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Make Me Smart with Kai and Molly

Low oil prices could hurt drillers carrying high debt

Scott Tong Nov 4, 2014
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Oil prices are down a whopping 28 percent since mid-June.  That’s great if you’re a consumer, not so much if you’re a driller.

During the boom, drillers that fracked for what’s called shale oil spent more money than they brought in. And they made up the gap by borrowing. Which was fine when oil sold for a high price.

Now, crude is down. Earnings are down. And lenders are fidgety.

“Many of the bankers, they’re very, very concerned about their loans to companies that are exclusively into shale formations,” says Ed Hirs of oil and gas firm Hillhouse Resources. He also teaches economics at the University of Houston. “These companies may not have the management expertise or the technical expertise to continue production and pay off these loans.”

And oil companies can be credit risks. Standard & Poor’s rates three out of four energy firms below investment grade.

The big question for lenders and investors is: how long will low prices persist?

“If oil were $80 for the next year or go even lower, cash flow is lower,” says James Burkhard, head of oil market research at IHS CERA. “And external finance would be probably lower as well, or more expensive.”

Of course, all oil companies are not the same. Those mostly in fracking in the more expensive formations are most at risk. More diversified companies and those invested in lower-cost conventional wells are less exposed. And if prices surprise analysts and rise quickly, the debt issue becomes less crucial.

For now, though, analysts and credit analysts are revising their expectations in a hurry, and fortunes are changing quickly in the oil patch. It’s nothing new.

“Look, having grown up here and seen what’s happened in this Oklahoma, Texas area, I’ve seen the booms and busts,” says Jake Dollarhide, co-founder and CEO of Longbow Asset Management in Tulsa. “I’ve seen companies go underneath overnight. Most of the time it was a two-headed monster: lower commodity prices, high debt. That’s a dangerous and scary scenario. And oftentimes it’s a recipe for insolvency.”

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