US shale gas investors eye billion-dollar gamble

US shale oil and gas equity investors are expecting a rebound in prices, given share issuance figures in the first quarter of 2016. But are they backing a dud?

Oil and gas wells in Wyoming's Jonah field (Pic: Ecoflight)

Oil and gas wells in Wyoming’s Jonah field (Pic: Ecoflight)

By Gerard Wynn

Investors backed a record amount of new share issuance by US shale oil and gas producers in the first three months of this year, even after a period of lower oil prices left some companies more battered than ever.

That’s the main finding in a new report by the Carbon Tracker Initiative, Beyond the Shale: Aboard the Price Roller Coaster.

Equity investors may be betting on bargains among US shale oil and gas exploration and production (E&P) companies, expecting a rebound in oil and gas prices.

But there are two grounds for caution.

US E&P valuations have fallen by an aggregate $340 billion since last May, the last time investors were betting on higher oil and gas prices.

Second, the analysis, which I co-authored, shows how more indebted companies are now even more leveraged than 10 months ago.

Some, including Chesapeake and Whiting Petroleum, have had to re-negotiate their borrowing terms after soaring leverage ratios looked set to exceed former credit facility covenants.

Below are four charts which illustrate some considerations for equity investors in U.S. shale.

Investors are pumping cash back into a weakened US shale industry in record amounts, with the first quarter this year seeing the highest E&P equity issuance since at least 2011.

Chart 1. US E&P equity issuance and WTI oil price, 2014 to late March 2016


But US E&P equity valuations have fallen by an aggregate $340 billion since May 2015, the last time investors were talking up the prospect of a rebound in oil and gas prices.

Chart 2. Market capitalisation of S&P US Oil and Gas Exploration and Production Select Industry Index, May 2015 to March 8 2016


In 2016, most E&P companies project lower output, and many will see less robust hedging.

The result will be lower pre-tax earnings, or EBITDAX. Creditors often specify a leverage ratio, in their borrowing terms to E&P companies, defined as net debt divided by EBITDAX.

Creditors often specify a maximum leverage ratio of four; a value of four is also the threshold which the US Office of the Comptroller of the Currency uses to define “sub-standard” E&P bank loans.

The chart below shows how Chesapeake’s leverage ratio is expected to exceed four at any conceivable oil  and gas price this year.

Both Chesapeake and Whiting Petroleum have had to suspend total leverage ratios, under their credit facilities.

Chart 3. Scenario analysis of Chesapeake, 2016, Net debt/ Consolidated EBITDAX ratio


While equity issuance soared in the first three months of this year, US E&P bond issuance has remained below recent historical levels, suggesting prospective creditors are exercising greater caution.

Do bond investors know something equity investors do not?

Chart 4. Bond issuance by quarter, U.S. E&P companies, 2014-2016 (as of March 8)


Gerard Wynn has two decade’s experience in energy, climate change, the environment and economics. In 2014, Gerard founded the consultancy GWG Energy, providing communications and analysis services in the fields of energy and climate change.

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