The spate of bankruptcies for over-leveraged E&P companies could be reduced somewhat this year as some producers have restructured their debt and oil prices have rebounded.
When oil prices plummeted to $30 per barrel from over $100 in 2014, oil companies faced headwinds and many of them were forced to file for bankruptcy starting in 2015. Over-leveraged energy companies that had relied solely on higher crude oil prices to bail them out of extremely high debt loads in the billions could no longer meet their debt service payments even as they slashed costs.
Low oil prices hit the energy industry hard as 144 companies succumbed and were forced to file for bankruptcy and creditors received only a small fraction of their investment. These bankruptcies involve approximately $90.2 billion in cumulative secured and unsecured debt.
The trend has not abated even as oil prices have steadily rebounded since 2016. As of March 31, six producers filed bankruptcy, representing approximately $7.5 billion in debt, according to law firm Haynes and Boone.
“There will be more bankruptcies this year but the number of them is on the decline,” said Bruce Bullock, director of the Maguire Energy Institute at Southern Methodist University’s Cox School of Business in Dallas. “With the rise in crude oil prices, borrowing bases are likely being increased, putting less pressure on debt-strapped companies.”
The number of E&P bankruptcy filings is declining with 67% fewer filings in 2017 compared to 2016, but debt levels remain high. The amount of debt of the companies who have filed bankruptcy in the first quarter of 2018 nearly equals the debt administered by filings during all of 2017. The debt level of the companies filing this year is also significantly more than the companies that filed during first-quarter 2016, which was the worst year of the downturn based on bankruptcy filings.
The bankruptcies and restructurings started in January 2015 with 44 companies that filed, but by 2016, 70 companies filed and that trend continued into 2017, said Charles Beckham Jr., a partner at Haynes & Boone who focuses on bankruptcy law.
“It has definitely slowed down and we are at the tail end of them,” he said.
Despite fewer companies filing this year, this does not mean some companies are not in trouble and facing the same fate. Too many producers are still overleveraged and the money they borrowed in 2013 to 2014 was based on oil priced at $100 a barrel. The maturities of some of the debt came due in 2018.
Independent producers “thrive” on new capital for development and exploration and most of them will borrow as much as the market will allow them to in the continuing search for the “next molecule of oil and gas,” he said.
Lenders and bondholders learned their lessons the hard way as energy companies had many layers of debt with complex capital structures, Beckham said. E&P producers traditionally have a first lien of debt of a reserve base loan from banks. Companies who needed more capital sought additional financing in the form of junior debt that was either secured or unsecured, but eventually were unable to make debt payments or interest payments to bondholders.
“The companies avoided restructuring for as long as they could, but the clock finally struck midnight for them,” he said.
Many of the energy companies that filed for bankruptcy had received financing from hedge funds and private equity firms who were flush with capital, said John Melko, a partner at Foley Gardere who focuses on bankruptcies.
While he believes that the market has bottomed out, Melko cautions that the energy industry is not at the end of the bankruptcy cycle yet.
“We will see more bankruptcies, but not as many,” he said. “Companies are hanging on as long as they can. It depends on whether they cut expenses enough. They’ve made it this long and they might survive.”
What got many of these companies in trouble was having high levels of first lien debt coupled with second lien debt in the form of unsecured notes and bond offerings, said Melko.
When oil prices began their downward slide in 2014, many companies operated for as long as they could, but eventually, they were unable to make their debt service payments as their revenue dried up and were forced to file for bankruptcy in the following years.
Some creditors have chosen to convert the debt of the company into equity, which makes sense if they believe the bottom of the market has been reached and they can “capture some of the equity themselves,” he said. Many of the companies converting debt to equity also had no choice because they were in “technical default,” which means they already had or were about to breach one or more loan covenants, such as maintaining required collateral levels or other ratios.
“Given the leverage of technical default, opportunistic lenders seeking to capture the upside sponsored pre-negotiated Chapter 11s where existing equity was wiped out, the company was left with a comfortable level of debt and the rest was converted to equity,” said Melko.
In a rising market, this locks in the “upside” because objecting creditors would have to prove a different valuation. They were frequently at a disadvantage because the bankruptcy plans backed by the sponsors typically “deals” included infusion of new capital by the holders, which is a difficult factor to value, he said. In some instances, the debtors conducted marketing efforts which failed to attract buyers, leaving the deal sponsored by the debt holder the only alternative to liquidation.
“They can get the most bang for the buck and realize the upside as the market increases
The companies which have filed for bankruptcy this year tend to be more middle-market firms who have less complex capital structures of $100 million to $500 million in debt, said Beckham.
Yet, some of them are still struggling and are likely headed toward the same outcome as other producers.
“The time is up for some of them and they have to figure out a solution to the problem and bankruptcy may turn out to be the solution,” he said.
The energy industry has historically outspent its cash flow due to large capital requirements, said Bullock.
“It fills the void with debt and secondary equity offerings,” he said. “In the downturn, the lack of cash flow made debt payments challenging. In this up cycle, there is a far greater emphasis on capital discipline and spending within available cash flow in order to prevent these types of events in the future.”
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