Zero Hedge confirms what SLL said back in December in “Oil Ushers in the Depression.” There’s always an oddball or two, but the funny thing about most creditors is that they want to get their money back. Thus, the shale industry is indeed about to run out of lifelines. From Tyler Durden at zerohedge.com:
Earlier today, Chesapeake Energy – in a mad scramble to conserve cash – eliminated its common dividend, a move which i) will save the company around $240 million per year, but ii) caused the stock to plunge to a twelve-year low.
The company said that a “reduction in capital” stemming from the “current commodity price environment” had left it unable to invest as much as it would like in its “world class assets.” Chesapeake also said its “liquidity position remains extremely strong with more than $2 billion of unrestricted cash on [the] balance sheet and an undrawn $4 billion revolving credit facility.”
As we noted this morning, it remains to be seen how that liquidity position will hold up in the face of persistently depressed prices. Of course one thing that’s perpetuating the “current commodity price environment”, is easy access to capital markets. We’ve discussed the dynamic on too many occasions to count, but because it is in fact one of the most important narratives around when it comes to understanding both the current state of the global economy and why illiquid corporate credit markets are so dangerous, we’ll recount it briefly:
Access to cheap cash via capital markets allows otherwise insolvent producers to keep drilling even as prices collapse, creating what are effectively zombie companies on the way to delaying the Schumpeterian endgame and embedding an enormous amount of risk in HY credit by flooding the market with supply just as demand from investors (who are delirious from hunger after being starved of yield by the Fed) peaks and secondary market liquidity continues to dry up. This dynamic has served to create a supply glut in a number of industries and has suppressed commodity prices in a self-feeding deflationary loop.
Unfortunately for retail investors, the read-through is obscured by accounting procedures.
As we’ve outlined previously, thanks to SEC rules on how drillers are required to value their reserves, producers are effectively forced to overstate the value of their O&G businesses by nearly two-thirds, which can lead unsophisticated investors who don’t bother to read the 10K fine print to believe that the businesses are healthier than they actually are.
Meanwhile, as we quipped earlier this month, drillers are about to be “zero hedged” as the price protection which accounted for 15% of Q1 revenue for around half of North American E&P companies (and which also helped keep bank credit lines open), rolls off.
Because the next round of revolver raids for the industry isn’t due until October, investors may have been lulled to sleep by exactly the kind of credit facilities Chesapeake cites as contributing to its “extremely strong” liquidity position. In short, banks are about to run out of patience with this industry.
To continue reading: Is Shale Out Of Lifelines?
