Q1 2020 Oil and Gas Industry Update: What You Need to Know
During the first quarter of 2020, oil markets—as well as the markets for other commodities and equities—saw unprecedented volatility and declining prices amid rising concerns over the economic effects of COVID-19. Initially, oversupply in the oil market, in addition to the price war between Saudi Arabia and Russia, caused prices to drop precipitously, as was the case following the OPEC+ meeting in March. This supply surplus and simultaneous demand decrease due to COVID-19 sent oil prices spiraling down to an 18-year low.
As effects of the oil price war and coronavirus pandemic continue to be felt, it’s becoming increasingly clear that the energy industry is likely to face substantial headwinds in 2020 and that many companies will be forced to restructure. Saudi Arabia and Russia, and potentially certain US state energy regulators such as the Texas Railroad Commission, are the main actors to watch as high supply and low demand overwhelm available storage capacity. Many oil-producing countries that rely on energy-related income for a substantial portion of their national revenue have adopted austerity measures and spending cuts as they aim to endure the oil bust.
West Texas Intermediate price per barrel at the end of Q1
Brent Crude price per barrel at the end of Q1
Total Active Rigs in the USA
West Texas Intermediate (WTI) closed at $20.48 a barrel on the New York Mercantile Exchange on March 31, 2020, a 67% decrease since Q4 2019. Brent fell 61% to $25.81 a barrel on the London-based ICE Futures Europe exchange over the same period.
In the March 2020 Short-Term Energy Outlook (STEO), the US Energy Information Administration (EIA) acknowledged a substantial level of uncertainty amid a highly volatile market environment. Warmer winter weather this year has contributed to below-average inventory withdrawals and put downward pressure on natural gas prices. US natural gas prices slumped this month to their lowest March levels in two decades. Additionally, several recent developments have contributed to significant revisions in the outlook for global oil demand and supply.
The reduced global oil demand forecast is a result of two main drivers: lower assumptions for global economic growth from reduced activity among global manufacturers, and less expected air travel, primarily as a result of COVID-19 stay-at-home orders. The resulting lower forecasted crude oil prices will lead to lower US crude oil production, as a result of a price-induced reduction in drilling and completion activity. The unprecedented drop in global oil demand in 2020, combined with the breakdown of the OPEC+ agreement to restrict oil production, led the EIA to forecast a global oil inventory build more than twice as large as the largest annual inventory build (1.8 million b/d in 1998) over the 40 years that the EIA has tracked international data.
The Baker Hughes rig count summary, as of March 31, shows the US as having a total active rig count of 726, which is comprised of 624 oil rigs and 102 gas rigs. This represents a month-over-month decrease of 62 rigs (54 oil rigs and 8 gas rigs from February 2020, and a year-over-year decrease of 280 rigs (192 oil rigs and 88 gas rigs) from March 2019. Despite the decrease in the rig count, overall the EIA shows production is up due to the continued use of efficient production methods.
Energy Commodity Prices: Q1 2020 Compared to Q1 2019
Crude Oil WTI
$20.48 vs. $60.14
$1.64 vs. $2.66
28% overall decrease
Oil: 624 vs. 816
Gas: 102 vs. 190
Total: 726 vs. 1,006
Government and Industry Response to COVID-19
The Coronavirus Aid, Relief, and Economic Security (CARES) Act
On March 19, the US Senate introduced the Coronavirus Aid, Relief, and Economic Security (CARES) Act in response to the continued spread of the COVID-19 pandemic. In a bipartisan effort, the Senate passed the $2 trillion economic stimulus bill, which was signed by the President on March 27. This legislation is aimed at providing relief for individuals and businesses that have been negatively impacted by the coronavirus outbreak and would provide significant administrative and liquidity enhancements for dealing with the current crisis. The assistance includes tax relief and government loans, investments and grants, and accounting and financial reporting relief for entities that can demonstrate a need for additional time to file due to the virus. Despite lobbying efforts, however, there are no specific provisions of the CARES Act targeted towards the energy industry.
