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July 22, 2015

U.S. Shale Revolution In A Liquidity Death Spiral

The shares of Chesapeake Energy, second largest natural-gas driller in the US, crashed nearly 10% on July 21 to $9.29, the lowest price since August 2003, down nearly 70% since oil began to plunge a year ago. The company’s $1.1 billion of 5.75% notes fell to an all-time low of 84.88 cents on the dollar. And its 4.875% notes dropped to 81.25 cents on the dollar, from 86 last week, according to S&P Capital IQ LCD.

All this in the wake of its announcement that it would suspend its dividend for the first time in 14 years. It’s trying to conserve cash, and that dividend costs $240 million a year. It’s dumping assets as fast as it can, including some Oklahoma fields that will save it another $75 million a year in preferred dividends. It’s cutting operating costs and capital expenditures. It’s trying to stay alive.

It has been cash-flow negative in 22 of the past 24 years, according to Bloomberg.

The only thing surprising is that it took so long, that Wall Street kept funding its cash-flow negative operations and dividends for all these years.

Chesapeake used to be mostly a natural gas producer. But the price of natural gas plunged over five years ago and has remained below the cost of production for most wells for much of that time. The only saving grace was that these wells also produced natural-gas liquids and oil, which sold for much higher prices. As its natural-gas business model collapsed, Chesapeake began chasing after oil-rich plays. But a year ago, the price of oil collapsed.

Among natural gas drillers, Chesapeake isn’t in the worst shape. Much smaller Quicksilver Resources filed for Chapter 11 bankruptcy in March. It listed $2.35 billion in debts and $1.21 billion in assets. The difference has been forever drilled into the ground. Stockholders got wiped out. Creditors are fighting over the scraps.

Then there’s natural gas driller Samson Resources. It was acquired by a group of private equity firms, led by KKR, in 2011 for $7.2 billion. Since then, Samson has lost over $3 billion. When Moody’s downgraded Samson to Caa3 in March, it pointed at, among other things, “chronically low natural gas prices” and invoked “a high risk of default.” Samson warned it might have to resort to bankruptcy to restructure its debt.

At the time, a JPMorgan-led group, which holds a $1 billion revolving line of credit, granted Samson a waiver for an expected covenant breach to avert default. But the group reduced the size of the revolver. Last year, the same group had already reduced the credit line from $1.8 billion to $1 billion and had also waived a covenant breach.

“Liquidity death spiral,” is what S&P Capital IQ called this principle by lenders to whittle down the size of the loan as the company runs deeper into trouble, as I wrote at the time. It eventually ends in bankruptcy.

On August 15, Samson has to make an interest payment of $110 million on a $2.25 billion junk-bond issue. That date is coming up in a hurry. And its debt “continued to wallow around record lows today after press reports circulated about restructuring negotiations along two different paths,” S&P Capital IQ LCD’s highyieldbond.com reported today.

The loan investor group want to find new money to get the company through a Chapter 11 bankruptcy. The bondholder group wants to find new money to fund an out-of-court restructuring via a debt swap.

Samson’s covenant-lite second-lien term loan due 2018 was quoted at 31.5/33.5 cents on the dollar. Its 9.75% notes due 2020 were “essentially worthless.”

And more bloodletting among energy credits: California Resources’ 6% notes fell to 77 cents on the dollar, a record low, according to S&P Capital IQ, “amid a repricing of the energy sector and more broadly a sell-off in commodities credits this week as oil and precious metals probe lower levels.”

Time and again, despite the collapsed prices of oil and gas, the players in the shale revolution have gotten more funding from Wall Street, whose ZIRP-blinded clients kept gobbling up the newly issued junk bonds, leveraged loans, and shares, taking on huge risks and hoping to make a little extra money in a Fed-laid minefield where all decent assets are way overpriced.

During the first half of 2015, according to Bloomberg, deeply troubled shale drillers were able to sell $32 billion in new debt and $12 billion in equity, in total $44 billion, more than during any half-year period since the go-go days of 2007.

Exhibit A: Halcon Resources. Though it has been drilling cash into the ground at a breath-taking rate, it went on a money binge in April, including a debt-for-equity swap and junk-bond sale that left some prior investors seething. The company has become ruinous for investors. Yet it keeps getting new money.

Each new wave of investors hopes it won’t suffer the same fate prior investors suffered. Bloomberg put it this way:

Halcon Resources Corp. almost ran into trouble with its banks in June 2013. And again in March 2014. And in February 2015.   
Each time, the shale driller came close to violating debt limits set by its lenders, endangering a credit line that provided as much as $1.05 billion in much-needed cash. Each time, Halcon’s banks, led by JPMorgan Chase & Co. and Wells Fargo & Co., loosened their restrictions, allowing Halcon to keep borrowing.

If there is a bankruptcy, Halcon’s unsecured bondholders might get, at most, 10% of the nearly $2.6 billion they’re owed, Standard & Poor’s estimates. Secured creditors such as banks will fare better. Many other investors, including stockholders, will be just about wiped out.

The Office of the Comptroller of the Currency has been warning the banks it regulates about these oil & gas loans. Their collateral has plunged with the price of oil and gas. And as banks begin to fret while investors lick their wounds, after all these years, a strange phenomenon in the world of ZIRP is showing up on the horizon: a cash crunch.

Devastating for the permanently cash-flow negative shale revolution.

Most drillers survived the last redetermination by their banks of their oil & gas credit lines. That was in April. These loans are backed by the value of the drillers’ reserves. But low oil and gas prices have knocked down that value, and drillers had to pay down their credit lines with money extracted from other investors. That’s where some of the new money went that drillers have raised.

The next redetermination cycle is in October. And hedges are now expiring which have partially protected drillers’ revenues from the oil price plunge. So it’s going to be tough. But turning off the money spigot will push these companies off the cliff. And banks would end up with the oilfields and have to get their hands dirty. So they’re not eager to pull the ripcord. But they can’t afford to play this “extend-and-pretend” charade for too long either, or else they’ll get sucked down too.

Courtesy Wolf Richter www.wolfstreet.comwww.amazon.com/author/wolfrichter  

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

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