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Oil’s Wild Ride

With ‘Lower for longer’ the mantra on prices, players in the energy sector try to hang on for dear life.
By Jennifer Warren |

The dramatic drop in oil prices over the last two years ago has roiled the Texas energy industry, resulting in lost jobs, reduced capital spending, asset fire sales, and bankruptcy filings. Some better-positioned firms, though, are riding out the hard times by working smarter, faster, and cheaper.

Take Kelcy Warren’s Dallas-based Energy Transfer Partners, for example. At ETP, a huge midstream pipeline company, the sales teams are partnering with their producer-customers to develop creative, “win-win” solutions in the face of the downturn. 

“We completed a transaction with a large firm where we offered relief on [transportation] demand fees,” says Matt Ramsey, ETP’s president. “In return, they offered us incremental volumes in the same [oil-and-gas] basins, extending contracts out for like 10 to 15 years. We can give in one [basin] and get in another, because we have the scale and balance sheet,” Ramsey adds. “Many smaller midstream firms cannot do this, or they are not active in enough basins.”

Exploration and production firm Pioneer Natural Resources is also working smarter. Chris Cheatwood, Pioneer’s executive vice president for business development and geoscience, says the Irving-based shale leader is still “making returns, but not huge,” by exploiting its 100-year inventory of high-quality rock in the lucrative, oil-rich Permian Basin in West Texas. The company is drilling horizontal wells with longer lengths, from 5,000 feet to 10,000 or even 12,000 feet, Cheatwood says. The longer lengths are less expensive to drill and complete, and they produce more oil.

Even so, “Lower for longer” seems to be the watchword for the state’s energy economy in 2016. And, the “correction” may persist well into next year, at least. “It seems Houston will have the broader ripple effect than Dallas,” says top bankruptcy and restructuring lawyer Stephen Pezanosky at Haynes and Boone LLP in Fort Worth. “Still, lots of energy players here are hurting. We’re hearing about oilfield services firms and their employees hurting, and [so are those] that service them, like hotels and rental-car companies.”  

To grapple with plummeting oil prices—a high of $107 a barrel in June 2014 fell to the $30 range this year for the U.S. benchmark West Texas Intermediate Crude—companies throughout the industry have tightened their belts in all kinds of ways. Still others—like Fort Worth-based Energy & Exploration Partners and Barnett Shale gas producer Quicksilver—have taken the more extreme step of filing for bankruptcy protection. The number of U.S. rigs declined to 464 at the end of March—down 584 from a year earlier—and Texas alone was running 209 of them, or 45 percent of all the rigs.

Rosewood Resources expects to structure a number of deals over the next 12 months.

In North Texas, where just 3 percent of economic activity derives from energy, job growth nonetheless slowed to 1.5 percent in 2015 from 3.6 percent the year before. According to the Federal Reserve Bank of Dallas, oil and gas employment in the state as a whole plunged nearly 20 percent last year, and “nearly all of the 63,800 energy jobs created [during the shale boom] from 2012 to 2014 were lost.” In April, the Texas Workforce Commission said the state lost jobs overall in March for the first time in a year, as a result of the continuing slump in the oil industry. And losses in the energy-producing regions, warned Robert Dye, chief economist for Dallas-based Comerica Bank, will “probably [spread] to secondary industries across the state” for the remainder of 2016.

The Dallas Fed’s April Beige Book reported that “layoffs were noted among several manufacturers, particularly of energy-related goods such as fabricated metals. Some energy [companies] noted they were loath to cut more jobs, but instead were completely eliminating overtime, or no longer matching 401(k) contributions. … Many said they may still have to trim headcounts further …” One firm that did just that—Dallas-based Hunt Oil Co., which had 4,500 employees at the end of 2014—said in April that it was planning to cut 10 percent of its workforce. 

