Liquidity is the life blood of any business. But when it dries up, a company can be faced to scramble for cash, being forced to do things that aren't in its investors' best interests. In a worst-case scenario, a company can be forced to declare bankruptcy, which can wipe out investors.
Oil companies are acutely affected by the ebb and flow of liquidity due to oil prices. High prices can make even the worst-run oil company flush with cash, while a deep downturn in the oil market can take away what precious liquidity oil companies have when they need it most.
Right now, we're in that later stage as the deep drop in oil prices over the past year has sapped the liquidity out of many oil companies. That, however, hasn't stopped the management teams of these companies from boasting of their liquidity through the crisis even though the liquidity most boast about isn't as secure as these companies' hype.
Underwater, but we still have plastic
Liquidity comes in a number of forms, and some forms hold up much better than others during a time of crisis. Cash, for example, is worth its weight in gold when markets turn south. On the other hand, the available borrowing capacity on a company's credit facility is much less secure. That's because these credit facilities are redetermined twice a year and can be increased when things are good -- and cut when they're not.
Obviously, we're in that latter stage right now. Oil industry cash flows are drying up, and oil and gas assets aren't worth what they were when oil prices were in the triple digits. And yet, oil companies still tell their investors that their credit facilities are a strong source of liquidity during these tough times, when these lines of credit could be cut over the course of the next year.
For example, on SandRidge Energy's (NYSE: SD) last conference call, CEO James Bennett boasted that the company had "over $1 billion [in] liquidity to start the year." However, $900 million of that liquidity was in the form of the company's credit facility. Meanwhile, Halcon Resources (NYSE: HK) boasted that it "did end the year with liquidity at about $533 million, which consisted of our undrawn revolver capacity plus cash on hand." However, about $500 million of that liquidity was its credit facility.
These amounts seem like a lot of money, but these oil companies shouldn't bank on them being available if oil prices remain weak. That's because the last time oil prices plunged, credit lines proved not to be as liquid as oil companies thought, as many saw their credit lines cut.
A trip down memory lane
We last saw this 2009, which was an awful year for oil companies. Not only was the global economy on the brink of collapse because of a credit crunch, but oil prices had already dropped significantly.
This one-two punch really sapped the liquidity from oil companies. Take BreitBurn Energy Partners (NASDAQ: BBEP), for example, which had a $900 million borrowing base to start 2009, of which it had borrowed $717 million. That left it with $183 million of liquidity it could have used to take advantage of the crisis to proactively buy cheap oil assets. Unfortunately, that liquidity turned out to be not quite as strong as the company would have liked: In April of 2009, its banks redetermined its borrowing base down 15% to just $760 million, leaving it with only $43 million in liquidity. This forced the company to make some tough decisions, including suspending its distribution so it could reduce its debt and preserve what little liquidity it still had.
There is a growing risk that the credit lines of oil companies could again be cut if oil prices remain weak. For the most part, energy companies aren't running into to many issues during the spring redetermination; Halcon and SandRdige both recently reported that their facilities were reaffirmed during the spring redetermination. However, for others, like BreitBurn, liquidity was worrisome: BreitBurn had borrowed $2.2 billion of its $2.5 billion facility. Like it did in 2009, BreitBurn was running the risk that its borrowing base would be redetermined lower, and it didn't want to see the credit line cut below current borrowings. That's why it proactively raised cash at less than ideal terms. Other oil companies might have no choice but to do the same before the year is over if credit facilities start getting cut.
If oil prices don't meaningfully improve this year, it could cause a liquidity crunch for oil companies when their credit lines come up for renewal. While many are making it through the spring redetermination without a cut, the fall could prove to be an issue, especially if there is no improvement in crude prices. This suggests credit facilities might not be the source of liquidity oil companies had been boasting about.