U.S. SHALE DOWN
In the boom years of the US shale oil industry, profitability was something of an optional extra. Companies were focused on growth, it was easy to raise capital, and making a decent return on investment could be put off for another day.
Now that growth is grinding to a halt because of the slump in oil prices, investors may become less tolerant of persistently low returns.
The industry's poor record of returns on investment was highlighted in a presentation last month from EOG Resources, the largest shale oil producer and one of the most efficient.
EOG said it made a return on capital employed of 12.4 per cent in 2013 and 13.7 per cent last year, but noted that comparable US exploration and production companies had done far worse — making just 3.4 per cent on average in 2013 and 4.3 per cent in 2014.
Given that those low returns were made with US benchmark crude prices averaging about $98 per barrel in 2013 and about $93 last year, prospects for profitability at today's price of about $47 a barrel look dire.
"Companies were so concerned with growth, they lost sight of profitable growth," says Dennis Cassidy of AlixPartners, a consultancy.
"People said the oil industry was doing great, and it was, in terms of growth and activity and feeling good about it. But when you looked under the covers, it wasn't really," he adds.
Generally low returns across the industry meant that oil companies had to keep attracting fresh capital to finance their investment programmes.
In 2013 and 2014 the US E&P sector raised $34.2bn in new equity, $62.6bn from bond sales and $191bn from syndicated loans, according to Dealogic.
Even the most successful companies were spending more on drilling and completing wells than they booked in cash revenue.
Continental Resources, for example, made cash from operations of $3.36bn last year, but spent $4.59bn on capital investment. Whiting Petroleum, the largest producer in the Bakken shale area of North Dakota, reported cash from operations of $1.82bn and capital spending of $2.86bn.
So far, the flow of capital into the industry has not dried up. US E&P companies have so far this year raised $7.93bn from bonds, $11.7bn from syndicated loans and $8.42bn from new shares.
Equity issuance has been particularly strong, with companies including Noble Energy, Encana, Concho Resources, Laredo Petroleum and Southwestern Energy announcing large placings.
On Monday evening they were joined by Whiting, which had been looking for a possible buyer, but opted instead to issue up to 40.3m shares worth about $1.4bn, and raise up to $1.15bn from new convertible notes.
Allen Gilmer, chief executive of DrillingInfo, an oilfield data company, says the willingness of investors and lenders to continue to support E&P companies is a marked contrast from other oil industry downturns, when capital investment dried up very quickly.
At a time of low interest rates, he says, the oil industry still looks attractive to some investors. "The world is looking for yield," he says. "That's the basic problem: there's not a lot out there."
The surge in interest in oil and gas investment from private equity firms is more evidence of that. Blackstone has said it has $9bn available for energy investments, while others including Apollo, Goldman Sachs's investment arm and Carlyle also have or are raising funds to put into the sector.
But there are signs that investors are becoming less tolerant of low returns. Whiting shares opened down 20 per cent on Tuesday in reaction to Monday's fundraising.
Despite the amount of private equity capital available to put into energy, only a few deals have so far been done, suggesting a gap in expectations between companies and would-be investors.
Greg Matlock of Ernst & Young, the professional services group, says: "There is a massive capital shortage on one side and a massive capital supply on the other, and they don't seem to be holding hands yet."
Many E&P companies are trying to avoid raising capital by covering their investment spending from their cash flow. Chesapeake Energy on Monday announced another round of cuts in its drilling programme to achieve that objective by the end of the year.
If the US Federal Reserve follows through with plans to raise interest rates, the E&P sector is probably going to see its cost of capital rise further.
"One day I expect the punchbowl will be taken away," says Michael Hulme of Carmignac, the French fund manager.
Investors will be selective, focusing on companies that can be profitable even at low oil prices, he adds.
"What you're looking for is the company that can put a dollar in the ground and get two dollars out; not the one that puts a dollar in and will get out 80 or 90 cents."
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