Oil Patch Braces for Financial Reckoning

Oil Patch Braces for Financial Reckoning
Smaller producers are girding for cuts to credit lines, as crude prices show little sign of rebounding

Magnum Hunter CEO Gary Evans says the company is selling a pipeline to raise cash. PHOTO: BRANDON THIBODEAUX FOR THE WALL STREET JOURNAL

By DANIEL GILBERT,  ERIN AILWORTH and  ALISON SIDER
Sept. 14, 2015 7:50 p.m. ET
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U.S. energy companies have defied financial gravity for more than a year, borrowing and spending billions of dollars to pump oil, even as crude prices plummeted. Until now.

The oil patch is expected to finally face a financial reckoning, experts say, with carnage occurring as early as this month. One trigger: Smaller drillers are bracing for cuts to their credit lines in October as banks re-evaluate how much energy companies’ oil and gas properties are worth. But with oil trading below $45 a barrel, bigger oil outfits are struggling to stay profitable, too.

Jim Flores, vice chairman of Freeport-McMoRan Inc., which pumps oil in the Gulf of Mexico, explained the industry’s conundrum this way: “It’s raining and it’s going to rain for a long time. We’re all going to get wet. A few people are going to drown. You just have to make it to the other side.”

Mr. Flores’s friend Al Walker, chief executive of Anadarko Petroleum Corp., one of the biggest oil companies in the U.S., recently told the audience at a Barclays energy conference, “Frankly at the end of the day, none of us have a great sense for where oil prices are going.”

Some smaller companies are already negotiating with their lenders, dumping assets at distress-sale prices and delaying payments to vendors as they try to preserve cash.

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“There clearly are companies that are going to have to reposition their businesses,” said Michael McMahon, a managing director at investment firm Pinebrook Capital Partners, which has $6 billion under management and provides cash to startup energy producers.

Though the financial pain likely will be concentrated among some of the smaller and more debt-laden companies, it could ultimately have big effects on the global oil markets.

Federal data released last month showed that U.S. production has finally started to fall, to about 9.3 million barrels a day in June, down roughly 3% since 2015 oil output peaked in April. And capital constraints could help push output down by 500,000 barrels a day by the end of 2015, Citi Research estimates.

That would be like Exxon Mobil Corp., the largest energy company in America, halting its U.S. oil production—and then some. Put another way, it would require nearly 20 publicly traded U.S. independent oil companies with a market capitalization of $2 billion or less to stop pumping crude altogether.

“With eight bankruptcies already announced this year, weaker producers could live or die by the whims of capital providers,” Citi analysts wrote recently, predicting that banks will reduce borrowing bases by as much as 15%.

If banks make cuts of this magnitude, some $10 billion of liquidity could dry up, according to a Wall Street Journal analysis of securities filings by 75 exploration and production companies. So far, only a few drillers have been spared; Rex Energy Corp., a Pennsylvania-based oil and gas producer, said last week that banks had maintained its $350 million credit line.

Even with stricter limits on how much drillers can borrow, some analysts think stronger companies will find a way to cope, such as obtaining cash infusions from private-equity investors. Even oil wells operated by an insolvent producer could also keep pumping if they’re acquired by another company, or taken over by creditors in a bankruptcy.

Small and midsize drillers pioneered the technologies that unlocked oil and gas from dense layers of shale rock across North America.

The shale specialists have proved resilient even as oil prices fell by nearly 60% in the past 15 months, slashing billions from their budgets, negotiating discounts from suppliers and drilling wells faster and cheaper.

But crude prices show little sign of rebounding this year, and many firms are still operating at a deficit. Of the 40 American producers followed by analysts at Wells Fargo Securities Research LLC, just two are expected to finance their operations from the cash they bring in this year.

This leaves companies largely dependent on cash from Wall Street to keep them going—cash that will be in shorter supply. Energy producers listed on U.S. and Canadian exchanges have raised nearly $21 billion by issuing shares so far this year, according to Dealogic, but the offerings had slowed to just $333 million in August.

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On the debt side, many American oil companies anticipate that banks will curb their credit lines, which are often secured by the value of oil and gas holdings. Low oil prices make those properties less valuable.

Banks already cut back on some credit lines in the spring, and are beginning another round of reviews that is likely to lead to further cuts.

“Those folks who squeaked by in the spring may have issues in the fall,” said Jim Rebello, a managing director at Duff & Phelps Securities LLC.

W&T Offshore Inc. said Sept. 1 it would sell a prized Texas shale-oil prospect for $376.1 million—half what analysts projected it could fetch when the company first weighed selling it last year. W&T, which operates in West Texas and the Gulf of Mexico, has said it plans to use the cash to pay back money it has borrowed on its credit line; it didn’t respond to requests for comment.

Lenders cut W&T’s credit line by 20% to $600 million earlier this year after it had already drawn $515 million. W&T took out another $300 million loan to help pay down debt, triggering a further reduction of its credit line, to $500 million. The company’s stock-market value has fallen by about three quarters in the past 12 months, to $234 million.

“They’re flying pretty close to the sun,” said John Freeman, an analyst at Raymond James. “That credit facility was going to be under some more pressure the rest of this year.”

Magnum Hunter Resources Corp. has obtained permission from lenders to delay paying its bills four times since April. It was briefly in default of its credit agreement last month because bills for $8.8 million hadn’t been paid in more than 180 days.

Gary Evans, chief executive of Magnum Hunter, said it had made payments to cure the default. And the company has more cash coming in soon; it plans to sell a pipeline and has a preliminary agreement for private-equity funding.

Halcon Resources Corp. last month persuaded lenders to forgive $500 million in exchange for a claim on its oil and gas properties and a higher, 13% interest rate. The company didn’t respond to requests for comment.

More distress is probably in store for many companies because the insurance they purchased as protection against low oil prices is increasingly expiring. Simmons & Company International estimates that 36 U.S. drillers have hedges to sell 33% of their oil for an average of $80 a barrel this year; next year, hedges would cover just 18% of their oil at $67 a barrel.

Wells Fargo analyst David Tameron said the healthiest thing for the oil patch would be for industry to go through “one final flush” where the price of crude falls to $40 a barrel and stays there for the next six months. Such a decline would force a number of companies out of business. “Get rid of the dead wood,” he said. “The worst thing possible, in my opinion, is if oil goes higher from here and everybody lives to fight another day.”

Write to Daniel Gilbert at daniel.gilbert@wsj.com, Erin Ailworth at Erin.Ailworth@wsj.com and Alison Sider at alison.sider@wsj.com