A regular reader of mine has questioned my recent analysis: While being positive on oil up until the break below $82, I've now become one of the most negative in the space as the price nears $60. He wondered aloud to me whether I've lost perspective. Have I? Hardly.
One of the incredible attributes of this oil market is its ability to breed selling as it goes lower, precisely because it puts more and more of U.S. and Canadian production at risk. How much at risk? Most of my pessimism on oil as it nears $60 a barrel is contained in the answer to that question and what I see as a major smoke job that's being done by many of the smaller and mid-cap oil companies and the analysts that follow them. I say "There Will Be Blood" -- and their distress is not yet being correctly measured.
Let's take two interesting company updates this week. ConocoPhillips (COP) updated with a capital expenditure slashing for 2015 of almost 40%, yet it is claiming that production will increase 7% next year. Similarly, Oasis Petroleum (OAS), with production far more reliant on short-term capex than Conoco, cut its spending budget by half, yet still says it will increase production by 10%.
Who's zooming who? Production increases with cratered budgets? These claims and others inside the distressed oil sector just don't jibe -- capex and production growth is only one of them. You can see the self-deception in several moves by the executives of these companies, including Continental Resources (CRO) CEO Harold Hamm's mistimed retirement of his short hedges, and major share repurchases from Transocean (RIG) and others.
The hope of these reinvestments are twofold: Either the oil price -- which IS, in fact, unsustainably low -- rallies back to a better break-even level for many of these players before the balance sheets become irretrievable, OR, the price of oil drives the well-financed majors to swarm around cheapened assets and start buying.
But the real Russian roulette being played is in the debt positions of these small-caps and mid-caps. Looking at the bond-to-cash flow positions provides a truer and grimmer outlook. Below is a glance at some of the worst of them, courtesy of my friend Jim Cramer's Mad Money research staff:
Truly, though, we're looking at a very partial list of the walking dead here, for whom the often bandied about "break-even" price for crude oil has no meaning: The burden of extreme debt service is far more onerous to survival -- in some cases as much as $15 a barrel.
It gets worse. The game now for many of these oil companies is merely to survive, and capex reductions alone won't solve the problem. They'll also need to find some refinancing of debt or some other borrowed capital just to keep the drilling going and the doors open. The trouble is, I've heard from several sources that revolver credit lines are being retracted by many of the smaller banks on Force Majeure clauses, and being renegotiated based upon $40 oil prices. In other words, the circling of the vultures has already begun.
Let me be clear: The death rattles I hear are distinct only in these marginal, badly capitalized and overleveraged players. I believe that other exploration & production companies are being provided with a generational opportunity and will not only survive, but come out the other end of this downturn stronger.
So, am I being overly negative in the ones I view as being at terminal risk? No, I don't think so. I think the bloodletting has only begun.