According to data compiled by Haynes and Boone, in just the first four months of 2016 there had already been double the amount of bankrupt energy debt than in all of 2015, with the total secured and unsecured defaults rising to $34 billion, double the $17 billion total for all of 2015.
We can now add two more major names succumbing to the Saudi onslaught against marginal shale producers when overnightfirst Linn Energy announced a prepackaged Chapter 11 deal, followed by Penn Virginia defaulting just hours later.
In the first case, oil and gas producer Linn Energy LLC filed for chapter 11 bankruptcy after reaching a deal with lenders to restructure its $8.3 billion debt load and obtain $2.2 billion in fresh financing. In its bankruptcy filing press release, Linn announced that the holders of more than 66% of its credit facility have agreed to the “broad terms” of a debt restructuring but didn’t provide further details. The lenders also agreed to let Linn Energy spend the cash securing their debt, known as cash collateral, and to help fund a new $2.2 billion term loan.
LinnCo LLC, a publicly traded affiliate, filed for bankruptcy alongside Linn Energy Wednesday. LinnCo was created to help Linn Energy raise additional equity capital and is taxed as a corporation, rather than as a master limited partnership like Linn Energy.
For those wondering if the bankrtupcy would prevent the company from pumping more oil, bad news: Linn Energy said access to the cash will allow it to continue normal operations without lining up new bankruptcy financing. However, the company still requires permission from the U.S. Bankruptcy Court in Victoria, Texas, to begin spending.
Having obtained creditor consents in advance as part of the prepack, we assume that once the existing equity is wiped out, the company will reemerge with a far smaller debt load. However, a problem may emerge if its partnership status with LinnCo poses a problem for investors. As the WSJ writes, partnerships, as opposed to corporations, take advantage of a structure that allows companies to avoid paying corporate income taxes. Investors’ hunger for yield fueled a boom in these partnerships, which pay out their available cash to investors. Linn Energy led a revival of this status among companies pumping oil and gas and was once the largest energy producer operating as a partnership.
Such partnerships bankrolled the shale boom, buying up the older, more predictable fields that other drillers were trying to jettison to chase new prospects in flashier shale formations. But the partnerships had to keep buying new fields to keep their output—and cash distributions—growing. Many took on heavy debt loads to fund their acquisitions.
Even before the price of oil began to slide in 2014, some critics raised questions about whether these companies would be able to keep their promises of steady and growing payouts. An earlier wave of partnerships went bust in 1980s when commodity prices fell. But proponents of the structure argued that more sophisticated hedging markets would allow upstream MLPs to produce reliable streams of cash.
In an effort to stem the hit to investors, Linn Energy completed an exchange offer last month in which holders of Linn Energy units were given the chance to swap them for stock in LinnCo. Shares in both companies are likely to be wiped out now that they are in bankruptcy, but the swap could address the tax issue for investors.
Following the April exchange, Linn Energy launched a second, similar exchange offer that is set to expire May 23. In its bankruptcy announcement, Linn Energy said it is going to ask the bankruptcy court to allow unit holders to continue to swap Linn Energy units for LinnCo shares.
The strategy is largely untested and many are watching to see whether it proves successful for Linn Energy.
The Linn bankruptcy was not a surprise: the company warned in March that a bankruptcy filing may be “unavoidable,” and said last month that it reached a settlement with bondholders on a restructuring that could take place through a chapter 11 reorganization.
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In the day's second bankruptcy, energy producer Penn Virginia also filed for chapter 11 bankruptcy protection Thursday. And just like Linn, the Pennsylvania-based explorer and producer deals said it had reached a prepackaged agreement with holders of 87%, or $1.03 billion, of its total funded-debt obligations to restructure under chapter 11 protection and eliminate long-term debt by more than $1 billion.
Penn Virginia said it expects to emerge from chapter 11 by the end of the summer.
Penn Virginia’s history dates back to 1882 with its founding as a coal concern in Virginia. It shifted to oil and gas in the 1980s, and more recently has pared its natural-gas holdings in favor of oil fields.
"Like many other exploration and production companies, Penn Virginia has been significantly affected by the recent and continued dramatic decline in oil and natural gas prices,” Interim Chief Executive Edward Cloues said. “We believe using the chapter 11 process is the most efficient way to achieve our financial objectives and deleverage the Company’s balance sheet."
As a result, now that two more energy companies are about to see their interest expense slashed drastically going forward, the only real impact on the company will be that their all in production costs will decline substantially, allowing both to pump more oil at even lower prices, and thus adding to the global supply imbalance, something that will infuriate Saudi Arabia and add even more output to a market that remains chronically oversupplied.