The Crude Downturn for Oil Companies

By John England, Andrew Slaughter, and Anshu Mittal of Deloitte LLP

The ups and downs in the crude oil and natural gas (O&G) industry over the past two years or so boil down to a 65 percent fall in oil prices, a $2.5 trillion loss in market value and a debt overhang of about $3 trillion. With persisting uncertainty about the timing of stabilization and recovery of oil prices, the financial stress in the industry is immediate and deteriorating.

In the United States alone, 35 crude oil and natural gas producers with cumulative debt of $18 billion filed for bankruptcy protection between mid-2014 and end-2015, and an additional eight have done so this year. The majority, however, are in Chapter 11 bankruptcy and continue to operate to maintain their production- and reserve-linked loans.

But stricter loan review guidelines by the Office of the Comptroller of the Currency (OCC), the banking regulator—for instance a borrower with debt/EBITDA ratio of more than four is now flagged as doubtful— and, could prompt banks to classify more and bigger O&G loans as “substandard and worse.” In fact, using similar financial and debt repayment metrics on 500 O&G producers globally, our analysis suggests a third of them are at a high risk of debt default and may file for bankruptcy protection, unless things take a dramatic turn for the better.

These stricter guidelines, along with the continued weakness in oil prices and expiration of hedges at favorable prices are choking the much-required cash supplies. U.S. shale producers are particularly vulnerable to the squeeze, as reduced funding immediately impacts their production due to the short investment cycle and high decline rates associated with shales. This impact has been evident in the past three months, with U.S. tight oil production having declined by about five percent this year.

In conclusion, 2016 will be a period of tough, new financial choices for the O&G industry, including the oilfield service providers and drillers. Staying solvent and navigating this downturn successfully will require technology-driven optimization solutions and tailoring of the operating model and, most importantly, innovative, flexible, and adaptive thinking in sourcing, managing, and deploying scarce capital. However, these conditions lay the foundation for a price rally and better years to come for those who can navigate these rocky waters.

The full article is available here: The Crude Downturn.