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Bond market signals distress for Appalachian gas drillers

The bond market revealed doubts among investors about the ability of some pure-play shale gas producers to survive the next five years in the face of sub-$2.50/MMBtu natural gas prices, according to an S&P Global Market Intelligence analysis.

A $600 million bond due in 2025 for Utica Shale driller Gulfport Energy Corp. traded at 50 cents on the dollar Feb. 3, according to S&P Global Market Intelligence data, while a $600 million March 2025 bond for Marcellus Shale gas and NGL producer Antero Resources Corp. was selling for 65.98 cents on the dollar, a 34% discount.

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"Without commenting about any individual company, what is abundantly clear is that current and futures strip Henry Hub gas prices present serious difficulties for highly levered gas producers," Raymond James & Associates oil and gas analyst Pavel Molchanov said Feb. 5. "Investors are rightly concerned about the financial viability of highly levered gas producers, hence the bond discounts."

Antero and Gulfport are taking two different strategies in 2020. Gulfport is setting its drilling budget to generate free cash flow, selling some assets and buying back its debt at the discount. Antero is using the time-honored tactic of "drilling through the trough" — riding out low prices by using asset sales to finance drilling to fulfill production obligations to its hedge portfolio and meet firm pipeline capacity commitments.

"We view Antero's high operating costs ... as a disadvantage relative to those of its peers during periods of weak commodity prices," S&P Global Ratings said late Feb. 3 when it downgraded Antero and five other shale gas producers because of predicted low prices. "We forecast that the company's upstream spending will outpace its internally generated cash flow through next year."

Other observers took a critical view of gas producers. "At strip, almost our entire gas coverage is unable to generate [free cash flow] at maintenance capital through 2025," analysts at energy investment bank Tudor Pickering Holt & Co. said before the S&P Global Ratings downgrades Feb. 3. "In our view, companies with leverage profiles greater than 1.5x [debt-to-EBITDA] at [futures] strip [prices] should at most spend to maintenance levels, but we believe a growing number should consider moderate declines in the coming years to ensure some [free cash flow] to pay off debt."

Unlike stocks, when the price of a bond goes down, the yield goes up. Bond yields, a function of the coupon payment rate and any discount to its purchase price, that go above 10% indicate a company under some distress, said Jake Leiby, the senior analyst for high-yield energy issues with credit research firm CreditSights Inc.

Only three of the 10 publicly traded companies focused on drilling for shale gas in Appalachia had 2025 bond yields below 10% on Feb. 4, according to S&P Global Market Intelligence data, with investment-grade integrated gas producer and utility National Fuel Gas Co., buffered by its midstream and downstream operations, yielding 2.85% and selling at a premium to par.

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"The [gas futures] strip determines the price of their product, and right now it's declining, reducing EBITDA and cash flow," Leiby said.

Companies such as Antero, yielding 25.32%, or Gulfport, yielding 23.58%, are not helpless. They can turn to assets sales to eliminate debt, although Leiby does not think that the Marcellus Shale market is strong now, when almost every driller in the basin is trying to shed leases and wells. "That wave of consolidation hasn't come," Leiby said.

The next fallback for debt-stressed companies will be to refinance unsecured bonds by pledging assets to new secured bonds that push any reckoning further into the future and allow for a recovery in the commodity markets, Leiby said.

"The market is trying to force a pullback in activity," Tudor Pickering Holt oil and gas analyst Sameer Panjwani said Feb. 4. Panjwani warned that producers need to cut spending far more than their announced drilling plans in order to balance both their books and an oversupplied gas market.

Lenders are no longer insulated from the vagaries of gas pricing that has cratered the value of shale gas stocks, Tudor Pickering Holt said Feb. 3: "2019 dragged credit, [reserve-based or credit revolver] lenders, and private equity investors into the unfortunate world of public equity pain."

"Ultimately, free cash flow and cash-on-cash returns will determine the success or failure of the upstream industry over the coming years and, until commodity prices rally and growth is cut, providers of capital across the capital structure will continue to flee the sector," Tudor Pickering Holt said.

This S&P Global Market Intelligence news article contains information about credit ratings issued by S&P Global Ratings. Descriptions in this news article were not prepared by S&P Global Ratings.