Is the Carbon Bubble Popping?

March 23, 2020

I don’t think I have to explain the carbon bubble to any readers here.

There is more carbon in the ground than we can burn.
At some point the world wakes up to climate change, and we stop burning it.
Or, something else happens that shines a light on the inherent contradiction.

Institute for Energy Economics and Financial Analysis:

Nearly $72 billion worth of U.S. oil and gas speculative-grade debt is distressed, an amount that has doubled since the year began, and is now at an all-time high as oil prices have collapsed, signaling a coming wave of defaults by oil and gas borrowers, S&P Global Ratings said March 19.

The distress ratio – the proportion of speculative-grade bonds paying 1,000 basis points, or 10%, above U.S. Treasury bills, compared to the total number of speculative issues – soared to more than 94% for the oil and gas sector this year after Russia and OPEC failed to reign in crude oil production at the same time the COVID-19 virus emerged, cutting into worldwide demand, Ratings said.

The distress ratio indicates the level of risk the market has priced into bonds. A rising distress ratio reflects an increased need for capital and often precedes increased defaults when accompanied by a severe and sustained market disruption, the rating agency explained. The U.S. oil and gas distress ratio is higher now than its previous peaks during the 2016 oil price crash and the Great Recession of 2008, the credit rating agency noted.

S&P also noted that nearly 40% of the U.S. oil and gas companies with less than investment grade credit ratings were on CreditWatch with negative implications or a negative outlook, more than twice its normal average of 19%. It expects defaults to rise when these oil and gas firms find no way to refinance that debt in today’s market, skittish with worry about the coronavirus.

“As financing conditions quickly become much less accommodative due to risk aversion from investors uncertain about the global impact of COVID-19, we may continue to see an increase in distressed debt instruments, followed by an increase in defaults,” Ratings said.

New York Times:

The energy sector has buckled in recent weeks as the global demand for oil suddenly shriveled and oil prices plunged, setting off a price war between Saudi Arabia and Russia. Oil prices are now one-third their most recent high, trading as low as $24 a barrel, and could fall further.

The crisis has been a body blow to the American oil and gas industry. Already heavily indebted, many companies are now struggling to make interest payments on the debt they carry and are finding it challenging to raise new financing, which has gotten more expensive as traditional buyers of debt have vanished and risks to the oil industry have grown. Companies are increasingly turning to restructuring advisers to work through their finances, and the weaker businesses could end up filing for bankruptcy.

Collectively, the energy companies in the S&P 500 stock index are down roughly 60 percent this year. Prices of bonds issued by U.S. energy companies — both the safer investment-grade kind and riskier junk bonds — have plummeted, while their yields have skyrocketed.

Even once-unassailable energy giants appear fragile. On Monday, S&P Global Ratings cut the oil behemoth Exxon Mobil’s credit rating, citing the impact of lower oil prices on cash flows, and some analysts are questioning whether it will be able to keep paying its current dividend. A week after Occidental Petroleum slashed its dividend, Moody’s Investors Service downgraded its rating of the company. Occidental is stretched by its acquisition of Anadarko last year, which required it to take on $40 billion in debt, and is now expected to make severe payroll cuts.

“The shale players were already stretched to their limits, and the virus has just broken every thread they were holding on by,” said Ed Hirs, an energy economics lecturer at the University of Houston.

The American shale revolution began around 2008 as oil prices flirted with $150 a barrel and when the U.S. faced chronic shortages of energy and dependence on Saudi Arabia and unstable producers like Venezuela and Nigeria. In the decade that followed, investors — and the Wall Street bankers who catered to them — were more than happy to provide financing for upstarts like Oklahoma-based Chesapeake Energy and Devon Energy.

Interest rates were low, and investors embraced the riskier debt that energy companies typically issued with the promise of higher returns. In the last 18 years, energy companies were among the largest issuers of junk bonds on Wall Street, according to analysis from JPMorgan Chase. In 10 of the last 11 years, energy companies were the single largest junk bond borrowers.

That borrowing binge meant that by 2014, almost all investors in junk bonds were heavily exposed to the fate of these companies. Since 2016, when oil prices began to drop, 208 North American producers have filed for bankruptcy involving $121.7 billion in aggregate debt, according to the Haynes and Boone’s Oil Patch Bankruptcy Monitor report released in late January. That means many investors in those bonds lost their principal. But debt offered by the companies that did survive the bust still accounts for more than 10 percent of the junk bond market.

“The main technology innovation there was financial innovation,” said Roman Rjanikov, a portfolio manager at DDJ Capital Management in Waltham, Mass.. “Somehow they were able to convince investors that never generating cash was cool.”

The problem with that model, he said, is that “when you lose access to that capital, things break down.”

Oil companies were already under pressure from lower oil and natural gas prices because of a warm winter even before the coronavirus outbreak and the price war between Saudi Arabia and Russia. Also, margins for refining and chemical production have been shrinking. And with analysts at Citi projecting that the global Brent oil benchmark price will go as low as $17 a barrel, things could get much worse.

