With oil and natural gas prices back from their 2020 lows, the credit crunch for U.S. oil and gas firms has subsided, and producers are reporting positive income and cash flows, fewer bankruptcies and better rates for borrowing.
The risk of U.S. producers defaulting on loans has dropped by 88% on average since the oil crash in March of last year, according to S&P Global Market Intelligence's market signal probability of default tool.
Commodity prices of $60-plus per barrel crude oil and $3-plus/MMBtu for gas have shored up company income statements and balance sheets. As producers reported higher realized prices and disciplined capital spending in the second quarter, net income and free cash flows turned positive, and fewer oil and gas companies are borrowing at double-digit percentage rates, according to S&P Global Ratings.
The number of bankruptcy filings among oil and gas exploration and production companies, or E&Ps, was at a six year low in the first half of 2021, according to law firm Haynes and Boone LLP, which tracks Chapter 11 filings.
The oil and gas sector still has the highest ratio of "distressed" borrowers — the proportion of speculative grade borrowers paying 1,000 basis points, or 10%, above the U.S. Treasury bill rate — in the whole economy. But this ratio dropped to a 10-year low of 1.86% in June before climbing to 4.6% in July, S&P Global Ratings said Aug. 5. By comparison, in 2020 the distress ratio was 30% in July and 39.5% in June after peaking at 87% in March 2020 as oil prices crashed, S&P Global Ratings said.
"Commodity prices, which have strengthened due to supportive OPEC policies, and natural gas prices, which have recovered due to producer discipline, have alleviated some of the stress in both sectors," S&P Global Ratings said in a note. "However, risks related to higher regulation and policies to promote clean energy initiatives are growing, which may negatively affect companies' balance sheets."
The oil and gas sector's declining share of distressed borrowers mirrored the national trend, in which the distress ratio was 2.6% of speculative borrowers in July, S&P Global Ratings said. "The ratio remains close to its lowest level since 2008 as accommodative financing conditions and an improved economic outlook have led speculative-grade composite spreads to reach seven-year lows."
The average market probability of default score for the member companies of the S&P Oil & Gas Exploration & Production Select Industry Index was 14% at the end of March 2020, according to S&P Global Market Intelligence. Above 10% is considered a danger signal. The probability of default figure had declined to 1.7% by Aug. 24.
The market signal probability of default score is not a credit rating, and it is not issued by S&P Global Ratings, a separate unit of S&P Global from S&P Global Market Intelligence. The score is the result of a mathematical model that calculates the likelihood of a company defaulting on its debt over a one-year to five-year horizon, based partly on how its stock is trading and fundamental financial data.
The number of E&Ps filing for Chapter 11 bankruptcy protection declined to 12 in the first half of 2021, with a total debt of $1.8 billion and with no billion dollar defaults, Haynes and Boone's "Oil Patch Bankruptcy Monitor" reported Aug. 9. It was the lowest total for the first half of a year since 2015.
"I would expect that we'll continue to have fewer oil and gas companies need to file bankruptcy," Houston-based Haynes and Boone partner Charles Beckham Jr. said. "There's still distress out there, and there's still mistakes that can be made by concentrating capital into narrow fields or finding out that the great discovery that a company may have had … fizzles."
More capital is flowing into private drillers from private equity investors as prices rise. This shifts the risk into the private sector as private equity money takes the place of bank lending, which has become more conservative, Haynes and Boone Energy Practice Group co-Chair Jeff Nichols said.
"The public capital markets are more conservative, and they want companies to generate free cash flow rather than building reserves," Nichols said. "It's the private side that has grown, and a lot more rigs are now owned in private hands, something approaching 60%."
"I see the risk taking more on the non-public side at this point, and the capital markets don't seem to be interested in fueling reserve expansion at the expense of future risk … especially through leverage," Nichols said.