Is The US Shale Industry About To Run Out Of Lifelines?

Tyler Durden's picture

Earlier today, Chesapeake Energy - in a mad scramble to conserve cash - eliminated its common dividend, a move which i) will save the company around $240 million per year, but ii) caused the stock to plunge to a twelve-year low.

The company said that a "reduction in capital" stemming from the "current commodity price environment" had left it unable to invest as much as it would like in its "world class assets." Chesapeake also said its "liquidity position remains extremely strong with more than $2 billion of unrestricted cash on [the] balance sheet and an undrawn $4 billion revolving credit facility."

As we noted this morning, it remains to be seen how that liquidity position will hold up in the face of persistently depressed prices. Of course one thing that’s perpetuating the "current commodity price environment", is easy access to capital markets. We’ve discussed the dynamic on too many occasions to count, but because it is in fact one of the most important narratives around when it comes to understanding both the current state of the global economy and why illiquid corporate credit markets are so dangerous, we’ll recount it briefly: 

Access to cheap cash via capital markets allows otherwise insolvent producers to keep drilling even as prices collapse, creating what are effectively zombie companies on the way to delaying the Schumpeterian endgame and embedding an enormous amount of risk in HY credit by flooding the market with supply just as demand from investors (who are delirious from hunger after being starved of yield by the Fed) peaks and secondary market liquidity continues to dry up. This dynamic has served to create a supply glut in a number of industries and has suppressed commodity prices in a self-feeding deflationary loop.

Unfortunately for retail investors, the read-through is obscured by accounting procedures.

As we’ve outlined previously, thanks to SEC rules on how drillers are required to value their reserves, producers are effectively forced to overstate the value of their O&G businesses by nearly two-thirds, which can lead unsophisticated investors who don’t bother to read the 10K fine print to believe that the businesses are healthier than they actually are.

Meanwhile, as we quipped earlier this month, drillers are about to be "zero hedged" as the price protection which accounted for 15% of Q1 revenue for around half of North American E&P companies (and which also helped keep bank credit lines open), rolls off.

Because the next round of revolver raids for the industry isn’t due until October, investors may have been lulled to sleep by exactly the kind of credit facilities Chesapeake cites as contributing to its "extremely strong" liquidity position. In short, banks are about to run out of patience with this industry. Bloomberg has more:

Halcon Resources Corp. almost ran into trouble with its banks in June 2013. And again in March 2014. And in February 2015.


Each time, the shale driller came close to violating debt limits set by its lenders, endangering a credit line that provided as much as $1.05 billion in much-needed cash. Each time, Halcon’s banks, led by JPMorgan Chase & Co. and Wells Fargo & Co., loosened their restrictions, allowing Halcon to keep borrowing.


That kind of patience may be coming to an end. Bank regulators have issued warningson the risks involved in lending to U.S. drillers, threatening a cash crunch in an industry that’s more dependent than ever on other people’s money. Wall Street has been one of the biggest allies of the shale revolution, bankrolling thousands of wells from Texas to North Dakota. The question is how that will change with oil prices down by half since last year to about $50 a barrel.


"Lenders in general are increasing pressure on oil companies either to raise more equity or do some sort of transaction to pay down their credit lines and free up extra cash," said Jimmy Vallee, a partner in the energy mergers and acquisitions practice at law firm Paul Hastings LLP in Houston.


Banks are already preparing for the next reevaluation of oil and gas credit lines, reviews which typically take place twice a year in April and October. The loans are based on the value of drillers’ producing reserves, which has shrunk as oil prices fell. Many companies are also losing protection as hedges that locked in prices as high as $90 a barrel begin to expire.


"There’s another redetermination cycle in the fall," Marianne Lake, chief financial officer at JPMorgan in New York, said July 14 during a conference call to discuss the company’s earnings. "And I’m not going to say likely but it’s possible we’ll be selectively downgrading some clients."


Banks so far have been willing to keep the money flowing because drillers that come close to maxing out their credit lines have paid them off by tapping public markets. U.S. producers have raised about $44 billion through bonds and share sales in the first half of this year, the most since 2007, according to data compiled by Bloomberg and UBS Group AG.



Now the appetite for that debt is dwindling. Bonds have become more expensive and are laden with more onerous terms, including liens against drillers’ oil and gas assets. The average coupon has increased to 6.84 percent in 2015 from 6.36 percent in 2014, according to data compiled by Bloomberg.

Yes, the appetitie for that debt (and equity) is indeed "dwindling", which means the practice of keeping banks appeased and credit lines open by raising money from BTFDers may have all but run its course. In fact, a recent UBS study indicates that banks are increasingly bearish on the space making them more likely to cut credit lines:

We'll close with what we said a few weeks back. Namely that the last line of defense against terminal cash burn (hedges) is about to fall and when it does, it's going to take bank credit lines down with it.

