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DW Monday: Drilling in Debt – Interest Rates and US Shale

By December 21, 2015 November 28th, 2019 No Comments

DW MondaySo far this year nearly forty North American E&P companies have filed for Chapter 11 bankruptcy with expectations of more to follow. Falling oil prices have forced many debt laden shale operators to reevaluate their capital structure. Next year, operators in the US are expected to cut capital expenditures by nearly four times the amount of any other country.

The North America region saw the largest reduction in investments this year, with Capex falling by approximately 35%.  With a fall of an additional 20% or more during 2016, operators will continue to focus on core assets in order to pay down debt. What caused the situation where North American oil companies are in such high debt and facing requirements for an extreme reduction in Capex?

Over the past several years operators have been able to access cheap debt due to low interest rates. With short-term interest rates as low as ever, the Zero Interest Rate Policy caused investors to look into riskier options with higher returns. Investors began sinking money into shale drillers through junk bonds as a vehicle to access growth from technological advances in unconventional oil and gas. These junk bonds offered high yield returns to investors in a low yield environment.

Fast-forward to late 2015 and the oil price environment has worsened considerably. Operators are struggling to manage their debt obligations while debt holders are, in some cases, only receiving 30 cents on the dollar of debt in bankruptcy. In combination, low interest rates, technology and high oil prices acted as a catalyst of the shale “bubble.” Many analysts believe that the recent increase in federal funds rate will put increasing pressure on the wounded industry, strengthening the dollar and stifling demand growth. Further hikes in interest rates could lead to steeper production declines, more bankruptcies, increased cost of capital and less exploration. In the meantime, we expect more shale E&P bankruptcies as hedges roll off throughout 2016.

Mitchell Zlotnik, Douglas-Westwood Houston
+1 713 714 5839  or  mitchell.zlotnik@douglaswestwood.com