Lower oil prices have benefited both individual consumers, via lower gasoline prices, and certain fuel-guzzling industries, like airlines and trucking. But to sustain itself and to reach profitability, the energy industry needs higher prices. “Oil prices need to reach $60 per barrel to get any type of growth in the U.S., which would be slight,” says Scott Sheffield, CEO at Pioneer Natural Resources. “At $50 oil, production is flat, and toward $40, production still declines. The world won’t get growth from U.S. shale [oil] in the $45 to $50 price range.” 

Individual investors have also taken a brutal beating from the industry downturn. Oil and gas stocks have been hit hard, with losses ranging from roughly 20 percent to 75 percent of company values over two years. The Financial Times reports $2 trillion in lost equity value overall.

By February, with the low prices holding, Exxon Mobil’s triple-A credit rating was placed “on watch.” To defend its rating, the Irving-based energy giant subsequently slashed capital spending by 25 percent. As a result of the lower spending by Exxon Mobil and other energy companies, oil and gas reserves are being left in the ground. The combination of this supply held off the market and the spending cuts will potentially set up higher prices by 2019-20, Sheffield and others believe.

Focus on Balance Sheets

While the super-sized majors like Exxon Mobil, Chevron, and British Petroleum soldier on, the focused independents like Pioneer, Houston-based Apache, and Oklahoma’s Devon have sustained much of the market assault. Last year, for example, Pioneer moved to fortify its balance sheet and shed debt with a $1.6 billion equity offering and the recent $1 billion (net proceeds) sale of one of its midstream operations. It also whacked capital spending for 2016 to $2 billion, down from $2.2 billion, and reduced its rig count by 50 percent.  

ETP’s Ramsey, a 30-year veteran of the industry, says this downturn emerged faster and harder than previous ones. “Technology in the business [had] allowed for more efficient production,” he says. “Then OPEC decided to take market share at all costs, making a perfect storm.” Anas Alhajji, chief economist at NGP Energy Capital Management, an Irving-based private equity firm that invests in energy, agrees about the effect of OPEC’s role—especially that of the Saudis. “Saudi Arabia is the dominant producer in the market. They increased production, taking market share from Libya and Iran even,” Alhajji says. “They are the only ones who can raise prices.” The real downturn started in November of 2014 when OPEC decided to stop “managing” the market, he says, and we’ve had lower prices ever since.

At the same time, firms like NGP are benefiting from the oil-industry rout by buying assets as energy companies, their credit lines shrinking, seek to soup up their bottom lines. NGP is snapping up properties from both public and private firms, providing the firms with some relief in the form of new equity capital. Trevor Rees-Jones, founder of Dallas-based Chief Oil & Gas, recently told Forbes magazine that he’s “licking [his] chops” over the prospect of buying some well-priced oilfields.

There are also big new opportunities in the market for more diversified firms with long investment horizons. One case in point: Dallas-based Rosewood Corp., which was established in 1935 by the legendary Texas oilman H.L. Hunt and is now owned by the Caroline Hunt Trust Estate.

Caroline Rose Hunt began diversifying her legacy oil and gas assets before the 1980s oil crash, largely with real estate developments like the Crescent Hotel and today’s Rosewood Court, a signature Uptown project. Schuyler Marshall, Rosewood’s CEO and board chair, acknowledges cash-flow shortfalls from the company’s current oil and gas assets. But he says Rosewood has been able to redirect cash from its real estate and private investment arms to seize new energy opportunities. 

Through company subsidiary Rosewood Resources, Marshall expects to deploy this “dry powder” and structure a number of creative deals over the next 12 months. “We’re talking to hedge funds and banks that will have assets returned to them from distressed sellers,” he says. “We hope to make arrangements to manage these properties, drill, and do so on a very reasonable basis, even breaking even on cost as long as we are incentivized.”

