Signs of a bullish turn in sentiment are emerging as companies tap debt and equity markets
Investors are regaining their appetite for riskier US oil and gas assets, as the rebound in crude prices bolsters hopes that the industry faces a brighter long-term future.
Signs of a bullish turn in sentiment are emerging as companies tap debt markets, while this week US oil exploration and production company Extraction Oil & Gas raised $633m in an initial public offering, the biggest in the sector since crude prices started to fall in mid-2014.
During a roadshow with potential investors last week, intense demand allowed bankers to price the deal above initial expectations. Several other companies are preparing for possible IPOs and some are likely to make announcements before the end of the year, advisers say.
High-yield exploration and production company bond sales, which dried up almost completely earlier in the year, are tentatively re-emerging. There have been five such sales since the start of September, accounting for more than half of the year’s $3.8bn haul.
“There is a pool of capital that wants exposure to the oil industry,” said Rob Santangelo, head of equity capital markets origination in the Americas for Credit Suisse. “We think the market is ready to put money to work.”
Good news for the US oil industry was delivered from last month’s Opec ministerial meeting in Algiers, which agreed a target to cut the cartel’s production. Oil prices climbed further this week after Russia indicated it would agree to a production deal thrashed out when Opec members meet at the end of November.
All told, the US energy industry is being buoyed by a shift in Saudi Arabia’s strategy away from its previous attempt to use ever-higher output to drive out rival producers, including US shale companies.
In turn the exploration and production sector of the S&P 500 is up 62 per cent from its nadir in January. The average yield on the Bank of America Merrill Lynch energy bond index has dropped from a peak of 21 per cent in February to 7.3 per cent last week.
Poppy Allonby, an energy investment fund manager at BlackRock, said the Opec decision was a “potential turning point for the industry”.
She added that in spite of the run-up in energy equities already this year, “the sector remains an underweight for many investors, and energy equities currently trade at a historically high discount to broader equity markets”.
US oil and gas producers are already benefiting from the recovery in crude prices: Brent for delivery a month ahead is up 80 per cent, and for December 2018 delivery is up 36 per cent. Oil production companies have been taking advantage of the higher futures strip, hedging future revenues to give themselves financial stability, even at the cost of giving away some of the upside from possible further price rises.
US companies have also been helping themselves during the decline, when the value of debt and equity plunged. Costs have been cut about 40 per cent since mid-2014, and the best shale reserves, most of them in the Permian basin of west Texas, are now among the lowest cost sources of new oil anywhere in the world, according to Wood Mackenzie, the research company. The number of oil rigs running in the US has been rising steadily since May.
US producers are increasingly looking to tap those improving equity and debt markets for more capital and money managers expect groups to refinance soon-to-mature debt now that the door is open.
The market for secondary equity issues has been very strong, with $26bn raised so far, making 2016 a record year, according to Dealogic. Gulfport Energy, an independent oil and natural gas producer in the Utica region, last week completed the largest bond sale from a junk-rated oil and gas exploration group since July 2015.
“The appetite has been tremendous on the debt and equity side,” said Scott Roberts, co-head of high yield investing at Invesco. “Companies have accessed public equity markets to strengthen balance sheets and repay near-term debt, to send a message to equity holders that ‘we’re doing the right thing. We are going to pay down debt.’”
The equity offerings have propelled debt prices higher, buoying investor confidence that groups will have the flexibility to meet their obligations. QEP Resources debt maturing in 2021 has climbed to 106 cents on the dollar from a low of 62 cents, boosted by two equity raises in February and June.
There was just one exploration and production company IPO in 2015, raising a mere $4.8m, last year, and none this year until Extraction Oil & Gas on Tuesday. In 2014, seven companies debuted to raise $5.2bn.
The freeze appears to be thawing and IPOs are starting to make headway.
Vantage Energy, which operates in the Marcellus and Utica gas shales of Pennsylvania, was heading for an IPO, although last month it agreed to be acquired by Rice Energy. Other floats are expected to go ahead.
David Baggett of Opportune, an energy consulting company, said he was advising “eight or nine” oil and gas companies working towards possible IPOs.
He cautioned that the US oil industry was still “a very long way from a robust recovery”, and would need higher prices for a broad-based upturn. His company is working on three times as many reorganisations and bankruptcy workouts as impending IPOs.
Even so, he said, it was clear the IPO market was starting to move again, particularly for companies with assets in the Permian basin.
“Investors are discriminating,” he said. “The action these days is in the Permian.”
Extraction’s assets are in Colorado, so its IPO marked a test of how far investors’ enthusiasm has spread to other regions.
More than 100 North American oil and gas production companies went bankrupt during the downturn, according to Haynes and Boone, a law firm.
Bankruptcies are expected to continue even if oil prices rise further, as companies that have been staggering on through various short-term fixes finally run out of cash.
Recovery rates from oil and gas company bankruptcies have been remarkably low in this cycle, the rating agency Moody’s has warned, giving investors another reason to be cautious about rushing back into US oil and gas companies.
A survey from Haynes and Boone last month suggested that banks were expected to continue to cut back companies’ maximum borrowing facilities.
Yet while it could be a long time before lenders and investors return to the exuberance of conditions before oil crashed in mid-2014, there is a general sense that the worst is over.
“The commodities complex is normalising,” said Peter Schwab, a former Goldman Sachs Asset Management director who manages a portfolio for Pax World. “The companies that need to restructure have done it and the others have engineered themselves out of [default]. The survivors have clobbered their way through.”