4531.18
SunCoke Energy Partners LPUnited StatesSXCP5051.18
TransAtlantic Petroleum LtdUnited StatesTAT1261.13
Global Partners LPUnited StatesGLP1,0711.12
NGL Energy Partners LPUnited StatesNGL2,6591.12
Sprague Resources LPUnited StatesSRLP4951.11
Amyris IncUnited StatesAMRS2661.07
Sunoco LPUnited StatesSUN1,6051.06
SM Energy CoUnited StatesSM2,3601.05
Solazyme IncUnited StatesSZYM2021

 

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.