Lambert here: Who woulda thunk the Fed’s easy money policy — no, not for you! — would contaminate millions of gallons of water and create exploding “train bombs”? Life’s little ironies…
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street.
Debt funded the fracking boom. Now oil and gas prices have collapsed, and so has the ability to service that debt. The oil bust of the 1980s took down 700 banks, including 9 of the 10 largest in Texas. But this time, it’s different. This time, bondholders are on the hook.
And these bonds – they’re called “junk bonds” for a reason – are already cracking. Busts start with small companies and proceed to larger ones. “Bankruptcy” and “restructuring” are the terms that wipe out stockholders and leave bondholders and other creditors to tussle over the scraps.
Early January, WBH Energy, a fracking outfit in Texas, kicked off the series by filing for bankruptcy protection. It listed assets and liabilities of $10 million to $50 million. Small fry.
A week later, GASFRAC filed for bankruptcy in Alberta, where it’s based, and in Texas – under Chapter 15 for cross-border bankruptcies. Not long ago, it was a highly touted IPO, whose “waterless fracking” technology would change a parched world. Instead of water, the system pumps liquid propane gel (similar to Napalm) into the ground; much of it can be recaptured, in theory.
Ironically, it went bankrupt for other reasons: operating losses, “reduced industry activity,” the inability to find a buyer that would have paid enough to bail out its creditors, and “limited access to capital markets.” The endless source of money without which fracking doesn’t work had dried up.
On February 17, Quicksilver Resources announced that it would not make a $13.6 million interest payment on its senior notes due in 2019. It invoked the possibility of filing for Chapter 11 bankruptcy to “restructure its capital structure.” Stockholders don’t have much to lose; the stock is already worthless. The question is what the creditors will get.
It has hired Houlihan Lokey Capital, Deloitte Transactions and Business Analytics, “and other advisors.” During its 30-day grace period before this turns into an outright default, it will haggle with its creditors over the “company’s options.”
On February 27, Hercules Offshore had its share-price target slashed to zero, from $4 a share, at Deutsche Bank, which finally downgraded the stock to “sell.” If you wait till Deutsche Bank tells you to sell, you’re ruined!
When I wrote about Hercules on October 15, HERO was trading at $1.47 a share, down 81% since July. Those who followed the hype to “buy the most hated stocks” that day lost another 44% by the time I wrote about it on January 16, when HERO was at $0.82 a share. Wednesday, shares closed at $0.60.
Deutsche Bank was right, if late. HERO is headed for zero (what a trip to have a stock symbol that rhymes with zero). It’s going to restructure its junk debt. Stockholders will end up holding the bag.
On Monday, due to “chronically low natural gas prices exacerbated by suddenly weaker crude oil prices,” Moody’s downgraded gas-driller Samson Resources, to Caa3, invoking “a high risk of default.”
It was the second time in two months that Moody’s downgraded the company. The tempo is picking up. Moody’s:
The company’s stressed liquidity position, delays in reaching agreements on potential asset sales and its retention of restructuring advisors increases the possibility that the company may pursue a debt restructuring that Moody’s would view as a default.
Moody’s was late to the party. On February 26, it was leaked that Samson had hired restructuring advisors Kirkland & Ellis and Blackstone’s restructuring group to figure out how to deal with its $3.75 billion in debt. A group of private equity firms, led by KKR, had acquired Samson in 2011 for $7.2 billion. Since then, Samson has lost $3 billion. KKR has written down its equity investment to 5 cents on the dollar.
This is no longer small fry.
Also on Monday, oil-and-gas exploration and production company BPZ Resources announced that it would not pay $62 million in principal and interest on convertible notes that were due on March 1. It will use its grace period of 10 days on the principal and of 30 days on the interest to figure out how to approach the rest of its existence. It invoked Chapter 11 bankruptcy as one of the options.
If it fails to make the payments within the grace period, it would also automatically be in default of its 2017 convertible bonds, which would push the default to $229 million.
