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21 September 2015

U.S. SHALE DRILLERS ARE DROWNING IN DEBT; GOLDMAN SACHS FORECASTS OIL COULD DROP TO $20 PER BARREL

September 18, 2015 

That’s the headline of Bradley Olson’s September 17, 2015 article in Bloomberg News, noting that debt for 30 companies in the U.S. shale oil industry have a debt level exceeding 40 percent of enterprise value. “As much as 400K barrels a day of [domestic] oil production is at risk — as oil companies like Samsung Resources Co run out of money and are forced to slow drilling,” Mr. Olson writes. “Total debt for half of the companies in the Bloomberg Index, of more than 60 producers — has risen to a level that represents 40 percent of their enterprise value.” “It’s a sign of distress that shows equity values falling in the face of oil’s crash,” said Rob Thummel, a Managing Director, and Portfolio Manager at Tortoise Capital Advisors LLC., who helps manage $15.6B

“Companies facing high debt loads, which include EnCana Corp. and Chesapeake Energy Corp., produced 1.1M barrels of oil a day, in the second quarter of this year,” according to data compiled by Bloomberg. “If more companies file for bankruptcy as Samson did Wednesday, or embrace the kinds of draconian cuts needed to survive, output could fall by 200K – 400K barrels,” Thummel added. And, no doubt lots of jobs. “That’s about the amount of oil from Oklahoma, the sixth-largest producing state, which pumped 356K barrels a day in June, government data show.

“We are going to see a major response because the financially challenged companies won’t be able to produce as much as they did in the past,” Mr. Thummel asserted. “As companies run low on cash, they may be forced to idle drilling rigs, confront bankruptcy, or seek more expensive financing and sell assets,” Mr. Olson noted. “Producers who had hoped for a price rebound later this year, have so far been disappointed. U.S. oil futures fell to $45.06 on Friday in New York; before rebounding $45.89 at 10:50 a.m. Futures are down by half in the past year. A glut of crude may keep oil prices low for the next 15 years,” according to the Goldman Sachs Group Inc. — which also recently suggested oil could fall to the $20 level.

How Low Can Oil Go? Goldman Sachs Says $20 Per Barrel A Possibility

Grant Smith and Ben Sharples, wrote on the September 11, 2015 Bloomberg News website that “while it’s not the base-case scenario, a failure to reduce production fast enough — may require prices near the $20 level — to clear the oversupply,” Goldman said in a report e-mailed Friday while cutting its Brent and West Texas Intermediate (WTI) crude forecasts through 2016. For the global surplus to end by the fourth quarter of 2016, U.S. output will need to decline by 585K barrels a day, with other non-OPEC production falling by a further 220K barrels a day,” Goldman said. The U.S. pumped 9.14M barrels a day of oil last week,” according to data from the Energy Information Administration (EIA). While the EIA this week cuts its 2015 output forecast for the U.S. by 9.22M barrels a day, production this year is still projected to be the highest since 1972. U.S. crude stockpiles remain about 100M barrels above the five year seasonal average.”

And, if all that isn’t enough, “Saudi Arabia and Iran will drive supply growth from OPEC,” Goldman added. The group, which supplies about 40 percent of the world’s crude, has produced above its 30M barrel-a-day quota for the past fifteen months,” in part, or largely in an attempt to drive the U.S. shale industry into dormancy. Iran’s Oil Minister, Bijan Namdar Zanganeh, has vowed to increase oil output by 1M barrels per day — once sanctions are removed, as the nation seeks to regain market share.”

Grim Choices For U.S. Shale Drillers

“Most shale oil companies can’t make money at $50 per barrel,” Mr. Smith and Mr. Sharples wrote, much less the potential for oil to fall further and nearer the $20. “Those that opt for bankruptcy, or debt restructuring, are likely to slow drilling,” said Mark Schwartz, a Partner at the consulting firm, HSSK LLC, who works on energy bankruptcy and energy deals. “The wells that are producing, will keep producing — because they can still sell the oil for more than it costs to shut them in,” he said. “But, in the shale plays which need constant new drilling to keep output high, some production will dry up because of the capital cost of going out, and producing more. In many cases, new wells won’t get drilled until restructuring is complete,” he said.

So, the outlook for oil and the U.S. shale industry does not look very good. If we do see $20 oil, I will most certainly be a buyer. Russia and Venezuela, among others, are likely to be particularly hard hit — perhaps one of the reasons Vladimir Putin has become so much more focused on foreign issues — Ukraine, Syria, the Arctic, — because domestically it looks grim. Half the restaurants in Moscow have closed since the beginning of this year, the ruble has imploded, inflation is kicking in, and the average salary in Russia has declined from $13,500 to less than $7,000. Will we see domestic unrest in Russia by sometime in 2016.

With respect to the U.S. shale and oil industry, there is likely to be a fair amount of mergers and acquisitions, as the playing field gets more competitive, and desperate. Investors and traders will try and position their commodities portfolio’s — with an investment footprint in those they believe likely to be velar winners — Exxon Mobile, Chevron, BP, etc.; and, an investment footprint in the takeover candidates. For those less well positioned, traders and investors will short those company’s stock prices — and, make money on the downside.

Finally, but no less important, tens of thousands of U.S. jobs in the shale and oil industry will be lost, one of the brightest areas of economic growth in the U.S. in the past five years. Perhaps another reason the U.S. Federal Reserve decided not to raise rates this week. V/R, RCP

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