To be sure, we’ve had our fair share at the retail crowd over the course of the dramatic decline in crude prices that began to accelerate late last year after Saudi Arabia decided to bankrupt the US shale space once and for all even if it meant killing the petrodollar in the process.
The thing about retail money is that it has a tendency to take the following rather simplistic view of asset prices: “that’s gone down a lot and I’ve heard the guys on TV talking about ‘babies being thrown out with bathwater’ so what I’ll do is conduct some armchair due diligence on the way to snapping up some ‘undervalued’ names.” This mentality is affectionately known as “BTFD,” and make no mistake, when the Fed is, as Jeremy Grantham recently put it, “bound and determined to engineer an asset bubble,” buying the dips isn’t necessarily too bad of a strategy.
The problem, however, is that when it comes to crude, the dynamics are complex, which means there are all manner of things going on behind the scenes, some are readily discernible to someone who understands a few basic concepts and knows how to read a 10K (PV-10 responds with a lag to price slumps), some less readily discernible but still easy enough to figure out if one is willing to invest a little time (the hedges are about to roll off and the second round of revolver raids is coming), and some require a more nuanced understanding of what it is exactly that’s causing prices to stay low (expectations for Iranian supply, Iraqi production, the battle between the Saudis and the Fed and what it means for keeping insolvent US producers in business and, most important, how QE and ZIRP counterintuitively create deflationary supply gluts).
Of course the muddied waters are just fine by struggling US producers because after all, someone has to be willing to buy into the endless string of secondaries and mom-and-pop’s post-crisis affinity for HY bond funds sure helps out when you’re trying to borrow more money. It’s against this backdrop that we present the following from BofAML which shows that “last week, flows into US stocks were largest in the Energy sector, where inflows were the largest since January and the fifth-largest in our data history, despite the retreat in oil prices following their late-August rebound. Inflows were chiefly from private clients, whose net buying of Energy stocks last week was the largest in our data history.”
Meanwhile, BofAML’s global fund manager survey shows a “record underweight in energy (net 33%),” as the “current allocation is 2.7 stdev below its long-term average [making it] by far the most detested global sector.”
So with the BTFD crowd backing up the truck, we go to WSJ who has more on what we can expect in the space heading into October when, as we’ve been warning for months, the revolver raids are set to come back around:
U.S. energy companies have defied financial gravity for more than a year, borrowing and spending billions of dollars to pump oil, even as crude prices plummeted. Until now.
The oil patch is expected to finally face a financial reckoning, experts say, with carnage occurring as early as this month. One trigger: Smaller drillers are bracing for cuts to their credit lines in October as banks re-evaluate how much energy companies’ oil and gas properties are worth. But with oil trading below $45 a barrel, bigger oil outfits are struggling to stay profitable, too.
Some smaller companies are already negotiating with their lenders, dumping assets at distress-sale prices and delaying payments to vendors as they try to preserve cash.
“With eight bankruptcies already announced this year, weaker producers could live or die by the whims of capital providers,” Citi analysts wrote recently, predicting that banks will reduce borrowing bases by as much as 15%.
If banks make cuts of this magnitude, some $10 billion of liquidity could dry up, according to a Wall Street Journal analysis of securities filings by 75 exploration and production companies.
Jim Flores, vice chairman of Freeport-McMoRan Inc., which pumps oil in the Gulf of Mexico, explained the industry’s conundrum this way: “It’s raining and it’s going to rain for a long time. We’re all going to get wet. A few people are going to drown. You just have to make it to the other side.”
This is of course something we've discussed exhaustively for quite some time and indeed, it's part and parcel of the entire Fed vs. Saudis premise. Accommodative capital markets and investors' ZIRP-induced hunt for yield are keeping US producers in business and the Saudis are betting their capacity to borrow (and ironically, this borrowing also benefits from low rates) combined with their sizeable FX reserves, will give them enough of a cushion to outlast their US competition.
When banks begin to cut credit lines next month, one of the last sources of financing for struggling US producers will officially bite the dust. At that point, you're reminded, there are only a few remaining available options, a list of which (courtesy of Citi) is below. Note the bolded option, consider it with everything said above, and you'll have a pretty good idea of who may end up getting suckered into financing a few more months of futile drilling for America's weakest energy companies:
"Lifelines for distressed producers could include public equity markets, asset sales, private equity, or consolidation [and] if all else fails, Chapter 11 may be necessary."