BPZ already tried to refinance the 2015 convertible notes in October and get some extra cash. Fracking devours prodigious amounts of cash. But there’d been no takers for the $150 million offering. Even bond fund managers, driven to sheer madness by the Fed’s policies, had lost their appetite. And its stock is worthless.
Also on Monday – it was “default Monday” or something – American Eagle Energy announced that it would not make a $9.8 million interest payment on $175 million in bonds due that day. It will use its 30-day grace period to hash out its future with its creditors. And it hired two additional advisory firms.
One thing we know already: after years in the desert, restructuring advisors are licking their chops.
The company has $13.6 million in negative working capital, only $25.9 million in cash, and its $60 million revolving credit line has been maxed out.
But here is the thing: the company sold these bonds last August! And this was supposed to be its first interest payment.
That’s what a real credit bubble looks like. In the Fed’s environment of near-zero yield on reasonable investments, bond fund managers are roving the land chasing whatever yield they can discern. And they’re holding their nose while they pick up this stuff to jam it into bond funds that other folks have in their retirement portfolio.
Not even a single interest payment!
Borrowed money fueled the fracking boom. The old money has been drilled into the ground. The new money is starting to dry up. Fracked wells, due to their horrendous decline rates, produce most of their oil and gas over the first two years. And if prices are low during that time, producers will never recuperate their investment in those wells, even if prices shoot up afterwards. And they’ll never be able to pay off the debt from the cash flow of those wells. A chilling scenario that creditors were blind to before, but are now increasingly forced to contemplate.
When the heck will the bloodletting stop? Read… The Fracking Bust Exacts its Pound of Flesh
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Some externalities lie under the ground. Please tell me that we (as in your proverbial taxpayer/bank rescuer) are not to pick up the pieces (I mean the underground napalm) of the GASFRAC bankrupcy from below the ground.
Santi, part of GFS’s claim to fame was that the propane/mix was recovered during production. Producers would be much less inclined to use GFS’s process if it meant pumping a gas that is of equal or higher value than what they’re producing down the hole.
(Use your brain please.)
Credit where credit is due: James Howard Kunstler laid this all out several years ago. If prices fell or interest rates rose, the whole house of cards would come crashing down. He thought interest rates would be the culprit, and in a way they are, even if it is falling prices that have been the proximate cause. Too many years of ZIRP for the capitalists and high interest rate credit cards, student loans, and HELOCs for the rest of us has so skewed the economy that creating supply is infinitely easier than generating demand. But, to repeat myself from several previous posts, the capitalist system will try any trick, any hair-brained scheme, to boost the economy save raising the pay of the workers.
It’s Neoliberalism versus the limits to growth + overshoot. IOW, this is what an unsustainable economic system looks like as it unwinds -and, in time perhaps, it will rapidly collapse. Yes, Kunstler and several others in the peak oil camp foresaw this connection between energy, economy and finance playing out this way, e,g, M. King Hubbert, Frederick Soddy, Colin Campbell, Ken Deffeyes, Jeff Brown, and others I cannot recall.
Productivity bites
investorsgamblers in the ass.Productivity bites
investorsgamblers in the ass.To Fed economists, polluted watersheds and train bombs are externalities.
Just a few years ago, a problem was home buyers who defaulted on their mortgages within the first year. It’s the same tune, played on different instruments…Wall Street has more money than it can find productive uses for, and this causes the creation of serial bubbles…
Ok, this is really in need of fact-checking.
First, bringing in HERO is utter, utter disingenuitiousness. HERO is an offshore drilling business that has absolutely NOTHING to do with fracking. Moreover, it also has nothing to do with “cheap money”. HEROt has been treading water for a long time because a) it had taken on some stupid debt back in 2006-2007, and b) offshore day rates have been volatile to say the least (Trico went bankrupt at least twice, I think, already). Day rates gap down (e.g. because offshore rig count drops because oil prices drop) – you hope they gap back up next quarter, and if they don’t, you file. Again – nothing to do with fracking, or with junk bonds, or with whatever else.
