High Debt Loads Threatening Many Smaller Oil Companies With Bankruptcy

Some analysts warn a wave of consolidation may be on the way.


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This spring, Denver-based Forest Oil merged with Houston’s Sabine Oil & Gas. Nothing unusual about that – energy companies merge all the time. What was unusual was that Forest was on the verge of bankruptcy.

“Forest Oil got bailed out,” says Tim Gramatovich, chief investment officer for Peritus Asset Management. “That was sort of the poster child of recent times, where the debt started to become almost distressed.”

Forest’s main holdings were in the Eagle Ford Shale in south Texas and the Permian Basin in west Texas. Oil production in both areas has skyrocketed over the past decade, thanks to fracking and horizontal drilling. So how did Forest, a company with nearly a century of experience in the oil business, all but go broke?

Independent oil companies like Forest rarely have the cash on hand to pay for new exploration and production. They have to raise the money from outside sources.

“For a variety of reasons, debt or borrowing tends to be the most favored instrument,” says Praveen Kumar, head of the Global Energy Management Institute at the University of Houston’s Bauer College of Business, “because generally debt is the cheapest form of financing.”

The problem is that fracking and horizontal drilling are expensive. Many companies underestimate how much it will cost to produce oil from a shale play, and overestimate how much they’re likely to get in return. “The shale fields tend to give out a lot of production up front, but then they decline also much faster than conventional wells,” Kumar says.

Then there’s the fact that shale plays, like Eagle Ford, tend to produce light, sweet crude, not the heavy crude most U.S. refineries are designed to process. U.S. law bars most crude oil exports, so companies can’t sell the excess to foreign refineries.

“So even though, say, the Brent price may be north of $100, the actual shale oil price could be much, much lower than that because of hitting the refining capacity,” Kumar says.

The result is that many companies are spending far more to find and produce oil than they’re making. Credit-rating agency Standard & Poor’s tracks nearly 100 energy exploration and production companies. It rates more than three-quarters of them “below investment grade” – in other words, at high risk of defaulting on their debts. Tim Gramatovich of Peritus says this can’t go on indefinitely.

“This is exactly like the telco [telecommunications] market was in 2000 and 2001, and it’s going to end very badly,” Gramatovich says. “So, what I see is a massive wave of consolidation, where the big will get bigger and sustainable, and the smaller guys will simply be gone.”

Consolidation wouldn’t be the worst thing for Houston. Being the energy capital of the world means Houston is also the financial capital of the energy industry. Many of the surviving companies are likely to concentrate here – if, in fact, they’re not based here already. But when one company buys another, there’s always the risk of layoffs.

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Andrew Schneider

Andrew Schneider

Politics and Government Reporter

Andrew heads Houston Public Media’s coverage of national, state, and local elections. He also reports on major policy issues before the Texas Legislature and county and city governments across Greater Houston. Before taking up his current post, Andrew spent five years as Houston Public Media’s business reporter, covering the oil...

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