Oil prices have endured a stunning decline this year. At one point, WTI, which is the main U.S. oil price benchmark, cratered into negative territory as market speculators needed to pay to exit their positions because they had nowhere to store oil. That implosion in the oil market has put tremendous pressure on finances across the energy sector.
As a result, several oil companies have already filed for bankruptcy while many others are evaluating that possibility. We asked our energy contributors which ones they thought seemed most likely to file by year end. They see the greatest risk for that outcome at Callon Petroluem (CPE 0.26%), Chesapeake Energy (CHKA.Q), Diamond Offshore (DO), and Occidental Petroleum (OXY -0.54%).
A perfect storm
John Bromels (Callon Petroleum): If I were looking for the "ideal" candidate in the oil industry to declare bankruptcy in 2020, I'd try to find a company that:
- has a high level of debt
- doesn't have much cash on hand
- has been assigned a "junk" credit rating by at least one ratings agency
- is overexposed to U.S. shale
- has taken steps to restructure its debt
Independent oil and gas exploration and production company (E&P) Callon Petroleum checks all five of those boxes. Wall Street has already taken notice: Callon's shares are down 88.8% so far this year.
The trouble began for Callon when it made a risky acquisition at exactly the wrong time. In December, it acquired fellow Texas shale E&P Carrizo Oil and Gas. Callon was already a 100% Texas shale play (and remains so), but now it's taken on $1.7 billion of Carrizo's debt. That bumped Callon's total long-term debt to $3.2 billion, or 4.5 times trailing EBITDA, in exchange for Texas shale acreage that's now of questionable value.
While the bulk of Callon's debt doesn't mature until 2023, it only has $13.3 million in cash on hand, which is hardly any cushion at all. The company's credit rating was already at junk status, but given current conditions, Moody's and S&P Global have both downgraded its credit rating further, to B-/B3, or "highly speculative." On April 1, citing confidential sources, Reuters reported that Callon was working with advisors to help restructure its debt.
Callon looks to be at extremely high risk of bankruptcy this year.
On life support
Matt DiLallo (Chesapeake Energy): Chesapeake Energy's financial situation is dire. The oil and gas driller entered the year with $8.9 billion in debt, roughly $300 million of which matures this year. The company had planned to address those maturities by selling $300 million to $500 million in non-core assets.
That plan, however, has gone out the window now that oil prices have cratered due to the COVID-19 outbreak. The company has already reportedly hired advisors to help restructure its debt, which could include filing for bankruptcy. That seems like a near certainty, as one large driller has already filed while several others are preparing to do the same. Meanwhile, one of Chesapeake's largest investors -- in both its debt and equity -- has also hired advisors to assist it in negotiations with Chesapeake.
Barring a quick economic recovery that fuels a spike in oil prices, Chesapeake Energy will likely file for bankruptcy at some point this year, probably by July 1, when it has a $136 million debt payment due.
Under a "best-case" scenario, Chesapeake and its creditors will agree to a pre-packaged bankruptcy deal that will preserve a slice of shareholders' equity. However, given the amount of debt it has outstanding, and the current level of distress in the oil market, a more likely outcome will be the complete wipeout of common shareholders. Because of the extreme likelihood that Chesapeake's stock ends up worthless, investors should steer clear of this beleaguered energy company.
A poorly timed merger
Travis Hoium (Occidental Petroleum): Sometimes acquisitions happen at precisely the wrong time for a stock, and that's where I think Occidental Petroleum finds itself after the $55 billion acquisition of Anadarko Petroleum last year. The acquisition loaded Occidental with debt and that's what could ultimately lead to its demise if oil prices don't rise soon.
You can see in the chart below that $35 billion of net debt hangs over the company, and with the stock plunging the last few weeks, the options for raising equity may be running out. Worse yet, management touted a hedging strategy that left the company exposed to falling oil prices below $45 per barrel. At one time that seemed unthinkable, and now it seems like a dream price for Occidental.
I don't think oil prices are going to rebound soon, so producers are going to have to hope that oil prices will rise some so they don't lose too much money on each barrel sold, but that may be a tall task given the negative prices we've seen recently.
Then there's the glut of inventory that could force producers to shutter wells that may never come back online. The damage will hit highly leveraged companies first and Occidental fits the bill.
A waterfall of defaults coming
Jason Hall (Diamond Offshore): While a lot of the focus has been on independent U.S. oil producers being the most at risk from the coronavirus oil crash, offshore drilling contractors are also in trouble. And it's looking like the first that could fall will be Diamond Offshore, following the surprising announcement that the company was going to skip an interest payment due on April 15.
Skipping a single interest payment may not seem like a big deal, but it's not the same thing as a consumer missing a payment on a credit card. For Diamond Offshore, along with most corporate debt carried by other companies, when a company defaults on one loan, it triggers a chain-reaction of defaults on essentially all of its debt.
As a result, Diamond Offshore has telegraphed its intention to recapitalize, something that would require a bankruptcy filing to accomplish, and that would almost certainly wipe out more than 95% of the equity held by common shareholders.
The company technically has until mid-May before it's in default, but it has retained both legal and financial representation, and chances are, it's already negotiating with its debt holders to reach an agreement to exchange most of its debt for common equity. That's what will wipe out shareholders, and why it's best to not buy Diamond Offshore stock until the terms of its almost-certain bankruptcy are announced.
In the current environment, a pre-negotiated deal is not guaranteed, and there's way too much at risk to make even a speculative investment in the company right now.