Somehow I don’t see Mr. Richter mentioning any of this. “Fracking suxxorz!! Junk bonds will herald the apocalypse!” Ok, fine. Good one.
Secondly, it’s nice that he mentions Quicksilver and Samson (stupid PE plays, if I remember). Chesapeake? No? Any of the majors? No? Who is actually doing the bulk of the fracking? Freaking Samson with like $1 billion peak EBITDA? Drop in the bloody bucket. Yes, these business should have failed, and will continue to fail, but until you have someone important blow up – no-one cares.
On that note – hey, what proportion of the junk bond market do all these issuers represent? Hell, how many dollars? ’cause there is over a trillion worth of junk bonds out there ($1.1tr? $1.2tr?), and I am betting all these over-levered oil/gas plays put together are not more than $50 billion. Which sounds like a lot except that a) default rates have been super depressed for a while, so think mean-reversion, and b) defaults won’t happen all at once. Quicksilver has just hired advisors. Everyone knows it’s dead, but it might take six months, hell, a year, for the official filing to happen. Who knows. I don’t. Point is – $50 billion defaults, even with zero recoveries, over 1-2 years, on a trillion market, is…meh. Shrug. Unpleasant, but so what?
So. Misleading article and fudged facts to beat a very, very dead horse about the apocalypse that just might take completely different forms. Just saying. Hey, why is this site still treating this author with any degree of credibility? Ain’t the first of his screeds that happened to contain…omissions, shall we say.
Cheseapeake is leveraged in a different way. Their business model is to land-flip at high speed. They blow up when they’re unable to flip their land. It takes a while for them to run out of cash.
It is no secret that oil and gas companies are highly leveraged. It is an extremely capital intensive and RISKY business. Chesapeake has problems, but they stem almost entirely from a megalomaniac CEO that over-extended the company beyond all reason. It’s slowly clawing its way back into balance, but will never be at risk of collapse. It’s just too big, successful and cunning.
But that’s beside the point – these examples of bankrupt companies have virtually nothing in common with each other and are absolutely not representative of the entire industry. Not even a sliver of it. WBH is a zero. Gasfrac has unproven technology that came out just at the wrong time. Hercules relates to this discussion about as much as JC Penney does. BPZ is primarily a conventional producer (i.e. no fracking) and focused on Peru. And Quicksilver is just incredibly overextended and poorly run and has been on the brink of bankruptcy for years, even when oil was at $90+ a barrel.
This is a very unimpressive piece of analysis that tries to wedge in bits of ‘information’ that together prove nothing, but try to make a point that is not backed up by any fact. What a shame.
Vampires, tapeworms and tumors all seem to be doing sort of rosy fevered okay for themselves, up to the point… And now it looks like senile dementia has set in too, soon with no one left to change the diapers, mind the exits and wipe the drool off. All these smart people with their “I know how this works” hubris, or is it just fortuity that they and their skill sets happen to be happily located in space and time to wreak the maximum amount of
profitdamage and pain from the wonderful system of asymmetric vulnerabilities that is our “modern” political economy? Along with kicking the legs out from under millions of ordinary people who are just trying to make ends meet, sans any notion or intent of taking more than a “modest competence,” https://books.google.com/books?id=2N1AAQAAMAAJ&pg=PA38&lpg=PA38&dq=modest+competence&source=bl&ots=VE8SkfPi-S&sig=aRNK3bl9sRYKySZ2gG-aqNBMP7o&hl=en&sa=X&ei=lpH4VJ_zNNDTgwSiiYTYBQ&ved=0CEUQ6AEwBw#v=onepage&q=modest%20competence&f=false, of Maslow’s ground tiers of necessities?What’s that I heard, the other day? “We need to GROW ourselves out of this crisis!” How’s that been working out for you, Mr. Malignant Metastatic Tumor? And the Wise (Mostly) Men who advise you and arm you with the weapons of “economics” and fill all the apparently inexhaustible demand for the other kinds of weapons, AK-47s and RPGs and TOW missiles and Hellfires? No liquidity trap problems there, are there? Not much of a future, either, unless you can become a Terminator-class Autonomous Battle Robot…
I’ll blame the “neo-liberals”. I’m doing to do so because of the “blue article”. If there’s no word for “blue” there’s no blue. As most peasants have no idea what a “neo-liberal” is, there’s no-one to blame.
