If Saudi Arabia is shocked at the relentless ability of the U.S. shale "marginal producers" to continue pumping even with oil prices below breakeven costs for many (which as reported recently have mysteriously tumbled from $70 to $40) at a time when the junk bond market - the traditional conduit of how energy companies have financed themselves - it should thank Wall Street, for one simple reason: investors have pumped a whopping $9.2 billion in new equity into energy companies year to date, the most since Bloomberg records began in 1999.
Even the experts are stunned by this unprecedented glut in stupidity of managers of other people's money: "Billions of dollars of dilutive equity continue to roll in with seemingly no end in sight," Houston-based oil investment bank Tudor, Pickering, Holt & Co. said in a research note.
Until only a few weeks ago, bankers, executives and investors had assumed the capital markets were closed to the energy sector, which is laboring under oil prices that have fallen almost 70 percent from the summer of 2014. Then, in early January, a handful of companies with assets in the prized Permian Basin in Texas successfully tested the waters. Now "the window is clearly open" for almost everybody, Tudor, Pickering, Holt & Co. said.
How is that possible? Simple: with the junk bond market clearly closed for virtually everyone because that particular subset of investors has gotten massively burned in recent months and in fact many distressed debt hedge funds have been forced out of business, the capital stucture has been pushed lower and has made equity the new "junk."
- Hess Corp. and Devon Energy Corp., have each offered more than $1 billion in new equity, while smaller companies like QEP Resources Inc. and Synergy Resources Corp. have also managed to successfully raise funds.
- Diamondback and Marathon both said their equity issuances would help provide liquidity to fund their capital programs. John Hess, chief executive officer of Hess, said he wanted extra cash to maintain a strong balance sheet, and equity offerings are more receptive than debt with the Bank of America/Merrill Lynch High Yield Energy Index rising to a record effective yield of 21 percent on Feb. 11.
- Pioneer Natural Resources Co.’s $1.6 billion offer on Jan. 5 was followed a week later by Diamondback Energy Inc.’s announcement of a $250 million sale. Pioneer Chief Executive Officer Scott Sheffield said he raised equity fearing lower oil prices. "We wanted to protect the company for at least a two-year period," he told the Credit Suisse Energy Summit in Vail, Colorado, last week.
- Weatherford, the world’s fourth-largest oilfield services provider, was the latest to throw its hat in the ring, offering 100 million shares at $5.65 a share, giving the underwriters a 30-day option for up to 15 million more. The company intends to use the net proceeds for general corporate purposes, including the repayment of existing debt. JPMorgan and Morgan Stanley will act as joint book-running managers of the offering.
In many ways this is reminiscent of what happened in the late spring and summer of 2015, when oil rebounded as high as $70 and the junk bond window was triumphantly reopened, only for oil to crash a few months later leading to historic losses for bond investors.
To be sure, the equity guys are next, but not quite yet: in a sign of investors’ appetite to support U.S. oil and gas companies, most of the firms that have raised equity so far this year have increased the size of their offering within hours of their announcement. With oil prices recovering, share prices have also risen from the offering, further enticing other producers to follow suit.
This is the proverbial "we've hit a bottom" thesis, based on nothing more than other "investors of other people's money" saying, or rather praying, that we've hit a bottom.
"People are seeing oil prices start to bounce back, and they’re starting to think that maybe we’ve found a bottom and can turn it around," said Carl Larry, head of oil and gas for Frost & Sullivan LP. “These share offerings are an opportunity for institutional funds to get into the energy play."
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The euphoria won't last, and the equity issuance window is already closing: confirmation of this comes from none other than Exxon CEO Rex Tillerson who moments ago said that the "wave of oil equity issuances is destroying value", adding that "global economic conditions are not inspiring", that "demand won't solve it quickly" and that "we're still oversupplying the market."
Translated: everyone who bought the record amount of stock sold by shale will soon be starting at a partial or total loss.
For now, The risk/return is clearly tipped in the institutions' favor: if they are right, and time the bottom, they will make billions in profits. If they are wrong, well, once again it's really just "other people's money" that will be lost.