Shale Marked For Death: Who Dies, Who Thrives

Summary

• A root cause of the recent spat between OPEC+ revolves around US shale and what its place in the global energy space should be.
• While somewhat similar to the oil rout of 2015-2016, energy E&Ps have fewer options available to them now vs. today when it comes to capital markets.
• Who survives? Those with strong balance sheets and a decent hedge book. Many names mentioned below could file for bankruptcy inside the next 12 months.
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Just a few weeks ago, it seemed there were deals to be had on a relative basis in upstream energy recently - key word being relative. Discounts to net asset value ("NAV"), recent public and private comps, and in comparison to the peer group matters not when the market goes from pricing in a $55.00/barrel market for West Texas Intermediate ("WTI") to $35.00/barrel. Anyone who thinks that the recent price action among exploration and production ("E&P") companies is out of line is not really looking at the numbers: Firms trade at similar multiples, or even a bit higher in many cases, on EV/DACF than they did prior to the crash. That touch of multiple expansion, alongside the heavy contango in crude oil, means only one thing: Investors are pricing in a decent recovery in crude over the balance of 2020. While it might yet happen if Russia and Saudi Arabia are willing to sit back down at the table together, it also might not.

That has created an interesting situation where I can be a short-term bear on upstream E&Ps while having a constructive view on an eventual return to mid-cycle pricing and, alongside it, an eventual recovery in valuations. How so? Some companies just might not make it. There's a light at the end of the tunnel, but many shale producers are going to give out before reaching it.

Who Will Survive?

We all know that the world cannot meet its needs on $30.00 crude that can be produced at a profit. Far too much is uneconomic at that price, and we will see an eventual recovery once the powers that be decide that they have made their point on who's the top dog when it comes to production. Whether a bankruptcy in shale occurs or not before that recovery comes down to three factors in my opinion - and none of those is really the current breakeven on their acreage. While that's important in the intermediate term, what matters now is:

• Hedge book.
• Leverage.
• Upcoming debt maturities.

Some producers do not hedge at all, others do. When oil sinks like a stone, having hedges in the $50-60.00/barrel range starts to look like it was a mighty smart decision. Whether or not that protection is in place also influences earnings, and by extension leverage metrics. This is incredibly important. Energy lending already was in a poor spot before this occurred. Banks were getting mighty stingy for anyone without an investment grade rating and secondary equity offerings just were not an accretive path forward in most cases. Nearly everyone already expected energy defaults to spike. That is only going to get worse in this type of pricing environment.

What I've done below is break out my upstream energy universe alongside their debt/EBITDAX (updated for current strip), percentage of their current 2020 estimated production that's hedged, and how much debt they have coming due inside of the next three years. To aid comparisons on the last factor - $1,000mm in debt for an oil supermajor matters very little while $1,000mm of debt at a small scale E&P could be a death sentence - I've framed the size of the refinance as a percentage of remaining market cap.

*Source: Author Calculations.

Side note, investors always should have information like this at the ready when these events occur. It can keep you out of making dumb decisions while seizing opportunities in others when blanket selling like we saw this morning occurs.

Looking at this data, it should become pretty apparent that there are a lot of producers out there in a tough situation. Chesapeake Energy (CHK), Extraction Oil and Gas (XOG), SM Energy Company (SM), Whiting Petroleum (WLL), Oasis Petroleum (OAS), and QEP Resources (QEP) all had bonds that were trading extremely distressed prior to this drop. If creditors thought there was little hope of equity recovery two weeks ago, the situation is certainly worse now. Meanwhile, there are some standouts on this list. Cabot Oil and Gas (COG) remains the standout natural gas play and many of the large oil majors (ConocoPhillips (COP), Chevron (CVX)) are in pretty strong positions when it comes to balance sheet health, especially when framed against their capital budget profiles. There are going to be great opportunities in upstream over the coming years, but I suspect at least 25%-30% of the above list will not survive in their current form.

If you were caught a bit flat footed on all of this news, fret not. I certainly was, and I did not have the short bias that I should have had. But most importantly, my positions were not down as hard as the rest of the sector and there were some great trading opportunities to dull the pain and hopefully pick up some long-term capital gains on the back end. Volatility means opportunity.

Analyst’s Disclosure: I am/we are long FANG. 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.