By Meenal Vamburkar & Cordell Eddings at Bloomberg
They have sold off hundreds of oil fields, eliminated thousands of jobs and slashed millions of dollars from capital spending and dividends.
But in this unforgiving new world of $30-a-barrel oil, it’s barely been enough.
As U.S. oil executives from Anadarko Petroleum Corp. to Hess Corp. take drastic measures to weather the worst slump in a generation and cling to their debt ratings, creditors are already writing some of them off. So much so that late last month, average borrowing costs for energy bonds with the lowest investment grades -- issues totaling $258 billion -- soared past those of the highest-rated U.S. junk borrowers for the first time. What’s more, debt issuance industry wide has all but ground to a halt after a record year in 2015.
Today’s cost-cutting may reduce excess crude supply and help oil recover in the years ahead, but a big question remains for leaders gathered in Houston at the IHS CERAWeek conference this week: Who will ultimately survive?
“Between falling demand and the geopolitical game of chicken, forecasting the path of oil companies has become extremely cloudy,” said Matthew Duch, a money manager at Calvert Investments Inc., which oversees $12 billion. Even an investment-grade producer “with the best of intentions can still just run out of room to move and run out of time. Things could get very bad.”
Saudi Arabia’s oil minister threw down the gauntlet at the industry confab by ruling out production cuts and challenging many of those very same leaders in Houston to “lower costs, borrow money or liquidate.” And with a wave of bankruptcies already ravaging the U.S. shale industry, Hess Chief Executive Officer John Hess warned “contagion” in the high-yield debt market is spreading to investment-grade producers as financing dries up.
Last year, investment-grade energy companies were still able to borrow with relative ease in the debt markets, even as U.S. energy producers posted losses of more than $15 billion and demand for junk-rated oil debt collapsed.
In 2016, it’s gotten a lot more expensive for everyone in the industry as the global economy falters. Not a single energy company has sold bonds this month, data compiled by Bloomberg show.
A big reason has to do with the unprecedented jump in financing costs afflicting companies including Anadarko, Devon Energy Corp. and Hess, which reflects deepening worries over the health of the cost-intensive industry as companies continue to lose money on every barrel of oil they produce.
Already deeply indebted, the loss of revenue from the oil glut has caused net debt at U.S. energy companies to more than quadruple in the past year to a record 8 times earnings before interest, taxes, depreciation and amortization.
That’s increased the focus on the weaker investment-grade producers. Yields on U.S. energy bonds with triple-B ratings -- the lowest tier above junk -- have almost doubled since oil last traded at more than $100 in June 2014, to an average 7.3 percent.
And in the past month, those yields have risen so much that bond investors now see the borrowers as a bigger risk than U.S. companies rated below them. They now have comparable notes that yield more the 6.56 percent average in the double-B category, data compiled by Bloomberg show.
“If they’re continuing to outspend cash flows in this kind of price environment, they’re not dealing with the reality of the situation,” said David Lund, a credit analyst at Thrivent Financial, which oversees $105 billion. “They’ll tell you they want to maintain investment grades, but are they actually taking action to support that? And enough actions?”
In many cases, they haven’t. Within the past 10 days, eight energy companies including Anadarko, Devon, Hess and Murphy Oil, lost their investment grades from Moody’s Investor Service, which said the slump in oil will hamper the industry’s ability to generate cash flow “for several years.” The downgrades came after many of the companies already cut payouts, sold shares or reduced spending.
While those four producers still have investment grades from Standard & Poor’s, the latter two had their ratings cut to the cusp of junk in early February because of increased levels of indebtedness.
Nevertheless, industry executives are putting on a brave face as their companies tout aggressive goals to strengthen finances and increase flexibility.
Devon has reduced both shareholder rewards and capital spending, fired 20 percent of its workers and announced an equity sale. CEO David Hager also emphasized that there are “no sacred cows” if further revisions are needed. Roger Jenkins, Murphy Oil’s CEO, said this week the company will look at sales of assets and consider cutting dividends if oil prices stay at current levels.
Hess, which plans to lower spending by 40 percent this year, probably won’t be adversely affected by the Moody’s downgrade because the producer isn’t looking to issue more debt, spokesman Patrick Scanlan said.
Anadarko spokesman John Christiansen pointed to the company’s announcement this week that it raised about $1.3 billion by selling assets and future royalty income.
“Everyone won’t lose,” said David Meats, an analyst at Morningstar Inc. “You just have to stay alive. Whoever the last man standing is will get to fill the supply needs of the market.”
Still, picking out the winners from the losers might not be so easy.
The deep cuts have have yet to make a significant dent in production because supplies in storage will continue to build through April, according to Bloomberg Intelligence. In fact, U.S. crude oil production is only down about 5 percent from its peak in 2015.
That suggests oil prices will remain under pressure as producers struggle to raise enough cash to pay debt. In the 18 months through December, 35 U.S. exploration companies with combined debt of $18 billion filed for bankruptcy protection, according to Deloitte LLP.
Morningstar estimates that globally, oil has to reach $65 a barrel to cover the cost of supply. Of course, there are exceptions for every producer and break-even levels vary based on hedges and costs associated with different oil fields, but $65 oil is still twice as high as where crude is today.
Then there’s Saudi Arabia. Even after agreeing to caps on oil production with Russia and two other OPEC members, the world’s top exporter made it clear there were no plans to reduce capacity as it seeks preserve market share. Iran also wants to boost output following years of sanctions, which only threatens to exacerbate the glut.
“All energy related names have been beaten to a bloody pulp,” said Jennifer Vail, the head of fixed-income research at U.S. Bank Wealth Management, which oversees $112 billion. “It’s going to be a big question how they come up with the cash.”