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:”
- Enough competitors could fail such that global industry capacity reduces and prices rise.
- Demand for oil could rise because it is cheap, leading prices to rise.
- 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|
|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|
|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.