Prior to the recent collapse in oil values, prices existed at over $100 a barrel for over three years. It made the economics of oil exploration, production and sale comparatively straightforward, but embedded costs into the industry.
More recently, a dip in demand and Saudi Arabia’s decision to maintain its production levels saw prices plunge to below $40, making it uneconomical for many oil producers to continue exploration and production. All sub-sectors of the industry have raced to reduce cost and right-size their businesses. New terminologies such as ‘Fit for 50’ circulated as oil majors adjusted themselves to the new reality.
The current economics has hurt everyone but some segments of the market are being hit harder than others. At the front end of the chain, the seismic and geophysical components of the industry are most likely to feel the pain, and some have already fallen victim while others are managing to convince their lenders to stick it out.
Although no oil field services companies will come out of this cycle unscathed, some of the services and maintenance companies are thought to be in a much more favourable position, particularly those that have distinctive technology or those that entered longer-term contracts during the boom times. Furthermore, it is those with strong relationships with their lender community and/or strong remaining shareholder support who are more likely to weather the storm.
Exploration and production (E&P), especially deep-water exploration, is coming under enormous pressure. Over the last 12 to 18 months, there have been a series of E&P companies in the U.S. that have filed for bankruptcy, especially those that issued high yield debt; highly geared capital structures and an approaching wall of maturity makes the outlook uncertain for a number of US E&P companies. Despite cuts, North Sea costs, including sizeable decommissioning burdens, remain too high and especially the medium-sized E&P companies in this region are expected to be hardest hit and some may even perish.
The lessons from recent US experience is that a swift restructuring has been critical to survival, with companies bolstered by fresh capital to keep production going and to ensure that the claims of senior lenders have not kept mounting. To the companies’ near term advantage, a lack of buyers has led lenders to shy away from enforcement as they are not generally interested in ultimately owning the underlying assets.
Above all, early and constructive engagement with lenders is imperative to ensure they are comfortable with the debtor’s plans, forecasts, how fresh liquidity will be spent and ultimately, where and what value remains.
While much of the oil and gas industry has stood firm in the hope of a market shift, there is now a recognition that prices are unlikely to stage a dramatic recovery and will persist in the current range. The world of “not quite so low for longer” points to a shake-out in the industry as companies will not be able to live at the $50 a barrel level or thereabouts in the longer term and the instances of debt restructuring will thereby increase. Conversely, for some, $50 is enough and if markets and lenders gain confidence around this price, consolidation will follow, in turn opening the way for more enforcement and distressed M&A.