In recent days, oil companies have cut their capital spending sharply. In Texas, the epicenter of the shale drilling boom, companies have axed at least $8 billion in the last few days from their 2020 capital budgets, pulling drilling rigs and canceling hydraulic fracturing crews. The job losses that follow will likely be significant, worsening what’s expected to be a deep recession in the United States.

At the same time, major bills are coming due. North American oil exploration and production companies have $86 billion in debt that will mature between 2020 and 2024, and pipeline companies have an additional $123 billion in debt coming due over the same period, according to Moody’s.

Reuters:

Chesapeake Energy Corp, the oil and gas exploration and production company that helped spearhead the U.S. shale revolution, has tapped debt restructuring advisers amid a rout in energy prices, people familiar with the matter said on Monday.

The Oklahoma City-based company, which was co-founded by late wildcatter Aubrey McClendon, was struggling with its debt pile of roughly $9 billion even before an oil price war between Saudi Arabia and Russia and the fallout from the coronavirus pandemic contributed to driving its shares down more than 50% in the last three weeks. 

Chesapeake has enlisted restructuring lawyers at Kirkland & Ellis LLP and investment bankers at Rothschild & Co who specialize in reworking debt, the four sources said. The company is studying its options and no debt restructuring move is imminent, the sources added, asking not to be identified because the deliberations are confidential. 

Chesapeake, Kirkland and Rothschild had no immediate comment. 

The advisers Chesapeake has enlisted have counseled on significant restructurings of large energy companies, including utility Energy Future Holdings Corp, the record $45 billion leveraged buyout that collapsed in 2014. Since 2018, Rothschild has partnered with Intrepid Financial Partners, a firm co-founded by former senior Barclays Plc executive Hugh “Skip” McGee, when advising oil and gas firms. Intrepid did not immediately respond to a request for comment.

Chesapeake shares are down 75% so far this year and were off more than 30% on Monday, giving it a market capitalization of just under $400 million. 

The company has said it is pursuing a reverse stock split to avoid being delisted from the New York Stock Exchange.

9 Responses to “Is the Carbon Bubble Popping?”

  1. indy222 Says:

    Big Oil won’t let that asset go to waste – Saudi Arabia can produce oil profitably even at Brent prices of around $20-23. Something’s better than nothing.

    So I don’t expect to see the Keeling Curve do more than a bit of a gentling from what is happening right now. If the CMIP6 models are right and ECS is actually +5.0C and not +3.0C, it means that indirect emissions will continue to grow and dominate as temperatures continue to rise. See MacDougall’s work in 2013 and 2016 and later studies.

    • rhymeswithgoalie Says:

      A few gleams of light:
      – Saudi Arabia was disappointed in the public offering of part of Aramco ($1.8T instead of $2T) and its share price has gone from $36.80 on 12/12/2019 to $28.55 on 3/23.
      – Fewer banks will be willing to lend to frackers again after so many have or will soon have gone belly up.
      – Air quality improvements from pandemic shutdowns (in China, in Italy’s hard-hit northern industrial area, in LA’s Long Beach port) have captured the notice of local residents.

      (Hey, I’m trying.)

  2. rhymeswithgoalie Says:

    I don’t think I have to explain the carbon bubble to any readers here.

    Know anyone who can update the Carbon Bubble Wikipedia page?

    https://en.wikipedia.org/wiki/Carbon_bubble

  3. jimbills Says:

    Here’s the coral bubble:

    Great Barrier Reef hit by third major bleaching event in five years
    https://www.nbcnews.com/science/environment/great-barrier-reef-hit-third-major-bleaching-event-five-years-n1166676

    “We no longer need an El Niño to trigger a bleaching event — we just need a hot summer,” he said. “And the summers are getting hotter and hotter because of global warming. That is astounding in itself.”

  4. doldrom Says:

    Is it a war between Saudi & Russia?

    Both have profitable oil at really low prices, but Saudi needs the money to keep its government and state going, they have little else. Russia can survive a long time at these prices, their exchange rate will adapt and they are largely self-sufficient.

    Russia has said nothing about a war with Saudi, only that there is too much production. Possibly they’re both trying to close down marginal producers such as American shale to put supply and demand in balance otherwise than by dancing around output cuts that impact the large suppliers disproportionately.

  5. greenman3610 Says:

    My understanding is Saudiis wanted OPEC + Russia to curb production to keep prices UP.
    Russia balked, and Saudi’s said OK, fuck y’all then.
    And of course they hope to crush US frackers as well.

  6. Kiwiiano Says:

    Even EVs need roads but what will we use to build and maintain roads without asphalt or concrete?

    • dumboldguy Says:

      We will use unobtainium, of course. And we will use electric dump trucks, “steam” shovels and “steamrollers” during construction. And eat “pie in the sky” for lunch.

    • rhymeswithgoalie Says:

      There are some green sources of natural asphalt/bitumen (i.e., that don’t need chemical processing), asphalts made from recycled motor oil, and asphalt-like materials made from agricultural waste.


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