The 50% plus decline in oil prices that started in the summer of 2014 surprised virtually all market participants with its speed and magnitude. In hindsight, the causes of the decline were largely supply-driven, but weaker global demand and market positioning also played a role. While many companies are adequately hedged in 2015, revenue and cash flow will be severely impacted in 2016 and beyond if oil prices stay near current levels.
To their credit, as it became clear that prices would stay lower for longer, management teams responded aggressively. Virtually all companies followed the typical playbook in a stressed industry: Capital expenditures (production) plans were materially reduced, dividends slashed, share repurchases suspended, and headcount eliminated. They have also sought to bolster liquidity through asset sales, covenant relaxation and debt issuance. The latter has been an option available to all but the most troubled credits, as non investment grade companies issued over $12 billion of senior unsecured and second lien debt securities in the first quarter of 2015.
However, the most surprising and encouraging response has been the ability and willingness of management teams to issue equity. As the chart above shows, the first quarter of 2015 was the second highest equity issuance quarter since 2003, trailing only the second quarter of 2014. The difference was that WTI crude oil averaged $94 in Q2 2014 versus $50 in Q1 2015. Equity issuance was not a foregone conclusion as evidenced by companies in other commodity-based industries like coal, copper, iron ore, gold, steel and aluminum. In these industries, commodity price declines have been significant over the last few years, but management teams didn't raise equity nearly as aggressively in aggregate.
Aside from their willingness, the ability of energy companies to issue equity stems from the fact that the stress in the oil markets has coincided with a benign domestic economic backdrop, which has served to isolate the pain and keep capital markets wide open. Another avenue for equity issuance, not captured in the chart, has been private equity. These firms have been actively raising funds, performing diligence and looking for acquisition and/or joint venture opportunities.
Key Takeaways: Oil and gas assets have been able to successfully attract external equity and debt capital during this first round of market stress. While robust equity issuance will not solve the long-term problems of lower energy prices, nor prevent some highly levered companies from having to restructure their balance sheets, it could push out or stagger the timeframe for defaults. This could help sentiment in the high yield market and buy time for a stronger commodity environment.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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