Ya gotta hand it to them sociopaths, they’ve even got the users of the word “neo-liberal” in bind.
Oil and gas extraction industries with a large amount of externalization (i.e. fracking, tar sands) are fruit too sweet for debt industries to pass up. The debt cookie jar opening in these industries is big enough for a lot of hands (drillers, engineers, contractors, railroads, trucking, refining, sand miners, etc.). Therefore, there is less emphasis in developing a relationship with the many debtors and more opportunity to wring them of capital when payment is due (they will get killed in court otherwise). In addition, oil/gas business cycles move quickly so the financial tether can be quickly snipped when margins get tight or go in the red. I’ve had a hypothesis on this as it relates to renewables.
Financing, as it is currently structured, does not play well with renewable energy development. Financing solar, wind, or hydroelectric projects in the modern banking environment is probably more in line with how lending should be done, though, in contrast with the fossil fuel industries, it is tortuously slow and full of relatively absurd scrutiny. Why? There are less actors in the play, less externality, and the finance cycle is long term. This used to be ideal for lenders. Less actors, less risk. Longer term, more stability. The whole system is inverted. Today there is effectively no way for lenders to screw the pooch so why bother with stable infrastructure. In fact, the riskier the financial venture, the more lax the lending.
As an example, American Municipal Power got a lot of flack over 20 years ago for proposing to build their Belleville Hydroelectric facility on the Ohio River. The arguments were as expected on the utility share holders end, “we’ll never make a return”, “it is too risky”, and the financiers were quite reluctant as well, though because they felt it would never yield as great a return as some other venture (say a Dot-com venture then or fracking in Northeast Ohio or North West Virginia now). It was commissioned in 1999 and is already paid for with a hefty dividend. The Belleville facility will be producing, easily, for another 100 years with minimal environmental impact and minimal maintenance costs. Long lifespan, low level of externality, and low maintenance equals uninterested lenders. Welcome to Bizzaro World.
For further information on the Belleville facility check out the video:
https://vimeo.com/9384571
As stated in the video, many of these projects have to be funded through government bonds or loan guarantees (however rational and beneficial they are long term) in a cooperative investment structure. I do like these models but it is difficult to get development going in these sectors when relying upon government institutions that are getting whittled away by the day.
There is another largely under-publicized aspect to this in addition to the prospects of junk debt defaults. That is the amounts of related derivatives exposures.
From this article back in December:
… “But according to a Brown Brothers Harriman analysis published Dec. 6, the energy sector has just suffered its own “Minsky moment.” That term refers to the point in time when a commodity which must, to sustain the debt leveraging it, go up indefinitely—takes a sudden turn lower and starts a debt crisis. “A lot of things were leveraged based on oil prices that can only go up,” states the analysis.
Whether the debt collapse will be mini or maxi, may be determined in the markets for $20 trillion in commodity derivatives exposure. About $4 trillion of that exposure is energy commodity derivatives exposure of the half-dozen largest U.S.-based banks. And because the shale energy producers have bought derivatives contracts from these banks to protect themselves against a plunge in oil prices, there is good reason to believe that the big banks’ $4 trillion energy derivatives exposure consists largely of bets in the wrong direction now.
Is it a coincidence that Republican leaders in Congress are in a strong push, with Wall Street, to pass legislation to allow commodity derivatives, among other types of these financial weapons of mass destruction, to be put under FDIC insurance?”
See: http://www.larouchepub.com/other/2014/4150oil_trigger_crash.html
“It’s going to restructure its junk debt. Stockholders will end up holding the bag.”
Well, no they won’t actually — as there will be no bag to hold.