Emerald Oil - Shareholders Should Not Expect Any Recovery

| About: Emerald Oil, (EOX)

Summary

Emerald Oil's assets have an estimated value of $179 million versus debt of $320 million.

Unsecured creditors may receive a partial recovery, but common shareholders should expect no return.

Lack of liquidity and the prospect of negative cash flow with zero capital expenditures appears to have prompted the Chapter 11 filing.

A borrowing base deficiency in itself is manageable for companies as long as they can maintain breakeven or positive cash flow.

Emerald Oil (NYSEMKT:EOX) recently voluntarily filed for Chapter 11, and also executed a non-binding term sheet with Latium Enterprises for the sale of its assets. From my calculations, Emerald's assets have an estimated value of $179 million under current market conditions. This would pay off its credit facility borrowings, but only a portion of its unsecured debt. As the common shares appear to be over $140 million out of the money, I believe they are worthless and should not expect a return.

Emerald's story is also interesting because of the information it provides about companies with borrowing base deficiencies. Emerald had a borrowing base deficiency for nearly six months before it voluntarily filed for Chapter 11. It appears that companies can exist with a borrowing base deficiency for a considerable amount of time, but there are potential consequences such as hedge terminations and asset sales. The final trigger for Emerald Oil's filing appears to be a lack of liquidity combined with negative cash flow even with zero capital expenditures.

Emerald now trades as EOXLQ on the OTC Pink Sheets marketplace.

Borrowing Base Deficiency

Emerald Oil has faced a borrowing base deficiency for quite some time. In October its borrowing base was reduced to $120 million, resulting in a $19.6 million borrowing base deficiency. Emerald entered into a forbearance agreement in November, which eventually ended up expiring on January 29th. As a result, Emerald was determined to be in default of its credit facility agreement.

The consequence of the default appears to be that its hedge position was terminated, with the proceeds going towards paying down the borrowing base on its credit facility. Despite this situation, it appears that the credit facility lenders were not eager to push Emerald into restructuring. With only $3 million per year in other (non-credit facility) interest costs and Emerald's asset value apparently high enough to cover at least the credit facility debt, credit facility lenders didn't have much incentive to push for a near-term restructuring.

Emerald managed to continue on for a couple months despite the default situation, and it appears that the voluntary Chapter 11 filing was due to a lack of liquidity combined with negative cash flow. Emerald's breakeven point with zero capital expenditures appears to be around $42 oil if production is around 4,300 BOEPD. With oil staying below that level and no remaining hedge, Emerald would be unable to avoid burning cash. With no availability under its credit facility, dwindling cash and probably no other way of raising adequate financing, a Chapter 11 filing ended up being the only logical outcome.

Asset Valuation

Although Emerald listed $405 million in assets and $361 million in debt in its bankruptcy filing, shareholders should not expect any recovery. Those numbers are only current as of Q3 2015 and balance sheet asset valuation may not match the real world asset valuation, which I am now going to estimate.

Emerald Oil expected Q4 2015 production to range between 4,700 BOEPD and 5,000 BOEPD. Due to the minimal capital expenditures since that time, production has probably fallen significantly and may be around 4,300 BOEPD now. At $30,000 per flowing barrel, that production may be valued at $129 million.

It appears that Emerald Oil has around 50,000 net undeveloped acres remaining after its most recent transactions. At the $1,000 per net acre price it received for some undeveloped leaseholds in a January transaction, Emerald's undeveloped land would be worth around $50 million.

The combined total of Emerald's oil and gas properties is therefore estimated at around $179 million. This would result in the credit facility being paid off, as well as a partial return for unsecured creditors. This is in agreement with Emerald's bankruptcy filing, which indicated that unsecured creditors are expected to get some return.

Emerald Oil recently reported having $111 million outstanding under its credit facility, so total net debt may be around $320 million now. Common shares are expected to be worthless as they appear to be over $140 million out of the money.

Conclusion

With Emerald Oil's assets estimated to have a current value of approximately $179 million and total net debt estimated at over $320 million, it appears very unlikely that the common shares have any value. Although the shares are still trading for $0.28, I'd expect this to eventually end up at zero.

Emerald's history indicates that companies can stay afloat for a considerable amount of time with a borrowing base deficiency, especially if there are forbearance agreements that delay a credit facility default. Even if there is a credit facility default, there may be no urgency for a Chapter 11 filing depending on the structure of the debt.

However, the potential for hedges to be terminated should be considered. I also believe that it is worthwhile to calculate breakeven points and cash flow with minimum capital expenditures to assess how long the company can wait for higher oil and gas prices. Companies with limited debt outside of the credit facility will probably be able to escape Chapter 11 until they literally run out of money to fund basic corporate options.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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