A Death in the Oil Patch

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While speaking to my father recently, I mentioned that I'd yet to see a significant business go belly-up in the energy sector since the downturn began.

Sure, there were the rumors swirling around Chesapeake Energy (NYSE: CHK), but the onshore exploration ace has plenty of liquidity levers to pull. Unfortunately, the same cannot be said for Oilexco, which recently announced preparations for a bankruptcy filing in the United Kingdom.

Oilexco, dual-listed in Toronto and London under the enviable ticker OIL, has been the most active E&P in the U.K. North Sea in recent years. Like ATP Oil & Gas (Nasdaq: ATPG), Oilexco has focused on properties that are non-core to the majors and has scooped up assets from the likes of Chevron (NYSE: CVX) and ConocoPhillips (NYSE: COP). It's a strategy that I've praised in the past, but something's gone terribly wrong.

Offshore development requires some serious coin. With the credit clam-up, both ATP and Oilexco have encountered liquidity problems. Through the end of the third quarter, ATP sported higher balance sheet leverage, by far -- so why is Oilexco the one to bite the dust?

Well, just as with your friendly neighborhood investment bank, the stuff that's on the balance sheet only tells part of the story. Turning to the notes that accompany these firms' financial statements, there's a doozy of a differentiating data point.

Under the section "Contractual Obligations," ATP lists $273 million due in less than a year. Oilexco? Nearly $600 million! The largest chunk, at over $250 million, owes to drilling contracts. Two long-term agreements with Transocean (NYSE: RIG) and Diamond Offshore (NYSE: DO) are the clear culprits.

Oilexco had the interesting idea that if it contracted out some rigs for extended exclusive engagements, the firm would control its own destiny. Having weighed itself down with these drilling commitments -- at sky-high dayrates -- this company has done just the opposite.

Morgan Stanley (NYSE: MS) will seek bids for Oilexco's assets as the firm operates under creditor protection, but it's not clear whether shareholders will see a dime of any potential proceeds.

On a personal note, I'm embarrassed to say that I've often used the debt-to-capitalization ratio as a useful proxy for an E&P's liquidity, without considering off-balance sheet commitments. The case of Oilexco is just one more reminder that diligent Fools need to focus on the fine print.