‘Oil Is Back,’ Tweets Trump. Not So Fast, Says Reality

Crude oil prices surged along with the market today, up 3% to $33 per barrel for West Texas Intermediate crude, on hopes for flattening of the Covid-19 infection curve. Oil company stocks rallied, with Chesapeake
CHK
Energy up 16% to $12.50 per share and ExxonMobil
XOM
up 8%. 

President Trump helped to spur the rally, tweeting this morning “OIL (ENERGY) IS BACK!!!!” 

If only four exclamation marks made it so. Sure, relative to the negative oil prices we saw last month, $33 looks downright juicy, but it’s not — except for bankruptcy attorneys. Indeed, Ken Coleman, who runs the restructuring practice at law firm Allen & Overy says he’s telling clients the bankruptcies are ramping up. “There’s going to be a major wave of restructuring” starting mid June, he predicts.

Since February, credit spreads on high-yield oil and gas bonds have exploded out by 1,000 basis points against 10-year Treasuries, reflecting the additional yield that investors demand for holding risky bonds. In the past month we’ve seen restructurings announced at Ultra Petroleum, Fieldwood Energy, Whiting Petroleum, Sanchez Energy, Diamond Offshore
DO
and others. Plenty more are reportedly prepping Chapter 11 filings, including Oasis Petroleum, Denbury
DNR
Resources, FTS International, and the onetime champion of the Great American Fracking Boom: Chesapeake Energy.

Some of these companies are even entering bankruptcy restructuring for the second time in less than 5 years, having already gone through it in the wake of the 2016 oil bust. But it will be different this time, says Coleman. In 2016 there were still plenty of private equity funds eager to provide lifelines. This time, Coleman is telling clients to prepare for “flat out liquidations” under Chapter 7 bankruptcy. Management teams who have been living high on the hog may have a hard time coming to terms with the new reality, where there may not be a buyer for distressed assets, at any price. “Guys were living large, the arrogance was there,” says Coleman. “But they’re not going to be able to bluff their way through this period.” 

Rodney Rayburn, high-yield portfolio manager at T. Rowe Price
TROW
, concurs: “many of the distressed and high yield investors who participated in any of those deals five years ago lost a lot of money and are unlikely to repeat that mistake.”

Could the recent oil price pop save any of these players? Unlikely. Consider Chesapeke Energy. The Oklahoma City company this month took an $8.5 billion charge against earnings reflecting the deteriorated value of its assets, and disclosed that it was likely to breach its debt covenants later this year. 

Chesapeake, with $9.4 billion in debt, has been heavily leveraged ever since its heyday under its late mercurial founder Aubrey McClendon a decade ago. Round after round of activist input from the likes of Carl Icahn has spurred the company to improve its balance sheet by selling billions of dollars in assets across the country, but to no avail. In a sign of the inevitability to come, Chesapeake bonds maturing in 2021 last changed hands for less than 5 cents on the dollar, according to FINRA data. 

In its morning research digest today, analysts at Tudor, Pickering & Holt closed the book on Chesapeake, terminating coverage of the company with a final rating of “sell” given substantial doubt of its ability to continue as a going concern. “We see low odds of CHK surviving in its current form or spending within cash flow without further expanding leverage metrics,” wrote the analysts. 

How bad are Chesapeake’s metrics? The worst. According to new data out this morning from Credit Suisse, Chesapeake will face a free cash flow deficit of $257 million this year, ramping to -$900 million in 2022. Its ratio of net debt to “EBITDX” (earnings before interest, taxes, depreciation and other extras) is a dismal 5.4 times expected 2020 results, and set to rise to 11x by 2022 assuming a starvation diet of capital spending that would see the company’s oil and gas production collapse from its current 450,000 barrels per day. 

Perhaps the most stunning metric on Chesapeake is its measure of net debt to total capital, which at 200%+ is far worse than any other sizable public company and implies that the market value of its assets is considerably lower than the face value of its debt. Thus the equity, trading today at $12.50 per share, should end up with zero value. 

Average debt-to-capital in the Exploration & Production universe is about 40%, with average debt at 3.5 x EBITDX. 

Though no other company is in as dire of straits as Chesapeake, there are some runners up. Denbury Resources, which has high costs due to its strategy of producing oil from old fields, is an industry leader on the ignominious metric of net debt to EBITDX with a 9.1x multiple, according to UBS data. Denbury’s 2021 bonds traded today at less than 5 cents, for a yield to maturing of 300%. Yet its shares were up 20% today to 29 cents. 

Oasis Petroleum, a pure-play Bakken operator, looks little better. Though its stock surged 33% today, Oasis bonds are deeply distressed, with its 2022 issue trading today at 13 cents, for a 180% yield. 

Some seemingly troubled companies appear to have a longer length of rope left before the noose tightens. 

Apache
APA
Corp, for instance, has $8 billion in debt, which represents five times EBITDX, and roughly 100% of its total capital value. Apache’s equity value is down 50% this year to just $4.4 billion, yet today shares climbed 12% to close at $11.92. Apache produces 440,000 barrels per day (about the same as Chesapeake) and will suffer a cash flow deficit of roughly $500 million this year, according to Credit Suisse data. And yet bond investors give it much better odds of survival; Apache’s bond issue maturing 2022 trades at 93 cents for a 7.25% yield. 

Then there’s Occidental, following its disastrously timed acquisition of Anadarko last year, Oxy is now a bigger producer than Chesapeake and Apache put together, flowing about 1 million barrels per day. Its debt-load albatross is $34 billion, or 7x EBITDX. Compare that with just $12.5 billion in equity market value. Perhaps thanks to its deep pocketed shareholders like Carl Icahn and Warren Buffett’s Berkshire Hathaway
BRK.B
, Oxy’s bond issues maturing 2022 last traded at 90 cents on the dollar. 

The Federal Reserve may help delay the wave via its announced $750 billion bond buying program. Banks too are showing a willingness to extend and pretend — allowing borrowers to slide on payments for a few months. “They are smart enough to know that there’s not a lot that can be done, so they are willing to enter into forbearance,” rather than foreclose on assets they don’t particularly want to receive anyway, says Coleman. “In the past they could have auctioned the debt,” but no one wants it now. 

“People think of bankruptcy as the end of the road. Very clearly that’s not the case. It’s a constructive process, a more efficient deployment of business assets.” Sometimes companies emerge stronger, like the airlines, which have gone through bankruptcy before, and will do so again. And again. Though the Chapter 11 process is expensive, the beauty of the American system of bankruptcy, says Coleman, is how it enables entrepreneurs to shed their old old skin and emerge anew. “You try, and the rocket blows up, but you just keep going.” 

In Germany there’s often crimanal liability for directors who have led companies into insolvency. The U.K. historically has thrown the bankrupt into debtors’ prison. Laws are gradually becoming more borrower friendly. Singapore, for example, is vying to become the Delaware of international restructuring, says Coleman. For now, though, “The best place to go bankrupt is the U.S.A.”