Gloomy Forecast: Oil Industry Bankruptcies Increase 471%

For an analysis of bankruptcies in the oil and gas sectors from 2014-2015, please see the research from the Gavin/Solmonese team, available here.

Joseph Richman, ABL Advisor

At the beginning of September 2014, the price of a barrel of crude oil on the New York Mercantile Exchange closed at $95.96 per barrel. By the beginning of 2015, the price had dropped approximately 56% to $53.27, slightly more than half what it had been a year earlier, on the first trading day of 2014, at $98.42. The fourth quarter of 2014 brought. an historic drop in the price of oil: a drop that set loose a disastrous shakeout of the oil industry. From the beginning of the decline in the price of oil through the end of the year 2015, no fewer than 80 upstream companies filed for bankruptcy protection. Contrasted with the same period the previous year (Fourth quarter 2013 to the end of 2014), that is an increase in corporate failures of roughly 471%. While it comes as no surprise that low oil prices cause bankruptcies in the oil industry, the data on these bankruptcies yields surprising conclusions; both about the industry as a whole and its future (or lack thereof).

Specifically, the low oil prices affected bankruptcy filings of upstream oil producers, companies that are directly involved with the extraction of crude oil. These companies fit generally into two different categories: oil exploration/production companies (those involved with the actual drilling of reserves) and oilfield services companies (those who provide services to, and are dependent upon, the explorers and producers – the remoras to the wildcatter’s sharks, if you will). In number, 45 exploration companies and 35 services companies filed over the period of the initial decline. While it is worthwhile to note that the explorers filed in greater number, this number is not so much larger as to be able to conclude that they were harder hit.

In fact, this statistic shows just how deeply the industry was affected as a whole. In periods of decreasing revenue impacting producers, one might ordinarily anticipate a greater number of services company filings due to reduced demand from their customers. As price drops, explorers would be expected to slow their pace of production in an attempt to preserve their in-ground reserves until they can sell their oil at a higher price. That slower pace of production would result in less need for the third party servicers (e.g. oilfield waste disposers would be left with less waste to process). In considering the data, that is not what happened here. Both producers and servicers have been affected almost equally – it is the oil industry, as a whole, that is getting battered.

Looking at the geography of the filings, an unsurprising pattern emerges: the Gulf coast oil industry has been the hardest hit. Approximately 54% of the filings occurred in the state of Texas, with 61% of the businesses headquartered in Texas, and many of those filings have been in the Southern District of Texas (encompassing Houston and Victoria). Houston oil companies largely have their reserves based in the Gulf of Mexico. Historically, those drillers have been some of the least efficient due to the high fixed costs of deep-water drilling. Efficiency was not a priority for these firms when oil was over $100 a barrel and profit margins were soaring. In those days, a manager was much more likely to spend money on developing new proven reserves to keep the tap open, rather than invest capital to increase efficiency. With the cataclysmic drop in prices, the least efficient producers were just unable to survive and were among the first to file.

It is important to contrast the relative efficiencies (or inefficiencies) in Texas with that of fracking producers in places like Oklahoma and North Dakota. Over the same period during the collapse, there have been only a handful of filings in fracking regions. In general, frackers can produce oil much more efficiently, some for as low as $15 a barrel. As the price of oil drops, so too drop these frackers’ margins. But, since their costs of ongoing production are lower, they can hang on. Though these more efficient firms have been able to survive thus far, this is not a cause for optimism. A policy of seeking to increase operating cost-efficiency may still not be enough in the reality of continued depressed prices. A recent report from Deloitte posits that one third of all oil firms could be poised for bankruptcy. Even the most efficient producers are in trouble if oil continues to trade at lows.

Looking ahead, the future of the oil industry is not promising. The largest proximate cause of the depression in prices is due to a worldwide supply glut. Recently, Russia and Saudi Arabia have led a charge to curb production. The problem with their agreement is that they are freezing production at January 2016 levels: levels that are already at record highs. Furthermore, with the recent lifting of sanctions on Iran, a major player is back in the market and increasing production. Failing a massive policy shift by OPEC, Iran and Iraq, 2016 is shaping up to be more doom and gloom for the oil industry. The wave of bankruptcies is likely to continue. So, we must ask ourselves – just as U.S. production was becoming the largest in the world, were we unwittingly selling out a future of $100/barrel oil in exchange for selling twice as much at a third of the price?

This article originally appeared in the ABL Advisor blog on March 21, 2016.