Hedge fund manager Jim Chanos famously called U.S. shale producers “creatures of the capital markets” for their heavy reliance on external sources of funding to grow. He has a point.
The shale industry has historically sought more than 40% of the capital it needs from debt and equity markets, and its appetite for outside financing to fuel the U.S. oil and gas boom of the last decade has been downright voracious. According to a Wall Street Journal analysis of FactSet data, the companies behind the boom have spent $265 billion more than they generated from operations since 2010.
Energy experts continue to raise expectations for the shale sector’s potential – the United States is projected to emerge as the undisputed global oil and gas leader over the next decade – but a key consideration is whether the sector will continue to have access to the capital it needs to achieve these lofty forecasts.
There should be no reason for concern. Producers survived the worst downturn in history and recently pushed U.S. oil production to record levels – with an output of 10 million barrels a day likely to be surpassed soon. Domestic oil prices have firmed up above $60 per barrel, recently hitting their highest level since 2014. Exports of both oil and gas are ramping up, with global demand for U.S. LNG finally expected to lift domestic gas prices, which have been throttled by oversupply for years.
Industry cash flows are rising, balance sheets are getting stronger, and producers are hedging more production to lock in attractive prices on future production – providing a critical sense of financial security for lenders.
The industry at large is also starting to heed investor calls for greater capital discipline in order to better reward shareholders with higher returns and dividends. In short, producers – particularly the stronger, large-cap companies – can be expected to keep capital expenditures much more closely in line with their operating cash flows than they did in years past.
As for the small- and mid-cap producers and oil services companies that may require significant external funding to dig out from the downturn or launch growth plans, the outlook is bright, too.
Equity financing slumped last year amid underperforming energy stocks. However, a number of smaller U.S. oil service companies that put off initial public offerings (IPOs) a year ago are now starting to pick up these plans again, heartened by rising commodity prices and a 30% increase in oil service shares since mid-2017. This includes FTS International, which announced its plan to launch an IPO earlier this week.
On the debt side, even before the New Year’s run-up in oil prices, Moody’s already had a positive outlook for E&P and oil services firms. Despite its conservative assumption that oil prices will remain in a $40 to $60-a-barrel range in the medium-term, Moody’s still sees earnings before interest, taxes, depreciation and amortization growing by more than 10% this year for producers. Service firms should see a 10% to 12% bump in operating profitability, according to Moody’s.
In 2017, U.S. E&P firms raised more from bond sales than in any year since the price collapse started in 2014, with offerings coming in at around $60 billion – up nearly 30% from 2016, according to Dealogic. Large-cap players like Whiting Petroleum, Continental Resources, Southwestern, Noble, Concho and Endeavor Energy Resources each raised $1 billion or more in the second half of 2017, but the rising tide of commodity prices is now lifting companies of all sizes.
The bottom line is that capital didn’t dry up when the price of West Texas Intermediate crude dropped from $100 a barrel in early 2014 to under $30 in early 2016. Indeed, capital rushed in as investors looked to capitalize on a perceived dislocation in the market – particularly private equity firms. Private equity was the top consolidator in the industry during the downturn and it remains interested in value plays for smaller outfits still struggling to pay their bills. Private equity firms may be a last resort source of capital for many, but they have proven to be an efficient player in the market, unafraid to bail out companies others had left for dead in bankruptcy.
In the end, the availability of capital for the energy sector will always come down to commodity prices, specifically where investors see oil and gas markets heading. With the OPEC cartel signaling a commitment to market management beyond 2018, banks and lenders are feeling more comfortable making loans to shale companies these days. Several E&Ps have reported that their banks increased reserve-based loan facilities during their last round of negotiations in the fall.
According to a survey of energy lenders from Macquarie, banks were using a WTI oil price forecast of just $47 a barrel for 2018 during negotiations. Such a price assumption will surely increase – perhaps materially – this spring when the next round of RBL redeterminations takes place. This will provide yet another source of financial strength for a sector that already has ample ways to tap capital markets for the funds needed to sustain Shale Boom 2.0.