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March 20, 2015

Oil Crash Leaving One Lifeline for Shale Drillers

By Tyler Durden at ZeroHedge 
The collapse in crude has provided voluminous evidence that investors in fact never, ever learn and the temptation to buy something “cheaply” usually trumps the fact that in many cases, the buyers haven’t the slightest clue as to the multifarious underlying factors that actually dictate prices. This was on full display over the past several months as retail investors rushed into shares of US-listed oil ETFs ahead of the widest contango in four years (Goldman would later confirm that any short-term "stabilization" is likely tied to retail ETF inflows). A further demonstration of this was EXXI’s recent offering of $1.45 billion in 11% 2020 notes —  the deal was upsized. Neither of these “investments” has turned out particularly well and as we noted earlier this week, the EXXI notes promptly fell 10%, while at the aggregate level, Bloomberg notes that shale-related junk bonds have cost bargain shoppers some $7 billion in just two weeks since the start of March. 
Meanwhile, producers are doing whatever they have to do to survive in the face of depressed prices and in addition to floating junk bonds, this means selling shares. Here’s more from Bloomberg:
U.S. oil producers are issuing new shares of stock at the fastest pace in more than a decade, looking to investors for a cash lifeline to pay down debt and keep drilling as crude prices continue to sink.  
Tapping equity markets has become the best option for companies such as Dallas-based RSP Permian Inc., which announced March 17 it’s seeking to raise as much as $232 million by selling additional shares. Calgary-based Encana Corp. and Noble Energy Inc. of Houston also have issued shares in the past two months to reduce debt.   
That brings funds raised in the first three months of the year to about $8 billion, more than 10 times the total in the same period last year. As the continued slide in oil prices further crimps cash flows, banks are pressuring these companies to shore up their capital and reduce debt to lower servicing costs and provide wiggle room...  
As recently as December and January, many producers assumed there would be little interest in pouring more money into the sector, and that funding from debt or equity wouldn’t materialize, said Rob Santangelo, co-head of equity capital markets Americas for Credit Suisse Group AG.  
That began to change in February when prices seemed to stabilize and frozen credit and equity markets opened up. The $8 billion in stock issued in the first three months of 2015 is the highest of any quarter in more than a decade. If the pace continues, sales of new equity would surpass the total of 2008 and 2009 combined, the last time oil prices crashed, according to data compiled by Bloomberg.  
The surge in equity offerings, even with the dilution of existing shareholders, now is widely considered the lesser of evils versus expensive borrowing or asset sales at reduced prices, said Troy Eckard, whose Eckard Global LLC owns stakes in more than 260 North Dakota shale wells.
That makes sense: why raise capital by issuing something you have to repay when you can just dilute existing shareholders with what may turn out to be worthless equity especially when  investors dying to catch a falling knife will be happy to hand over their money? 
“Equity does not have to be paid back and requires no disbursements of revenue and net profits,” Eckard said. “It buys into your plan and works for companies that can make it through the downturn in commodity prices.”  
Investors are coming to the table in the belief they are buying in at the bottom of the market and will reap gains in the long-term as oil prices recover, said Christian O’Neill, an energy analyst at T. Rowe Price International Inc., which owns shares in numerous producers.
The problem here (well, besides the whole giant dilution and gullible retail investors thing), is that just as high yield debt issuance works to keep prices depressed by ensuring that producers have to keep producing at a breakneck pace to keep what little cash is still coming in flowing so coupon payments can be made, so too does issuing more and more equity put pressure on prices by keeping insolvent companies solvent: 
Meanwhile, the same companies that are offering investors double-digit yields may ironically be shooting themselves in the foot (and, as we suggested last month, contributing to disinflation) because as the Bank For International Settlements notes, keeping current on debt payments often means maintaining elevated production because keeping a leverage-driven bubble inflated means doubling and tripling down and this is exacerbated by investors’ willingness to take on risk if it means squeezing out a few basis points of yield versus “safer” debt which, depending on where you look, may actually produce loses thanks to NIRP.
The inevitable result here will be yet more supply, exacerbating the shortage of storage and validating what we said a few weeks back which is that in fairly short order, US on-land storage capacity will be exhausted meaning each incremental barrel will have to be dumped directly onto the market, a scenario which is clearly not conducive to supporting prices.
In the end, this is yet another example of what we discussed here almost a month ago. Namely, that easy money policies have contributed to overbuilding and oversupply and have actually served to perpetuate disinflation in some cases, the commodities markets being one of them. 
Courtesy Tyler Durden, founder of ZeorHedge (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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