As regular readers are no doubt aware, a long-running theme here has been the vicious deflationary feedback loop inadvertently created by DM central bank policy. In the case of the heavily-indebted US shale complex it works like this: investors’ quest for yield in a world governed by ZIRP and NIRP drives demand for HY issuance which in turn allows otherwise insolvent drillers to keep drilling by tapping the debt market to stay afloat. Meanwhile, the very act of continuing to drill puts more pressure on prices, imperiling the companies even further and encouraging still more debt issuance, which leads to more drilling and so on and so forth. This is exacerbated by the fact that the more debt you take on, the more interest expense you incur, adding further incentive to drill, drill, drill. In short: the entire sector is digging itself a hole (no pun intended).
This is a microcosm of the dynamic that’s taking place in the macroeconomy. Those with access to easy money overproduce without witnessing a concurrent increase in demand from those to whom the benefits of ultra loose monetary policy do not immediately accrue. Defaults are averted when troubled companies tap yield-starved investors for cash, which leads to further excess capacity, still more pressure on prices, still lower yields, further herding into risk assets, and around we go. Citi’s Matt King recently described this as “creative destruction destroyed” and as the process by which “zombies are born.”
Here’s WSJ with more on the “pressure to pump”:
Both independent and state-owned companies are involved in the borrowing bonanza, issuing $86.8 billion worth of bonds in dollars, euros and yen globally this year, up 10% from the same period in 2014, according to Dealogic, a data-tracking company. The rise is largely due to a high number of bond sales in Europe, the Middle East and Africa, and in the U.S., where both Exxon Mobil Corp. and Chevron Corp. have recently tapped investors…
Add in syndicated bank loans and total borrowing by the oil-and-gas sector rose to $2.5 trillion at the end of 2014, up from $1 trillion of outstanding debt at the end of 2006, according to the Switzerland-based Bank for International Settlements. It has warned that an “oil-debt nexus” could create a vicious circle whereby overindebted companies pump more oil to ensure they can pay interest on their loans, adding to the current global oil glut, and further depressing energy prices…
Oil companies are borrowing more in part because they were caught flat-footed by the halving in oil prices since last summer. Several, including Chevron, BP PLC and France’sTotal SA, have announced plans to slash costs and capital spending. But the oil-price decline means revenues have fallen quicker than they can cut outlays.
Some major oil companies are borrowing more to ensure they can afford still-high investment plans and keep their commitments to pay generous dividends—a key element of their appeal to equity investors.
Cheap borrowing rates have underpinned oil companies’ thirst for debt. Many are eager to secure funding now before global interest rates start to rise and in case the broader economic backdrop deteriorates.
“Those who can borrow at affordable rates will go to the market now,” said Yash Kaman, head of natural resources at Deutsche Bank AG in Hong Kong.
Investors have been eager to lend as they continue to search for higher-yielding assets in a global market where interest rates are low.
And here’s more from BIS:
Overall, the stock of debt of energy firms has risen even faster than that of other sectors. Debt issued by oil and other energy firms accounts for about 15% of both investment grade and high-yield major US debt indices, up from less than 10% just five years earlier.
A substantial part of the increased borrowing has been by state-owned major integrated oil firms from emerging market economies (EMEs). From 2006 to 2014, the stock of total borrowing (syndicated loans and debt securities) of Russian companies grew at an annual rate of 13%, that of Brazilian companies 25% and that of Chinese companies 31%. Borrowings of companies from other EMEs increased by 17% per annum. The increase in the leverage of EME companies contrasts with the stable leverage of comparable-sized large firms in the United States (Graph 2, right-hand panel). These EME companies have substantial existing production and therefore revenue. In many cases, their borrowing has coincided with large dividend payments to their sovereign owners. Hence, their behaviour appears similar to that of large, cash-rich firms in other sectors that have used very easy borrowing conditions in international markets to increase equity returns.
US oil companies have also borrowed heavily. They account for around 40% of both syndicated loans and debt securities outstanding. Much of this debt has been issued by smaller companies, in particular those engaged in shale oil exploration and production. Indeed, while the ratio of total debt to assets has been broadly unchanged for large US oil firms, it has on average almost doubled for other US producers - including smaller shale oil companies. These firms borrowed heavily to finance the expansion of production capacity, often against the backdrop of negative operating cash flow. Indeed, shale investment accounts for a large share of the increase in oil-related investment. Annual capital expenditure by oil and gas companies has more than doubled in real terms since 2000, to almost $900 billion in 2013 (IEA (2014)).
And finally, a few of our favorties: