IEEFA update: Loan program for coronavirus-impacted businesses excludes oil and gas companies. Or does it?
At first glance, Congress’ recent legislation to help the U.S. deal with the public health and economic fallout from the coronavirus has little to offer the hard-pressed oil and gas sector. A closer look at the purpose of the aid package and the reaction from industry interests, however, reveals complex internal stresses confronting the sector before, during and after this crisis.
As IHS Markit has noted, oil and gas returns have been poor for years
The legislation is meant to help companies hurt by the economic downturn caused by the COVID-19 pandemic. But before the coronavirus hit, the oil and gas industry already faced market forces that whittled away any robust demand scenarios. Industry attempts to rebalance an oversupplied market were undermined by a price war between Russia and Saudi Arabia. As energy consultancy IHS Markit noted, oil and gas returns have been poor for years. The industry is weakly positioned for the future.
As the coronavirus scenario unfolds, demand for oil and gas will continue to plummet and Russia and Saudi Arabia may or may not come to any agreement despite growing financial distress. Bottom line: Expect continued oversupply and oil prices that are much lower for much longer. After the crisis passes ‒ none too soon ‒ there is little likelihood of a fast rebound for oil and gas.
While current legislation has little to do with any recovery for the sector, it illustrates acute stresses and strains within the industry. Three primary provisions in the legislation offer clues to these stresses.
- Oil and gas companies do not qualify for economic support, based on a literal reading of the provisions on business support ‒ although it’s hard to know what mischief is crammed into an 880-page bill. The legislation contains some basic goals and rules. The primary goal: government loans are intended to cure liquidity crises of companies harmed by the coronavirus pandemic. But oil and gas industry liquidity and other problems predate February 2020. The energy sector (consisting of oil and gas companies) has been at the bottom of the S&P 500 index for most of the last decade. The independent companies that comprise a large part of shale producers present the weakest case for coronavirus-related harm. A cross-section of 34 shale-focused companies in North America has racked up negative free cash flows in every single year over the past decade, according to an IEEFA analysis. Many of these firms have taken on debt loads that had been proven unmanageable even before the current oil market turmoil. A clever corporate accountant might be able to identify some losses related to canceled or delayed projects in order to stake a claim for federal loans, but that would likely apply primarily to large companies currently involved in development projects. Smaller firms, particularly fracking companies, have, if anything, only miniscule claims from damages caused by COVID-19.
- Money lent should be paid back in five years and should reflect real risk. Five-year financing probably doesn’t do much for these oil and gas companies. While many fracking companies have upcoming maturity dates over the next two years, their debt problems are long-standing and unrelated to the coronavirus. Persistent financial underperformance has soured investors on the shale industry, making it all but impossible for shale producers to raise new money from debt and equity markets. The number of bankruptcies in the “oil patch” doubled in 2019 compared to 2018 – again, long before the term coronavirus entered the public lexicon. The credit ratings of nearly all the 34 fracking-focused, cash flow-challenged companies in IEEFA’s sample are rated below investment grade. Yields for such bonds have soared to nearly 10 percentage above U.S. Treasury bonds. During the 2008 financial crisis, for example, companies with credit ratings below investment grade could only borrow money if they agreed to pay interest rates of 20 percent, according to Federal Reserve Bank data. Assuming that some shale producers applied for bailouts, the idea of a risk-based interest rate poses a difficult problem. In 2008, the Bush-Cheney administration canceled financing for federally-backed new coal plants because rising construction prices and uncertainty related to climate change made it impossible for the government to assess risk and decide on an interest rate. Market forces suggest the fracking sector is headed for a prolonged period of bankruptcies and defaults. Any intervention at the federal level is likely to be small, and will only kick the can down the road for a few companies.
- The legislation grants “wide authority” to the executive agency, in this case the Treasury Department. The Treasury Secretary could make loans or offer other benefits to otherwise ineligible companies by fiat, regulation or waiver. Our expectation is that no transaction consistent with statutory intent will take place with oil and gas interests. Any money allocated would be based on special pleadings.
So, why did Congress and the President short-change the oil and gas industry at a time when Washington spends in trillions and chatters in billions? There are significant rifts in the oil and gas sector. Individual company and subsector interests now weaken the historical unity of the industry. In a recent interview, Scott Sheffield, the CEO of Pioneer Natural Resources, an independent oil producer, suggested that ExxonMobil hopes smaller independents will fail so that they and other large players can come in and “pick up the pieces.” He also concluded “we have no solutions” to the financial conundrums facing the industry. Sheffield’s comments highlight the rift between oil majors and smaller independents. Another rift, according to Sheffield, was the Russia-Saudi Arabia conflict, which he believes is sufficiently disruptive to warrant a direct appeal for White House intervention.
In a constricted market, looking to gain market share through the failure of others is unlikely to succeed. For example, some of the fracking and coal interests believe the current economic downturn will favor them over any growth in renewable energy. Recently, IHS Markit made it clear that the oil and gas sector is poorly positioned to take advantage of any rising market activity and that renewables are likely to fare better as the economy rebounds.
To meaningfully restructure the oil and gas industry would have required even more than $2 trillion
Amidst these conflicts, ideas that surfaced in Washington to include a purchase for the Strategic Petroleum Reserve or to support industry debt relief did not explicitly make it into the law. For the federal government to meaningfully restructure the oil and gas industry would have required an even larger allocation than $2 trillion and probably weeks of additional horse‑trading over issues unrelated to the coronavirus. Sheffield acknowledged as much with his oblique reference to independent players’ debt load, which would make consolidation of the independents unlikely because of too much debt.
The economic downturn will reduce oil and gas demand temporarily. Over the short- to medium-term, the oil and gas sector will recover, albeit slowly. But the headwinds facing the industry will remain. Long after the current crisis is resolved, the industry will still face fierce technological competition that will restrain prices and crimp profits. It will still confront rising competition from energy alternatives, particularly renewable energy and storage. It will still have to deal with persistent oversupply in electricity, transport and petrochemical markets. And its political influence will further decline as the sector’s historical cohesion continues to fracture.
Expect any largesse from the new legislation to the oil and gas sector to be based on special dispensations to lobbyists bearing gifts during an election year. These grants of taxpayer‑supported benefits ‒ if and when they occur ‒ will have little to do with the smooth functioning of the nation’s energy supply, and even less to do with the coronavirus.
Tom Sanzillo is IEEFA’s director of finance.
Kathy Hipple is an IEEFA financial analyst.
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