This means October is the expiration date for heavily indebted US drillers and perhaps for HY credit as well, because once the defaults begin in earnest and HY spreads start to blow out, the BTFD-ing retail crowd will head for the exits, triggering a very non-diversifiable, unidirectional flow for bond fund managers who will then be forced to hold their noses and dive into the ever-thinner secondary corporate credit market and it is precisely at that point when everyone's worst nightmares about shrinking dealer inventories and illiquid credit markets will suddenly be realized.

And speaking of stress in HY energy, we'll leave you with the following chart which shows just how risky investors believe the space has gotten versus HY in general:

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Oh regional Indian's picture

Shale and all it's derivative FIRE related activities have not even felt the Iran effect yet, which is building, multi-billion dollar projects flying off the shelf, 21 nuclear reactors (dumbfucks).....

When the Iran effect hits (by design), perhaps one the triggers in months upcoming, things will "fall" into place. (edit: meaning oil slides further and further...GOD will have one very stumpy leg come september...)...

One way or the other, the march to Agenda 21 will not be denied except by a deux ex machina...

Meanwhile, we need to wake the fup....

KnuckleDragger-X's picture

Chesapeake is just an obvious turd floating on top. I live in oil country and I've got bets with friends on exactly which optimists crash first, but I lost on Chesapeake since I figured they'd go down months ago.....

youngman's picture

I think this is a 5 year playout....its going to be tough going for 5 years but by then oil and gas will be back as a profitable investment game...

Dr. Engali's picture

They haven't run out of lifelines yet. Old Yeller can always monetize oil debt and the fed can own them too. 

Soul Glow's picture

At what cost?  The purchasing power of the dollar is already on the ropes.  The diminishing returns of the Fed's power shows when you look at stocks.  Sitting at highs for all of 2015 and no growth is taking its toll on growth.  They bail out the next crash and the dollar goes belly up.  

Dr. Engali's picture

When dealing with digital fiat, the cost to them is nothing. They don't even have any printing costs while conjuring digital FRN's.

Dr. Engali's picture

I am aware of what he is talking about.

Soul Glow's picture

^^ This is what will crash the markets.  Shale plays are going belly up like no one is considering and the banks over sold their junk bonds at high premiums.  2008 MBS all over again.

vq1's picture

good thing the north pole is melting. More channels for access to drill!


Now we just gotta gang up on Russia with Norway.

Cold Response - Military Training Exercises

2010 - 9k troops - 14 nations

2012 - 16k troops - 15 nations

saints51's picture

You will be able to buy these properties for pennies on the dollar. They have a few trolls telling you to buy oil. That is because they are about to lose big. Be diverse and preserve your family wealth with property,mineral rights,gold,silver and timber.

There is a ton of property for cheap. Look carefully and you will find it.

lehmen_sisters's picture

This cheap property, where is it? You talking in the states? 

disabledvet's picture

Once had a fish called a Cobia on the line here.

They eat so much they literally float to the surface they get so fast.

Needless to say "they're still eating." Saw that clown from a mile away and sure enough...she hammered that fly line and FOIGHT LIKE HELL.


That's a Cobia.

She did escape unfortunately. Would've made a yummy dinner. Needless to say the guy with the camera was disappointed too.

"The one that got away." One of the reasons I came back here I guess.

chairman of the bored's picture

Cobia is good eating,indeed DV.  I'm partial to Dolphin(Mahi-Mahi).How long before eating seafood makes you glow green in the dark?!!

gaoptimize's picture

OT: Does anyone else believe that the market thinks the PPT will not let the DOW close more than 200 pts down at the end of a trading day, and this puts essentially a floor on intraday range?

chinaboy's picture

Is this a "made in wall stret" disaster?

FJ's picture

World Class Cash Position

Chad_the_short_seller's picture
Chad_the_short_seller (not verified) Jul 21, 2015 11:36 AM

OAS to zero

LawsofPhysics's picture

If you actually want to get shit done then the spice must flow...

Should oil stop flowing, then you can kiss your lifestyle good-bye.

Hope Copy's picture

this is coming into a 'Stratigic Reserve' issue for the US Congress.  They can bail out shale oil if they would aknowledge that to get inflation into the picture, instead of entering a depressionary phase the base energy sector has to have  a increasing 'soveriegn base and not rely on imports, especially when they have just made a deal with Iran, the country most responsible for the recent oil crash  These trading agreements TIPP and the rest don't create stablilty, just short term benifit that can be easily eclipsed in a few years if the major base operating cost of industry, energy, are not within the local economy's control.  Ask Putin.

cbilds's picture

Apparently, old Davie Einhorn got it right this time...

onmail's picture

Lenders are anyway TBTF (backed by US govt)

And they want free money

Thats why they want to get bankrupted fast

and claim QE money

(then finally run away to Israel in case of bad weather)