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As oil and gas bankruptcies rise, S&P warns of coming shale producer downgrades

With oil and gas drillers filing for bankruptcy at a rising clip in 2019, credit rating agencies say the number of companies in distress is marching higher and they are bracing for more credit downgrades and Chapter 11 filings this fall.

Exploration and production companies, or E&Ps, are producing more oil and gas in North America than ever before and that production is causing of credit worries — the increased demand from Mexico and LNG isn't enough to sop up gobs of hydrocarbons finding their way to market.

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Investors as well as lenders appear worried about the sector, according to SunTrust Robinson Humphrey Inc. oil and gas analyst Neal Dingmann. Investors peppered companies with refinancing questions during presentations at The Oil and Gas Conference by EnerCom Inc. in Denver, Dingmann told his clients Aug. 14. "Investors not only questioned what [was the] potential cost of capital … but whether the market was even open to such transactions."

Chapter 11 filings this month by Halcón Resources Corp. and Sanchez Energy Corp. helped drive the number of oil and gas E&P bankruptcy filings to 26 so far in 2019, outpacing the 21 seen in all of 2018, law firm Haynes and Boone LLP said their mid-August Oil Patch Bankruptcy Monitor.

For several of these producers, such as Halcon, the filings follows a previous trip through Chapter 11 during the 2015-2016 oil and gas downturn and marks a capitulation, the firm said. Many firms reorganized three years ago only to discover there were no potential buyers, Buddy Clark, co-chair of Haynes and Boone's energy practice said. "They've been limping along," Clark said. "The public markets have just shut down and there are no obvious exits."

"For these producers the game clock has run out of time to keep playing 'kick the can' with their creditors and other stakeholders," the Haynes and Boone's presentation said.

Credit rating agency Fitch Ratings said the current 5.7% default rate among high-risk energy companies may grow this fall as lenders' patience runs out and oil and gas prices stay stuck in the cellar. "The year-end 2019 energy rate could climb above 7% if EP Energy LLC elects to file rather than do an out-of-court exchange for its nearer-term maturities," Fitch Senior Director of Leveraged Finance Eric Rosenthal wrote.

S&P Global Ratings noted in early August that the number of speculative-graded companies' borrowing at rates 10% or more above what Treasury bills pay continues to grow, indicating that riskier borrowers are paying more for money.

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According to S&P Global Ratings, 18.4% of less-than-investment grade borrowers are paying 10% or more for loans, while the average spread among speculative oil and gas borrowers has widened to 3.49% above the risk-free T-bill rate, from 2.31% in July 2018. Some borrowers may not be able to find a lender this fall, S&P warned. "A number of issuers with distressed issues will face refinancing risks in the short term if financing conditions do not improve, including Unit Corp., Denbury Resources Inc., California Resources Corp. and Pioneer Energy Services Corp.," Ratings said in its note.

Tightening credit is likely to hit the shale gas sector hard this fall, Ratings noted, after the credit rating agency lowered by 18% the natural gas price it uses in credit determinations to $2.25/MMBtu for this year, and by 9% to $2.50/MMBtu for 2020, in anticipation of more "free" gas hitting the market from Permian Basin shale oil wells when Kinder Morgan Inc.'s 2 Bcf/d Gulf Coast Express Pipeline LLC pipeline opens this fall. Permian shale gas is often termed "free" because most oil producers are largely indifferent to its price and at times offload it for negative prices.

"Oil wells in the Permian Basin are producing natural gas as a byproduct to oil-focused drilling, meaning gas production is growing at an unfettered pace and not adhering to the laws of supply and demand," Ratings noted in late July. "It's likely that undisciplined, Permian byproduct gas production, will continue to account for a significant percentage of gas production growth in the coming years."

Cheap Permian gas caps the price that the nation's gas producers, many in the Marcellus and Utica shales, receive for their output. While the U.S.'s largest gas producer, EQT Corp., is rated as investment grade, most of the nation's other pure-play gas producers, almost all in Appalachia, are speculative grade and — without naming names — Ratings expects to be downgrading several of them.

"Given the magnitude of our price deck revisions since the beginning of the year, we anticipate there could be some rating actions especially for low-rated natural gas companies and those who are unhedged," Ratings said.

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