The number of North American oil and gas producers filing for bankruptcy increased significantly in the second quarter of 2020 and the worst may be yet to come.
In a quarterly update of bankruptcies in the sector, the international law firm Haynes and Boone LLP reported a total of 14 companies entering bankruptcy, up from five in the first quarter.
The second quarter's number tied for the fourth-worst quarter since Haynes and Boone began tracking such events in 2015. The tally is far below the 34 reported in the second quarter of 2016, but the combination of low oil prices and demand weakness from the COVID-19 pandemic could lead to a scenario where that grim record is challenged.
"The second quarter shows we're ramping up, and I don't know if the third quarter will be the crest," said Buddy Clark, a partner in the law firm's energy transactions group. "There are plenty of companies that can still be impacted. We will probably see an increase in filings through the end of the year."
In the case of a number of producers, bankruptcy appears to be a matter of not if, but when. Many candidates for Chapter 11 bankruptcy have worked with creditors to make the process as painless as possible.
"It's not like many of them are going to stumble into bankruptcy," said Charles Beckham, a partner in Haynes and Boone's restructuring practice. "Many of them haven't filed yet because they've found a smooth glide path instead of tripping and falling."
The 19 bankruptcies announced so far this year have had a combined debt of approximately $13.1 billion, an amount that could increase significantly in the next several weeks with some of the names rumored to be on the brink of bankruptcy.
"I think we're going to see an upward curve of companies filing for bankruptcy," Beckham said. "June will be a heavy month, not only with the number of bankruptcies but the amount of debt."
The number of bankruptcies will likely increase not just due to the collapse of oil prices, but the continued lack of outside support for the upstream segment. Public markets remain essentially closed off to producers, and banks are similarly disinterested in providing additional assistance. Clark said private equity funds have the money to enter the fray, but most are taking a conservative approach.
"I don't know if they want to jump in yet," Clark explained. "There are certainly a lot of people watching. I think there's a lot of capital for the right opportunities. I don't think people are going to jump in with both feet; they're going to be cautious."
Even though the market difficulties will likely force an increase in bankruptcies, there is little expectation that M&A activity will increase significantly. To the contrary, fights between potential buyers and sellers over the value of assets could intensify, Beckham said.
"Those who are in the money and those who are out of the money today will be fighting over the value of assets to protect their relative positions," he said. "There's also a realization by some of these buyers that these assets on the market may be tarnished [by long-term contracts or other impediments]. The assets may look good, but you'd better look under the hood."