Low oil prices, lower credit availability, and piling debt loads forced a few dozen oil and gas firms in North America to file for bankruptcy protection in the third quarter. As many as 44 oil and gas producers, oilfield services companies, and midstream companies sought protection from creditors in bankruptcy courts between July and September, the latest data from law firm Haynes and Boone showed.
Those 44 bankruptcies in Q3 could even be a low number compared to the wave of filings expected after the fall borrowing base redetermination in which banks are forecast to further slash the capital available to firms for borrowing against their reserves.
The shale patch is feeling the pain not only from the crisis but also from the growing negative sentiment among banks about lending money to heavily indebted drillers.
The low oil prices and the high debt levels, coupled with the market view that oil prices and demand will continue to be depressed in the near term, have resulted in a surge in bankruptcies in recent months.
Even more filings are set to follow, according to Haynes and Boone’s Oil Patch Bankruptcy Monitor, using data through September 30.
“The continued presence of COVID-19 cases in the U.S. and abroad casts a pall over world-wide energy demand and contributes to a collective gloom that prices and industry activity will not turn the corner anytime soon,” the law firm said, as it enlisted 17 oil and gas producers in North America that filed for bankruptcy in the third quarter alone. This was a 21-percent increase over this time last year. Although E&P bankruptcies slowed down their pace in August and September after 9 filings in July, “the August and September lull may reflect just the calm before the storm if borrowing bases stay low,” Haynes and Boone said.
With many listed companies facing debt maturities, “If capital markets fail to open up for these producers to refinance their bonds, they will be heading full speed towards a debt maturity wall with no option but to file for the protection of the bankruptcy courts starting in 2021,” the law firm noted.
With producers cutting spending, the oilfield services sector feels even more pain—as many as 26 companies filed for bankruptcy in Q3, according to Haynes and Boone data. Just one midstream operator filed in Q3, but “it is likely that a number of midstream companies may need to seek protection of the bankruptcy courts over the remainder of 2020,” the law firm says.
Amid low oil prices and negative sentiment, reserve-based loans are expected to further shrink this fall, Haynes and Boone’s survey showed.
“Though respondents expect borrowing bases to decrease less than the reductions predicted for spring 2020, most producers have limited availability under their borrowing bases and are not in a position to absorb even a minimal decrease,” the law firm said.
Although the reserve-based lending (RBL) approach will survive the current crisis, according to an overwhelming 82 percent of respondents, Haynes and Boone warns that companies will see the ‘new normal’ in lending—less capital and tighter terms.
Moreover, banks are set to lend money only for the value of producing wells, not prospective wells. So shale drillers are likely to receive credits only for wells that currently generate cash flow that can repay the loans.
Warnings started to emerge as early as in 2018 that the business model of most of the shale patch—borrow to drill now and think of returns later—is unsustainable. The 2020 crisis exposed the vulnerabilities of this model, seen in the surge in bankruptcies as availability of capital slowed to a trickle while debt loads soared, maturities approached, and investors demanded profitability, not production records.
“Survival of the fittest is on display in the industry,” an E&P executive said in last month’s Dallas Fed Energy Survey.
The early U.S. shale run was never sustainable, as drillers were vastly outspending their cash flows, Wood Mackenzie said in a report in September.
The 2020 crisis will result in annual declines in shale production this year and next, while the average growth rate over the next decade will be less than one-fifth that of the previous three years, said WoodMac, adding that “It will be like driving with the parking brake on.”