Texas Oil Drillers Consider Cutting Production; Pace of Layoffs Increasing
In a letter to the Texas Railroad Commission, Pioneer Natural Resources and Parsley Energy urged the TRC to allow cutbacks to production. The companies requested a virtual meeting no later than April 13 “for the purposes of determining the reasonable market demand for oil, whether wasteful production either is occurring or is reasonably imminent, and, if so, the necessary and appropriate proration order to prevent such waste.” Bloomberg reported that one corner of the US oil market has seen the first record of negative crude prices in history. Wyoming Asphalt Sour, a dense crude oil used mostly to produce paving bitumen received a negative 19 cents per barrel bid from trading house Mercuria Energy Group Ltd. in mid-March, effectively asking producers to pay to offload their output. Texas Railroad Commissioner Ryan Sitton has been in contact with Saudi leaders and was invited to an upcoming OPEC meeting to discuss potential solutions to the oversupply position.
Oil and gas companies are reacting quickly to adjust their cost structures in response to the precipitous decline in oil prices. Apache Corp. announced another round of layoffs after reducing its Permian rig count to zero. This follows their announcement in January of the closure of their San Antonio office. In addition, Halliburton announced the furlough of 3,500 workers for two months to help address the steep decline in oil prices.
M&A Activity and Major Capital Projects
M&A activity in oil and gas slowed markedly after a high volume of deals last autumn. After a decade of funding the expansion of unconventional oil and gas, Wall Street investors have virtually shunned investments in the energy sector. A senior M&A analyst at Enverus noted that “investors who funded the shale revolution over the last decade have become vocal in advocating for pay-outs and cutting back on providing new capital. That flowed through to limited M&A and a negative reaction to deals for much of the year.”
The various explanations as to the slowdown of M&A activity fundamentally boil down to money. After more than a decade of expansion, investors see a mature industry, with slowing productivity, which should be maximizing profits and generating returns rather than pursuing growth. The collapse in WTI to around $20 a barrel with no prospect of serious uplift means there is more focus on restraining spending, maximizing profits and generating returns. As a result, capital providers have tightened the financial screws when lending to E&P companies, whether it is for new operating capital, boosting output or mergers and acquisitions.
Decrease in spend on capital projects from 2013 by the five largest integrated oil & gas companies
Collectively, all the oil majors have been forced to decrease spending on capital projects (CAPEX) to a 13-year low. According to a new report from the Institute for Energy Economics and Financial Analysis, “in 2019, the five largest integrated oil and gas companies—ExxonMobil, Shell, Chevron, Total and BP—spent a total of $88.7 billion on capital projects, down nearly 50 percent from the $165.9 billion they spent in 2013.”
Debtwire’s Data on Transactions report for the first quarter documents six new Chapter 11 bankruptcy cases in the Oil & Gas and Energy Conglomerate sectors.
McDermott International, Inc. filed for bankruptcy in late January. In mid-March, the plan for reorganization was approved by the court and calls for eliminating more than $4.6B of debt and clearing the way for a $2.7B sale of its Lummus Technology unit to Chatterjee Group and Rhone Capital. McDermott had full support from secured creditors for the plan but faced resistance from some equity holders, whose shares will be canceled under the plan. Proceeds from the sale will be used to repay the Debtor-in-Possession (DIP) financing in full and provide liquidity post-emergence.
A Fort Worth-based natural gas driller received the final court order which allows them to draw down on the remaining $70 million in DIP financing after resolving final objections from holdout creditors. An attorney for Shearman & Sterling LLP has described the outcome as “a pretty soft landing into Chapter 11” which the company filed in late January. The order provides much needed liquidity while completing the remaining court proceedings.
San Antonio-based oil field service company Pioneer Energy Services Corp., which provides drilling and production services to oil-and-gas companies in the United States and Colombia, filed for bankruptcy protection at the beginning of March. A handful of investment firms, including Credit Suisse, Ascribe Capital and Loomis, Sayles & Co., are poised to take control under the prepackaged bankruptcy plan that strikes a debt-for-equity swap with bondholders and erases about $260 million in debt from the company’s books.
Oil-field-services company CARBO Ceramics Inc. filed for bankruptcy protection after reaching a deal with its senior lenders on a debt-for-equity swap. The Houston-based company, which provides ceramic technology used by shale drillers that rely on hydraulic fracturing, filed with a deal that hands control of the company to senior lenders owed $65 million, Wilks Brothers LLC and Equify Financial LLC.
Riveron brings energy companies an uncommon agility, applying extensive technical accounting, finance, and operations expertise to accelerate the timeline and impact of change. Our experienced team, including restructuring experts from Conway MacKenzie, have sat on all sides of the table from executive roles in accounting and operations to investor roles in private equity and investment banks. We understand the unique challenges facing the energy industry and partner with our clients to achieve exceptional results.