Oil and Gas Bankruptcy: Strategies To See It Coming
Oil prices recently topped $50 per barrel, nearly double their February 2016 lows. How has the dramatic bounceback in oil prices impacted credit risk for oil and gas companies?
Here’s an updated look at risk heading into the second half of the year, as well as tips on how to spot customer and supplier financial distress going forward.
Industry Stress Index Surges
With a dramatic decline in oil prices since mid-2014, the record number of oil and gas company defaults comes as no surprise. And while the recent recovery of oil prices provides some relief, the bankruptcy rate for the industry is one of the highest of any that we monitor.
To put the risk in context, the risk of failure for domestic oil and gas extraction companies is nearly 1 in 12, compared to an average bankrupcy risk across all industries of slightly more than 1 in 50, according to the FRISK® Stress Index.
Or, put another way, of the 590 domestic oil and gas extraction companies we monitor, 57 have the very highest risk of bankruptcy based on their FRISK® bankruptcy risk score.
Five Oil-and-Gas Case Studies
To identify the early warning signs of financial distress for oil and gas companies, we analyzed five recent energy-company bankruptcies: Ultra Petroleum Corp., Swift Energy Co., Magnum Hunter Resources Corp., Samson Resources Corp., and Sabine Oil and Gas.
Not surprisingly, there was a common pattern of financial stress among them, well before the actual filing. Danger signals included:
- Bottom-quartile of Oil & Gas Operations peers on most key financial ratios
- A FRISK® score deep in the ‘red zone’, 6 or more months prior to filing bankruptcy, suggesting a probability of failing as high as 50% over a 12-month horizon.
- Foreboding company financials quarter after quarter, such as deep losses; negative free cash flow; negative working capital; a plunge in shareholder equity; and cash flow from operating activities in the red
- Large losses due to writedown of oil and gas properties
- Reclassification of outstanding debt as short-term, after violation of long-term debt covenants
- Missed interest payments, debt restructuring with key creditors for increased liquidity, rating-agency downgrades
- Auditor and management warnings in the MD&A
- Spending/exploration/production cuts as liquidity tightened
- Troubled stock performance, with share prices often dropping sharply; listing exchanges warning of non-compliance with listing requirements.
The trick is to see these red flags and act on them early. View the entire library of CreditRiskMonitor case studies to see how bankruptcy risk unfolds in more detail.
2016 Credit Outlook: Headwinds Continue
Many experts believe that oil overcapacity will be with us well past 2017, with depressed oil prices continuing to pressure company cash flows. But from a credit standpoint, regardless of what happens in the longer term, the recent rebound is “too little, too late” for companies already under financial stress.
Troubled companies have already piled up operating losses, run through available liquidity, sold assets and shelved capital projects. Many drilling-and-exploration operations that were bleeding red ink when oil was at $30 per barrel are still unprofitable at $50.
While some borderline companies will find a way to get their balance sheets in order, many are out of options to refinance debt when it comes due. As a result, we believe that 2016 will continue to be a tumultuous year, with more bankruptcies to come.
Which Companies Will Be Next?
How to determine which troubled companies will dig their way out and which will fail? Learn to spot the early signs of bankruptcy for your public oil-and-gas customers, suppliers and vendors:
CreditRiskMonitor is a financial news and analysis service designed to help professionals stay ahead of public company risk quickly, accurately and cost-effectively. More than 35% of the Fortune 1000, plus thousands more worldwide, rely on our commercial credit reporting and predictive risk analytics for assessing the financial stability of over 58,000 global public companies.
At the core of CreditRiskMonitor’s service is its 96% accurate FRISK® score, which is formulated to predict public company bankruptcy risk. One of four key components calculated in the FRISK® score is crowdsourced subscriber activity. This unique system tracks subscribers' patterns of research activity, capturing and aggregating the real-time concerns of what are essentially the key gatekeepers of corporate credit. Other features of CreditRiskMonitor’s service include timely news alerts, the Altman Z” score, agency ratings, financial ratios and trends. CreditRiskMonitor’s network of trade contributors provides more than $135 billion in trade data on their counterparties every month, giving them visibility into their biggest dollar risks.