The Pandemic Strikes Again: Energy Sector Bankruptcies Rise
- 7 min read
While the airline industry has benefited from a special federal stimulus loan package tied to the impact of COVID-19, the energy industry has not been as fortunate to date. Many energy companies were distressed before the pandemic hit the US in early 2020. The shutdown that ensued upended the energy industry and has sent many companies into a downward financial spiral. Almost overnight, the global demand for oil disappeared and prices plunged, which set off a price war between Saudi Arabia and Russia. The price for a barrel of oil shrank to unprecedented low levels and has left many energy companies struggling to make debt payments at a time when many traditional funding sources are not available given current asset values.
Although the coronavirus accelerated the financial plight of many energy companies, some were experiencing financial hardship prior to the onset of COVID-19. Beginning in Q2 2019, energy restructurings were on a sharp increase with filings in the 2nd quarter rising 300% over Q1 2019. In 2019, a total of 46 energy companies filed for protection under Chapter 11, representing an increase of over 64% from 2018. According to a 2019 report from law firm Haynes and Boone, a surge in bankruptcies began in May 2019, following a -23% correction in West Texas Intermediate (WTI) prices from mid-April to mid-June. They also noted that bankruptcies in the upstream sector have increased as energy spot prices remained subdued amid a cyclical downshift in the economy. These market conditions had a severe impact on shale companies, especially those who had taken on considerable debt to finance expansion projects. These companies are now facing the reality of a huge debt load with dwindling revenue, necessitating either an in-court or out-of-court restructuring.
The year 2020 began quite unremarkably but conditions quickly weakened. Since January 2020, oil prices have fallen from $63 per barrel to a one-day drop into negative territory in April 2020. Although prices have rebounded to about $40 per barrel, prices will likely remain flat due to low demand and this does not bode well for oil producers. Industry stability continued to fall apart on March 6, when producers in the Organization of the Petroleum Exporting Countries (OPEC) failed to reach a deal and the price for a barrel of oil dropped to $41.28. Saudi Arabia and the Russian Federation then flooded the market with oil and in a 3-day period prices fell more than $10 per barrel to $31.13. Prices continued to fall, but on April 2, the United States reached a production deal with OPEC whereby production was subsequently cut by 11 million barrels per day. However, US crude storage was reaching capacity of about 19 million barrels. On April 20, the market hit rock bottom and prices fell to ($37.63), the lowest price in history. As countries have started easing lockdown policies and productions cuts remain in place, prices have started to rise, yet with COVID-19 not showing any signs of slowing in many parts of the US, there will likely not be a significant increase in demand that would drive prices up considerably. Many US companies are still allowing their employees to work from home, so people are driving less for work and leisure driving is also way down. In addition, there is a decrease in commercial transportation. The energy sector is also affected by less coal usage and diminished electricity use, either from businesses closing down and shutting off electricity or people trying to conserve energy within their homes.
Although things are slowly starting to recover and consumers are starting to use more energy, the damage is done and will continue to deepen as the pandemic continues and the economy stalls. Energy companies affected by the pandemic, especially those who were already struggling with high debt, will not outpace this economic downturn and many will have to turn to bankruptcy protection. Through August 31, 2020, 53 energy companies have sought protection under Chapter 11.
While many of the larger and more stable energy companies will likely survive this crisis, many small and mid-sized companies will not. The at-risk companies have too much debt, face looming debt maturities, and do not generate enough cash flow to make interest payments. The key to stability will be how long oil prices stay depressed. The Energy Information Administration has forecasted a decreased demand for oil and liquid fuels to continue throughout 2020 and 2021 when compared to 2019 levels due to the pandemic’s lasting impact on travel. In light of this, energy companies are increasingly turning to restructuring advisors to evaluate their financial profile and make recommendations on the best strategies to weather these tough market conditions.
The downturn in the oil industry has exposed much of the economic vulnerabilities that exist. Over the past decade, the US has become a major oil and gas producer because energy companies have had ready access to capital. Quick capital allowed shale companies to dramatically ramp up production both on and offshore. While companies with strong balance sheets had access to traditional borrowing, many smaller independent producers relied heavily on the junk bond market to finance their expansion. With access to money now unavailable, the weakest players might be forced to consider bankruptcy protection. As companies restructure, many will be forced to reduce their workforce and countless US jobs will be lost. This wave of bankruptcies threatens the stability of those regions that rely on oil and natural gas production to support their economies.
What’s Next for the Energy Sector?
The global pandemic has caused an energy oversupply that we have not experienced in recent history. Demand for oil is at historically low levels and will likely stay depressed though 2021. Extreme financial pressure is being felt at all levels of the energy industry. Producers, gathers, and other midstream companies, as well as refiners, all need to adjust to doing business in a post-COVID-19 environment. While there is still a possibility that the energy industry will receive a stimulus package designed specifically for them, negotiations are currently stalled. An oil industry stimulus package would help to keep some companies afloat until oil prices rebound to sustainable levels. In the meantime, energy companies continue to lose value. The S&P 500's energy sector has lost more than 40% of its value this year — despite the dramatic rebound in the overall stock market over the past months. Now, more than ever, energy companies need the assistance of restructuring advisors who can evaluate their businesses and help them navigate the rough path ahead.
To learn more about Epiq’s energy related bankruptcy practice, see https://www.epiqglobal.com/en-us/results/restructuring-bankruptcy/energy-future-holdings.