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September 18, 2015

Oxy Ugly Spin-off Highlights Subprime Crisis in U.S. Shale Sector

Occidental Petroleum made a sweet deal on November 30, a masterpiece of Wall Street engineering. And just about every investor that touched is now getting their hands burned off.
That day, Oxy spun off California Resources. It held Oxy’s oil-and-gas exploration-and-production assets in California. It’s the state’s largest natural gas producer and its largest oil-and-gas acreage holder with operations in the basins of Los Angeles, San Joaquin, Ventura, and Sacramento.
Oxy was the big player in the miraculous scam of the Monterey Shale formation in California, which had been hyped for years as the largest reserves of oil in the US. Any studies that showed that this oil wasn’t recoverable with todays’ technologies due to the geological mess underground in earthquake land were shunted aside.
The EIA finally conceded that point in May 2014 and slashed the delusional estimates of the reserves by 96%. California isn’t exactly the easiest place for fracking in the US. When the EIA finally acknowledged reality, Oxy was the biggest loser.
Six months later, after the dust had sort of settled, Oxy exited in a grand manner by spinning off 80.5% of its California dream to Oxy shareholders. Shares started “regular way” trading under the ticker CRC on December 1, 2014.
Energy spinoffs were hot in 2013 and 2014. Hedge funds clamored for them. They’d buy a big stake in the parent company and push the board to do a spinoff that entailed loading the spinoff up with debt to fund a fat special dividend back to the parent. The scheme was supposed to temporarily jack up the price of the parent company’s stock. “Unlocking value,” it’s called.
Wall Street made sure that there were enough unwitting or yield-desperate buyers for the debt. Hedge funds got their way, made their money, and the lucky ones bailed out. Then came reality.
As part of the spinoff, California Resources paid Oxy a special dividend of $6 billion. To fund this dividend, California Resources issued three different bonds totaling $5 billion and some leveraged loans for the remainder. This debt now costs California Resources about $330 million a year in interest.
When California Resources reported its second quarter “earnings,” investors were confronted with a net loss of $68 million, on revenues that had plunged 45% to $609 million. It was buckling under its $7.3 billion in liabilities.
On September 15, Moody’s slashed the corporate rating two notches from Ba2 to B1, and the misbegotten bonds three notches from Ba2 to B2. All of it with “negative outlook”: these babes are deep junk and sinking deeper.
It’s ugly, after all the hype about the Monterey Shale and the glorious spinoff. Moody’s cited “weak credit metrics for leverage, cash flow coverage, and operating and capital efficiency that are more typical of single-B or Caa rated peers.” It lamented CRC’s “relatively high” costs of production, SG&A expenses, and interest costs totaling $31.71 per barrel of oil equivalent. It pointed at the low oil prices that it didn’t expect “to improve materially in 2016.” And less than 5% of CRC’s 2016 production is hedged.
California Resources has cut capital expenditures and drilling activities. It’s trying to sell assets when no one is willing to pay enough for them. But lower production, the inevitable result, isn’t going to help service this mountain of debt.
Moody’s thinks the company has enough “liquidity” – cash and access to a revolving line of credit at the bank – to get through 2016. And then what?
If it’s lucky. But the bank might cut the limit of the credit line and push the company into what S&P Capital IQ called the “liquidity death spiral.”
Now the question is if California Resources can survive without having to resort to a debt restructuring, bankruptcy, and a total shareholder wipeout to deal with the mountain of debt that Oxy stuck it with to fund the special $6 billion dividend.
Bondholders and stockholders have serious doubts. Its stock is currently trading at $3.35 a share, down 66% from its 52-week high, as bottom-fishers have jumped in after the low of $2.67 in August. And its bonds are getting killed. S&P Capital IQ’s LCD reported that all three bond issues hit record lows yesterday after the Moody’s whack-down the day before:
The 5% notes due 2020 plunged 10 points, with block trades as low as 68.25 cents on the dollar. The 5.5% notes due 2021 dropped to 66 cents on the dollar. The 6% benchmark notes due 2024 dropped 8 points to 66 cents on the dollar.
A special word of praise is due these 6% notes, and the syndicate led by Bank of America that put the deal together and shoved it into bond mutual funds and ETFs: these $2.25 billion of notes were sold just about exactly a year ago on September 11, at par, and were, according to LCD, “one of the top-25 largest single tranches ever sold.”
These kinds of deals can only be pulled off near the peak of an insane credit bubble, after the Fed has spent years trying to force investors further and further out toward the thin end of the risk branch. Now these branches are breaking off. And the mostly unwitting buyers that hold these fruits of Wall Street’s labor in their funds are made to feel the pain.
Courtesy Wolf Richter www.wolfstreet.com

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