The new U.S. presidential administration led by Democrats Joe Biden and Kamala Harris has been straightforward about its clean energy plans, involving a hardline stance against oil and natural gas exploration. Increased regulatory headwinds could place further pressure on an already distressed industry throughout North America. Although the strongest operators are likely to handle the transition in stride, weaker ones will need to fight harder to survive. Here is a look at the exploration and production (E&P) companies most at risk of bankruptcy in 2021.
Regulations May Increase Distress
CreditRiskMonitor®'s FRISK® Stress Index for the oil and gas extraction industry in the U.S. has risen more than 200% since 2007. The index, which shows the collective probability of bankruptcy for any industry or portfolio, is higher for this group today than it was during the depths of the Great Recession of 2007-08. Of the 142 FRISK®-rated companies in U.S. oil and gas extraction, nearly two-thirds fall into the high-risk FRISK® score "red zone."
The proprietary FRISK® score brings together four complementary metrics into one easy to use indicator, including stock market performance, financial statement ratios, bond agency ratings, and the crowdsourced research behavior of CreditRiskMonitor subscribers. The FRISK® score works on a "1" (highest risk)-to-"10" (lowest risk) scale, with anything in the bottom half of that range falling into the aforementioned red zone, indicating major financial stress. Companies deep in the red zone have a substantially higher risk of bankruptcy, as shown below.
Approximately two-thirds of the oil and gas extraction industry requires careful monitoring in 2021. The present dilemma is not a partisan issue, however; the current landscape was formed before the news of a Democratic administration. To provide one prime example of the many that are available, California Resources Corporation declared bankruptcy in mid-July. This company, the largest E&P name in California, emerged from bankruptcy on Oct. 27 just in time to face another potential headwind, as Biden’s comments suggest an accelerated transition away from oil and natural gas towards alternative energy. The bankruptcy process, however, helped California Resources deal with a heavily leveraged balance sheet (the company’s debt-to-assets ballooned to 100+% prior to its bankruptcy); in the end, its financial stability should actually improve moving forward even under the new administration.
Other distressed E&Ps will likely falter in the years ahead as they too seek out help with debt-heavy balance sheets. A key factor to watch is a company's access to capital at reasonable rates, since E&P names generally use debt backed by their reserves to fund exploration efforts. Below is a list of 10 industry operators that have as much as 50% risk of bankruptcy over the next 12 months.
|Company||FRISK® score||Liabilities-to-Market Capitalization|
|Amplify Energy Corporation||1||8x|
|Callon Petroleum Company||1||9x|
|HighPoint Resources Corporation||1||19x|
|Laredo Petroleum Inc.||1||10x|
|SM Energy Company||1||5x|
|Sundance Energy Inc.||1||34x|
|W&T Offshore, Inc.||1||4x|
|Abraxas Petroleum Corporation||2||10x|
|Carbon Energy Corporation||2||37x|
|Kosmos Energy Ltd.||2||4x|
At the top of the list is Callon Petroleum, which focuses on unconventional oil and natural gas reserves in the Permian Basin of western Texas and southeastern New Mexico. Over the past year, the company's FRISK® score has descended from a "5" to a "1."
Cumulative cash flow has been negative over the last 12 months, which is a factor that the financial ratios component captures in the FRISK® score. A recent exchange offer helped to reduce the company's debt load, yet involved issuing warrants and increasing its interest rates towards a range of 6.125% to 9%.
SM Energy has a larger footprint, stretching across the South Texas and Gulf Coast Region, Rocky Mountain Region, and Permian Region, but it too is struggling to deal with industry headwinds. SM Energy's FRISK® score has bounced between a "2," where it currently sits, and a "1" in 2020. Although free cash flow was positive in the third quarter of 2020, working capital remains negative, indicating financial strain. Like Callon Petroleum, SM Energy exchanged certain obligations, enticing debt holders with warrants and a 10% interest rate. The move lowered its overall debt level, but the 10% interest rate was up from 1.5% for a convertible bond and 5% for the next lowest coupon issue.
HighPoint Resources Corporation is taking a different route. It has agreed to be acquired by Bonanza Creek Energy Inc., which has a more stable FRISK® score of "7." However, in order to complete the deal, Highpoint Resources bondholders are going to be asked to agree to a recapitalization plan. The backup plan, if bondholders don't agree, is for Highpoint to declare bankruptcy before proceeding with the acquisition. Most leveraged E&P names are unlikely to find suitors willing to step into complex merger deals like this if industry conditions remain difficult when the new administration is sworn in.
The U.S. oil and natural gas sector has been struggling to deal with low energy prices. This issue existed before the global pandemic, was only exacerbated when COVID-19 shuttered economies around the world, and now increased regulations may make things even worse. Large and financially strong companies will handle the headwinds here in relative stride, but financially weaker names may not be able to muddle through the industry downturn without a trip through bankruptcy court. Contact CreditRiskMonitor today to find out how we can help you avoid the ongoing challenges in this industry and the many others we cover.