The company “caught the industry by surprise” by “drilling faster and cheaper than anyone, including the majors, in the Eagle Ford and Woodbine sandstone plays,” Marshall says, referring to oil and gas fields in South and East Texas. Eager to prove themselves, his data-driven team assessed wells drilling for $8.5 million to $9 million which they believed could be drilled for $7.5 million. They drilled one 5,000-foot horizontal well for $5 million.

“We think it’s [going to be] ‘Lower for longer’ for a different reason: the many undrilled locations with known reserves,” Marshall says. “While that’s good news, there are thousands of wells spread across companies who know the science, have the capability, and, when prices go up, will drill again.” 

Debt Burden

Unlike previous commodities crashes, the energy industry’s debt problem is steeper and deeper this time. “The debt structures are more complicated than they used to be,” says Pezanosky, the Haynes and Boone attorney. Where previously the “debt stack” was mainly senior secured debt and trade debt, “now it’s senior secured debt, second lien debt, sometimes third lien behind that, possibly unsecured bond debt, unsecured tranches, trade debt, vendors, and counterparty contracts with significant exposure.” 

One banking watchdog estimates global oil and gas industry debt totaling $3 trillion—three times what it was before the Great Recession. One explanation for the binge: the hunger by investors for higher returns in a yield-starved, low-interest-rate world. Hard assets, like oil and gas, became appealing after the financial crisis. 

Haynes and Boone began compiling a list of bankruptcy filings of exploration and production firms in January 2015. In its latest tally, 52 producers with more than $17 billion in cumulative debt had filed nationally. Now “activity is increasing, both in the number of bankruptcy filings and out-of court-restructurings,” Pezanosky says. “Distressed companies are hiring restructuring advisors, lawyers, financial advisers, share restructuring advisors, and investment bankers—at a fevered pitch.” As a result, his firm is planning to hire more restructuring lawyers, since the current teams are working very long hours.

Restructurings are also taking up more time at Dallas’ Winstead PC. Said Sargon Daniel, fomerly an energy practice lawyer there: “We have seen a noticeable increase in debt restructurings or related transactions as bank redeterminations and the burden of sustained low prices have caused breaches of covenants or defaults in debt obligations.” 

If they continue, low oil prices are sure to trigger more bankruptcies and restructurings. But, they may not result in the immediate industry consolidation that some have predicted. “An overleveraged company cannot merge with another overleveraged company,” says Pioneer’s Sheffield, who expects the bankruptcy count to reach 70 firms. But, “once creditors control many of these assets, then you’ll have more consolidation going forward.”

What’s Ahead

To return to full competitiveness, the U.S. energy industry is aiming to ride out the hard times and wait for a better day. Jay Hatfield, manager of a New York-based, energy midstream exchange-traded fund, notes that U.S. oil production steadily declined earlier this year, “as was expected by most analysts,” in response to a cut in capital expenditures for exploration. His fund expects prices to further stabilize soon, as inventories are reduced and the summer driving season begins.

Although the expected wave of M&A transactions may not materialize right away, Energy Transfer Equity, the general partner of the Energy Transfer family, last fall announced that it would acquire one of the largest midstream firms in the country, Williams Cos., for $37.7 billion. (Williams is currently suing Energy Transfer over some of the deal’s terms.) After scrutinizing the proposed transaction, the stock market pummeled ETE’s stock, from a high of $35 down to $6 at one point. But pipeline companies build and plan for decades-long operations, and analysts eventually could rue their pessimism.  

Ramsey, the Energy Transfer Partners president, suggests that, instead of the previous “party at $100 oil,” the energy downturn will “right-size things” as it identifies those oil and gas basins that make the most economic sense. However, he cautions, “people believe the industry will turn up immediately, and it never does.” Meantime, he says, oilfield service costs will increase as soon as possible, chipping away at some of the previous cost savings, and idled manpower and equipment will have to be secured. “That’s the protracted upturn I expect,” Ramsey says. 

In the big picture, the energy executive is resigned to view the downturn somewhat optimistically. “It’s good to have a forest fire every once in a while,” he says.  


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